The real problem is not that firms took innovated and took risks, it's that no one seems to have been held responsible. All the "failed" banks, investment houses, and businesses should have been allowed to fail. They should have been liquidated to pay their creditors and their assets allowed to be bought out by firms that acted responsibly. Instead, the irresponsible were/are bailed out, and their managers are allowed to continue operating.
The lesson is: Take risks. You will pocket profits right away and bailouts will cover any downside.
That's a nice, plausible position to take, and very popular too. Well done for saying what the people want to hear.
Now, taking a more realistic view, when Lehman collapsed, the stock market went into free-fall. The links between all those financial corporations are so thick that if one of them is allowed to fail, it threatens to bring the whole thing down.
If the governments of the world had not, with uncommon speed and purpose, stepped in and "bailed out the banks", money would, at this point, be more useful as fuel in a stove than as a bartering device.
The idea of letting failing companies fail is valid as long as they don't bring down the whole system. If you let companies grow to such a level of interconnectedness and size that they have the potential to destroy the whole world economy in a matter of months, and then you suddenly realise that they are that big and they are failing, the correct course of action is not to let them fail, but to sort out the short-term problem (i.e. bail them out) and then work on the long-term problem (cut down their size and complexity so they can once again fail without destroying everything).
Until a proper regulatory framework is in place to prevent financial companies from getting so intertwined and large that they can bring down the whole house of cards (for that's what every economy is, a house of cards based upon the common trust that it's all going to work out ok), it is in fact very reasonable to suggest that a good medium-term step is to get those companies to "stop innovating", given that their incentives are such that they will inevitably bring the whole thing down if allowed.
This is a more realistic view than the "let them fail" silliness.
Paul Krugman of the NY Times wrote extensively both during the crisis and since about the correct way to handle this situation:
1. Put the failing bank into "receivership". I.e., a "receiver" (temporary managerment) appointed by the government takes over the company and tries to salvage it.
2. Fire the original management team. I.e., the ones that got them into this mess with their excessive risktaking. Good. They should suffer the consequences of their bad management decisions. That's capitalism.
3. Take on whatever additional debt or equity financing is necessary to turn the company around - without paying any regard to the positions or desires of the current stockholders. The current stockholders' positions' will likely get diluted to nearly worthless. Good. They should suffer the consequences of their bad investing decisions. That's capitalism.
4. After the company is turned around, take it out from under government receivership, hire a new management, and (if needed/appropriate) launch it public again via an IPO.
There's a long, established history for handling failed banks this way (read up on the S&L Crisis), and it's the proper way to keep an institution alive and out of bankruptcy, without rewarding the management and stockholders who brought it to bankruptcy in the first place.
Krugman often pointed out, though, that the Obama administration was too scared to go this route - perhaps because they were worried about the absurd accusations of "socialism" that the Psychotic Right would undoubtably have started screaming about.
So instead, they chose to reward the management and shareholders that caused the problem, by using government money to help prop up the value in their worthless company. Moral hazard indeed! Privatize all the profits, but give all the losses to the public. And socialism is the evil here?!?!?!?
Your comment loses value through the unmitigated bias showing through. You had me until 'Psychotic Right' as though viewing the problems through a left/right filter is the explanation.
The fact is we'll never know what would have happened if large companies were allowed to fail, because they weren't. It might have been worse, it might have been better. For sure it would have been worse in the short term, but these issues should be measured over the medium to long term. One of the messages that has been sent out with the current handling is that there is a Fed put on any high risk adventure, and that's not good.
Personally I think that there is something to be said for the 'bandaid' approach. Not sticking something over the top to cover the problems, but a short sharp shock of pulling it off and let the problems be.
The problem with the bailouts is that they cover over the fact that some companies were allowed to fail. Lehman, for one. And the world didn't stop turning. Sure, this caused liquidity problems and risk premiums to escalate dramatically, to the detriment of employment and the real economy. But it's foolish to pretend that this isn't going to happen anyway. The problem with Krugman and others is that they believe a lack of demand is the problem. They view the problem through this prism, and as such they come up with solutions that match their world view.
Others (including me) say that perhaps the problem is excessive debt. And until that excessive debt is eliminated from the system, productive companies are unable to make use of the resources tied up in the unproductive ones currently taking shelter with public money. You say the institutions should be kept alive, I say that they should be destroyed and the buildings and staff and infrastructure released to new institutions who can find a way to be competitive.
I believe you shouldn't look at the problem in terms of a company or bank failing. That's just the symptom. Once the debt had built up excessively, it was only a matter of time and method for the companies to fail. The problem was watering down of regulation that had stood the test of time for 70 years, and regulators becoming toothless. So far, this hasn't been fixed.
This is a not a left/right blue/red debate. It is a debate as to the level that central governments should take in directing and manipulating markets. Neither 'side' is debating this. Nobody will try and defend central planning and a command economy, because it is comprehensively proven as a failed model, yet we seem to be reversing backwards into this situation on the say-so of a bunch of people who couldn't see the problems headed their way. They don't seem to realise that controlling the fundamentals of money (supply and price) causes wrong investment choices through inappropriate price signalling. And then they try and correct those choices by further fiddling with central control instead of letting the chips fall where they will fall. Because they're going to do this eventually - no amount of bailing out will fix a fundamentally out-of-date business model.
Lehman was indeed allowed to fail, and the crisis that its failure caused was sufficient to ensure that no government would be stupid enough to try that experiment another time. Of course, this is all theorising, but the general thinking in financial circles is that the government had to step in with monster bailouts to restore confidence precisely because Lehman was allowed to fail.
You're ignoring the possibility of taking them over through bankruptcy and covering their potentially system-killing commitments directly. Bailing them out just puts more money in the hands of the people who created the problem in the first place.
exactly. The money quote:
“In most industries, when people are paid too much their firms go bankrupt, and they are no longer paid too much,” he told me. “The exception is when people are paid too much and their firms don’t go broke. That is the finance industry.”
I think a second big factor in this is that people tend to suffer from scope insensitivity, so it feels much nicer to win $5 ten times and then lose $100 once than it feels to lose $5 ten times and win $100 once.
I don't think that's true when you have incentives so that you make some proportion of the $5 each time you win, and don't have to pay any of the $100 when you lose.
I don't agree that the banks should have been allowed to fail in the heat of the crisis. That would have meant that our access to cash would have stopped.
I certainly get the point that, now that things are stable, the governement needs to haul all these failed bank leaders into a room and make them pay back the bonuses earned leading up to the crisis.
I'd like to make an amendment:
Take risks. You will pocket profits right away and bailout will cover any downside as long as you can make enough people think you are too important to fail.
Another way to get bailed out is to make sure that folks who have the power to do a bail out think that keeping you alive will benefit them. You can do that with political support.
I was going to say something similar: Take huge frikkin risks that can sink the world if they fail. You'll make billions and bailouts will cover any downside.
Comments
The real problem is not that firms took innovated and took risks, it's that no one seems to have been held responsible. All the "failed" banks, investment houses, and businesses should have been allowed to fail. They should have been liquidated to pay their creditors and their assets allowed to be bought out by firms that acted responsibly. Instead, the irresponsible were/are bailed out, and their managers are allowed to continue operating.
The lesson is: Take risks. You will pocket profits right away and bailouts will cover any downside.
That's a nice, plausible position to take, and very popular too. Well done for saying what the people want to hear.
Now, taking a more realistic view, when Lehman collapsed, the stock market went into free-fall. The links between all those financial corporations are so thick that if one of them is allowed to fail, it threatens to bring the whole thing down.
If the governments of the world had not, with uncommon speed and purpose, stepped in and "bailed out the banks", money would, at this point, be more useful as fuel in a stove than as a bartering device.
The idea of letting failing companies fail is valid as long as they don't bring down the whole system. If you let companies grow to such a level of interconnectedness and size that they have the potential to destroy the whole world economy in a matter of months, and then you suddenly realise that they are that big and they are failing, the correct course of action is not to let them fail, but to sort out the short-term problem (i.e. bail them out) and then work on the long-term problem (cut down their size and complexity so they can once again fail without destroying everything).
Until a proper regulatory framework is in place to prevent financial companies from getting so intertwined and large that they can bring down the whole house of cards (for that's what every economy is, a house of cards based upon the common trust that it's all going to work out ok), it is in fact very reasonable to suggest that a good medium-term step is to get those companies to "stop innovating", given that their incentives are such that they will inevitably bring the whole thing down if allowed.
This is a more realistic view than the "let them fail" silliness.
+1.
Paul Krugman of the NY Times wrote extensively both during the crisis and since about the correct way to handle this situation:
1. Put the failing bank into "receivership". I.e., a "receiver" (temporary managerment) appointed by the government takes over the company and tries to salvage it.
2. Fire the original management team. I.e., the ones that got them into this mess with their excessive risktaking. Good. They should suffer the consequences of their bad management decisions. That's capitalism.
3. Take on whatever additional debt or equity financing is necessary to turn the company around - without paying any regard to the positions or desires of the current stockholders. The current stockholders' positions' will likely get diluted to nearly worthless. Good. They should suffer the consequences of their bad investing decisions. That's capitalism.
4. After the company is turned around, take it out from under government receivership, hire a new management, and (if needed/appropriate) launch it public again via an IPO.
There's a long, established history for handling failed banks this way (read up on the S&L Crisis), and it's the proper way to keep an institution alive and out of bankruptcy, without rewarding the management and stockholders who brought it to bankruptcy in the first place.
Krugman often pointed out, though, that the Obama administration was too scared to go this route - perhaps because they were worried about the absurd accusations of "socialism" that the Psychotic Right would undoubtably have started screaming about.
So instead, they chose to reward the management and shareholders that caused the problem, by using government money to help prop up the value in their worthless company. Moral hazard indeed! Privatize all the profits, but give all the losses to the public. And socialism is the evil here?!?!?!?
Your comment loses value through the unmitigated bias showing through. You had me until 'Psychotic Right' as though viewing the problems through a left/right filter is the explanation.
The fact is we'll never know what would have happened if large companies were allowed to fail, because they weren't. It might have been worse, it might have been better. For sure it would have been worse in the short term, but these issues should be measured over the medium to long term. One of the messages that has been sent out with the current handling is that there is a Fed put on any high risk adventure, and that's not good.
Personally I think that there is something to be said for the 'bandaid' approach. Not sticking something over the top to cover the problems, but a short sharp shock of pulling it off and let the problems be.
The problem with the bailouts is that they cover over the fact that some companies were allowed to fail. Lehman, for one. And the world didn't stop turning. Sure, this caused liquidity problems and risk premiums to escalate dramatically, to the detriment of employment and the real economy. But it's foolish to pretend that this isn't going to happen anyway. The problem with Krugman and others is that they believe a lack of demand is the problem. They view the problem through this prism, and as such they come up with solutions that match their world view.
Others (including me) say that perhaps the problem is excessive debt. And until that excessive debt is eliminated from the system, productive companies are unable to make use of the resources tied up in the unproductive ones currently taking shelter with public money. You say the institutions should be kept alive, I say that they should be destroyed and the buildings and staff and infrastructure released to new institutions who can find a way to be competitive.
I believe you shouldn't look at the problem in terms of a company or bank failing. That's just the symptom. Once the debt had built up excessively, it was only a matter of time and method for the companies to fail. The problem was watering down of regulation that had stood the test of time for 70 years, and regulators becoming toothless. So far, this hasn't been fixed.
This is a not a left/right blue/red debate. It is a debate as to the level that central governments should take in directing and manipulating markets. Neither 'side' is debating this. Nobody will try and defend central planning and a command economy, because it is comprehensively proven as a failed model, yet we seem to be reversing backwards into this situation on the say-so of a bunch of people who couldn't see the problems headed their way. They don't seem to realise that controlling the fundamentals of money (supply and price) causes wrong investment choices through inappropriate price signalling. And then they try and correct those choices by further fiddling with central control instead of letting the chips fall where they will fall. Because they're going to do this eventually - no amount of bailing out will fix a fundamentally out-of-date business model.
Lehman was indeed allowed to fail, and the crisis that its failure caused was sufficient to ensure that no government would be stupid enough to try that experiment another time. Of course, this is all theorising, but the general thinking in financial circles is that the government had to step in with monster bailouts to restore confidence precisely because Lehman was allowed to fail.
You're ignoring the possibility of taking them over through bankruptcy and covering their potentially system-killing commitments directly. Bailing them out just puts more money in the hands of the people who created the problem in the first place.
exactly. The money quote: “In most industries, when people are paid too much their firms go bankrupt, and they are no longer paid too much,” he told me. “The exception is when people are paid too much and their firms don’t go broke. That is the finance industry.”
I think a second big factor in this is that people tend to suffer from scope insensitivity, so it feels much nicer to win $5 ten times and then lose $100 once than it feels to lose $5 ten times and win $100 once.
I don't think that's true when you have incentives so that you make some proportion of the $5 each time you win, and don't have to pay any of the $100 when you lose.
I don't agree that the banks should have been allowed to fail in the heat of the crisis. That would have meant that our access to cash would have stopped.
I certainly get the point that, now that things are stable, the governement needs to haul all these failed bank leaders into a room and make them pay back the bonuses earned leading up to the crisis.
I'd like to make an amendment: Take risks. You will pocket profits right away and bailout will cover any downside as long as you can make enough people think you are too important to fail.
Another way to get bailed out is to make sure that folks who have the power to do a bail out think that keeping you alive will benefit them. You can do that with political support.
I was going to say something similar: Take huge frikkin risks that can sink the world if they fail. You'll make billions and bailouts will cover any downside.