Why the push to failure?

<sup>Cross posted on

The Economic Populist –

A Community Site for Economics Freaks and Geeks</sup>

Failure in war can be a bad thing.  Failure in business can be a personal loss, and in some instances a detriment to the economy.  With the recent calamity hitting the two largest mortgage lenders, not to mention other large American business concerns, it seems to a select few that failure is indeed a viable and good option.

A gamble with very high stakes is being openly promoted by adherents to a free-market orthodoxy.  These individuals, gaming on anger and the perceived loss of utility of these given enterprises, are pushing the public onto this wager.

It is a game of economic Risk, where they believe the prize is their perceived fruits of their ideology.  The economy, weighed down onto it the full weight of bad decisions, is in need of help.  Intervention and regulation would make rational medication to this sickness.  First and foremost with the ailing giants of the home loan industry.  But these free-market libertarians believe such action would not pose as the cure.  A clarion call has gone out by this group.  In particular, the resistance to bailing out the two mortgage giants, Fannie Mae and Freddie Mac.  Actually, bailing out any large American company, or in many cases consumers.

Let the homeowners eat cake!

Now I’m not saying that the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Mortgage Corporation (“Freddie Mac”) aren’t deserving of scorn.  To be sure, not only should their books be audited and their activities curtailed, but the upper managers need to be removed.  But these free-market fanatics simply want to throw out the baby with the bathwater (or at least attempt to sell it a parachute first!).

Why does it seem to me that all Washington ever seems to talk about these days is bailouts? Bailout Freddie Mac Bailout Fannie Mae

Bailout Wall Street. Bailout homeowners. Is it possible in America today that no one is allowed to fail?

You know, Phil Gramm was right. We are a nation of whiners. No one wants to believe that failure is an option anymore. Whatever happened to personal responsibility? Or learning from your mistakes? Or going through transformative difficulties that just might change your life and your behavior? But it seems like failure is off the board nowadays and that it’s government’s job to rescue everybody.

Whatever happened to the philosophy of Friedrich Hayek, the great free-market economist and Nobel Prize winner, who said the great thing about capitalism is the freedom to succeed beyond your wildest dreams, but that there is also the freedom to fail?

– short excerpt from “Is Failure No Longer An Option?”, Larry Kudlow

What you have read above is just a small example of the tune being sung by those on the conservative and libertarian right.  In the past, I have talked about Larry Kudlow, but I actually thought he could see the bigger picture.  Now he has advocated that the two giants be broken up, which may not be a bad idea.  Where I find fault with his ideas, is that he and his kind want to see them fail.  How could they not see the damage that could happen on an aggregate scale?

Simply to break up Freddie and Fannie and the securitization of the remaining debt porfolio would not solve anything.  It is sort of like the running argument about nuclear weapons and an incoming asteroid; if a nuke is launched instead of one giant problem would we be faced with a multitude of smaller catastrophic impacts?  The same here, without real and proper regulation, what happens if we see a chain reaction of failures of the newer 12 “mini-fannies and baby freddies”?  And making the remaining $5 trillion notional mortgage debt into packaged securities simply transfers the risk onto an already weakened financial system is asking for problems.  We now know there is no uniform value for this debt, and pricing these new mortgage-backed securities would be difficult at best in the current housing environment.

Most economists are proclaiming that we are heading into a recession.  Overall housing prices will depreciate in such an environment.  Purchasers of this debt will want some sort of guarantee, and thus we could be back to having the government make some sort of promise.  Assuming that these purchasers aren’t foreigners banking on commodity-backed sources like petrodollars, then these buyers themselves will need access to credit.  The Federal Reserve, assuming they drink this kool-aid of “risk transfer”, will have to extend the borrowing window to companies like Goldman Sachs and others, this will batter the US dollar as an excess of liquidity is introduced.

Lastly, institutional investors themselves, assuming they hold onto their fiduciary responsibilities, will attempt to offset.  If one believes that the credit derivatives market is large now, wait until this goes through! If the government attempts to clamp down on the over the counter market like swaps, then the action will simply be moved overseas.  This is why you haven’t seen much regulation introduced in petroleum trading, as it is very easy to transfer such activity beyond American jurisdictions.

It’s more than just a simple bailout, it’s about societal stability.

Perhaps my perspective is tainted from the fact that I believe in what I call “managed capitalism.”  I’ve never thought that laissez-fair capitalism to be appropriate in this day and age, what Milton Friedman preached as his idea of “freedom,” simply cannot be applied to our society.  This may sound like an anathema to many (and no doubt I’ll get the hate mail), but we have many dependencies ranging from the disabled to infrastructure needs to veterans.  The only way to utilize a system in which people like Larry Kudlow and Ron Paul advocate would be to cut loose these dependencies.  

You see the current debate over Fannie Mae or Freddie Mac or even General Motors is a much larger philosophical one as it an economic one.  Joseph Schumpeter (and others like Frederich Nietzsche) touted a concept known as “creative destruction.”  Basically, one form of goods or services is done away with one that is more improved.  The horse and carriage industry was wiped out by the automobile one.  This was sound and practical in the early era of industrial economics, though it did cost workers their jobs.  But as we progressed into a more advanced stage the costs get higher and higher, in many cases beyond the money issue.  Stability and order (note, I’m not talking in the same sense that one hears from fascist ramblings) for a middle class to sustain their families and in the end Democracy, must be made paramount.  

GM and beyond

There are many, including myself, who are upset with General Motors and the possibility of a buy out.  The company knew that the SUV party would not last forever.  And not just General Motors, but Ford and Chrysler, both for decades have not had their act together.  If, as management often claimed, they were doing the right thing, then why has companies like Toyota eaten their lunch? It’s almost justifiable to oppose any assistance to these companies.

Saying this, one needs to a bigger picture.  There is a smart progressive way and the stupid conservative way in doing this.  The latter could be seen in Japan for over a decade in the form of “zombie companies.” Legal entities that by all accounting standards should have declared bankruptcy and be liquidated but by some action by a banking group or government were kept alive.  Mimicking this is not in our best interest.

So why save GM or Ford?  Why not let “market forces” do their voodoo and allow these companies disappear? After all, as many in the bubble would say, a “better” one will arise from the ashes; probably by some young entrepreneur or a private equity group.  To which I say fat chance! If starting up an auto group and successfully competing against any giant were easy, then Tucker in the late 40s would be around, and newer companies like Zenn and others would have mopped the floor with the Big Three.

The fact remains, given the inherent costs, starting up an auto companies is significantly cost prohibitive.  And to build one in short order to replace the jobs and economic loss from the vaporization of the Big Three, is almost borderline fantasy.  I say borderline, because there is only one sure way to make that a reality, and it is something conservatives and the current Republican Party would never do.  That is subsidization of these start ups either monetarily or other means.

I highly recommend everyone pick up Prof. Ha-Joon Chang’s “Bad Samaritans,” it goes into detail how the Asian Tigers built up their industries.  I’ll give you a hint, it wasn’t free and fair trade!  These countries knew it was in their national best interest to have a strong manufacturing base, and the government did just about everything it could to promote domestic industries for home markets and export.  The US government, despite claims to such, have abandoned such an agenda decades ago.  

The loss of industry means the loss of knowledge.  Engineering skills soon go untaught because students don’t feel their is a future in such knowledge.  And it isn’t just the high end high tech stuff either, we are losing such time honored skilled craftsmen like glass blowers and such.  Short of the development of a whole new industry, jobs in blue-collar (and increasingly white-collar) work is becoming a zero-sum game. Wage arbitrage is probably the best example of this.

A loss of an industrial pillar weakens the nation as a whole, making us more dependent on a foreign source for a good. It’s really a national security issue, as we have established a fragile web, symbolized in Just-In-Time this or that.  We have transferred onto ourselves risk in return for a supposed discount to the price future goods (and in the case of the investor class) and return on equity.  Unfortunately, these folks haven’t taken in all the variables!



Should every wager be backed by the taxpayer?

Ultimately, we all end up paying for any buyout the state initiates.  The question becomes then, what are the limits of our generosity?  The probability of a given sector of the financial industry imploding and granting assistance has risen tremendously.  One need only look at specific cases like Long-Term Capital Management (LTCM) which saw itself self-destruct in 2000.  The government feared that a run on equities as the hedge fund try to bail itself out.  Soon intervention was had, and we warded off a potential stock market crash.  

There have been several other similar cases since then.  Each time, either the state or a group of institutional investors came in.  But none of these incidents can mirror the possible calamity that would befell one of the large hedge funds or blue-chip company or government-backed entity.  Be it the size of the enterprise or their portfolio, what we have now has grown so exponentially, that failure would be a fatal systematic shock.  But we return to the question at hand, should we aid and bail a business concern in crisis, particularly one whose nature is that of speculation?

Until we set about reform in the market system, particularly in the spot and derivatives field, we are call to heed such a bail out.  I should note that this is not entirely an American problem.  There have been similar situations all over the world.  It is within our grasp to set limits to speculation.  Repealing many of the deregulation legislation here and abroad must be promoted.  For example, raise the margin requirements and lower the position limits on many futures contracts.  You don’t need to outlaw speculation, it does serve its purposes.  But it needs to be monitored and regulated.  Not moving towards such an agenda is simply granting permission for the ramped abuse of these financial products.  

Lastly, as a society who looks forward to retirement, we need to decouple the financial welfare of that outlook with that of speculation.  Capital gains on 401Ks and other such investment retirement vehicles is also often met with capital losses.  Retirees demand a safe and dependable income. Gaming the market as the sole means of achieving a semblance of comfortable living is an open invitation to disaster.

A religion by any other name

The free-marketeers have been playing semantics for a long time, tying the words “freedom” with “free market.” Profit is deemed to be ecumenical whose only moral or legal objections should only be found by the taste of the market. Freedom’s political connotations are merged with an economic perspective.  Allow anyone to set up any enterprise. Should such activities born harm to a community, then said community will not assert monetary benefit to such an establishment.  Eventually, it is believed by these folks, that the “bad company” will be replaced by a “good company.”  Thus salvation comes in the knowledge that the system will heal itself in time, like paper cut on a finger.  Government is there only to set a basic set of rules and essentially become a night watchman state. Intervention, they believe, will only halt the repair or maintain the pain.  They talk of civil liberties, but ultimately this is come to be an auxiliary for the liberty to pursue profit. And in this religion, salvation don’t come cheap!

Uncertainty has often been placated by possibility with these folks, often the latter being a new privately-produced answer.  Hence their bravado in speaking out in the allowance of failure in an entity.  If A goes, need not worry because a person (or market) will come up with B.  But it is this very prognostication that they fall back on, that is also in this author’s opinion, one of their greatest weakness.  For what happens if some private entity or person doesn’t come up with B?