20 February 2009

Love it or hate it, bank nationalization is inevitable

All the gnashing of teeth of a possible bank nationalization misses the real point- it is inevitable, regardless of whether anyone wants to do it or not. The major US banks (like Citigroup and Bank of America) are technically insolvent, and unless some miracle occurs that turns their non-performing loans back into gold then these institutions are doomed.

Sure, it’s theoretically possible that the government would just stand by and allow a Citigroup to keel over, and wind up being liquidated in a bankruptcy, but policy makers would never allow such a disorderly crash. Show me just one congressman (other than Ron Paul) who would be willing to allow all the depositors in Wells Fargo to lose their savings?

Instead, the government will be forced to step in and supervise an orderly dissolution, much as what occurs with FDIC conservatorships. I find it strange to hear so many critics about nationalization when nary a complaint is uttered when the FDIC seizes lenders and proceeds to find buyers, and disposal of assets. That’s all we’re talking about here. The only difference is that the big banks are of an order of scale larger than anything the FDIC has hitherto dealt with, potentially saddling the government with enormous liabilities as they pick up the pieces.

Of course, I personally favour the hands-off approach, allowing depositors to be completely wiped out (this would definitely stop any moral hazard in its tracks, when everyone realizes they have to take personal responsibility for putting their money in safe institutions), but I know it will never happen.

Sooner or later the federal government will be forced, kicking and screaming, to seize the nation’s big banks. I am sure this is not what Messr Geithner would like to do, but he won’t have any choice. Unfortunately, judging by the collapse in bank share prices it looks like this will happen sooner than later. As we’ve already seen in many other bank failures over the last year, depositors start to withdraw their money when their bank’s stocks are in the sub $5 range, which creates a dynamic that drives the institution into the ground.

We’re all Keynsians now

I just watched a Charlie Rose interview with several well known economists about the new US administration’s bailout efforts and was struck by the absolute unanimity in agreement that such policy efforts are a good thing. In fact, all of Charlie’s guests insisted that even larger bailouts are in order to avoid having a “lost decade” such as Japan saw. I suppose I really shouldn’t be all that surprised considering how this is exactly why people become economists- in order to be technocrats who craft policy. Still, the fact that no one questions the logic of interventions is incredible.

The Frontline documentary on the crash of 2008 also plays right into this general belief that running the economy is all just a matter of good, level-headed, policy making. The documentary infers that the financial crisis could have been stopped in its tracks if only policy makers had used a more comprehensive approach early on, and appeared more confident.

Of course, I can understand the natural desire we all have for hope. We also don’t like to think that events are out of control. It is far more comforting to believe that the only reason bad things happen is because some person’s incompetence, or mistake, than to consider that there was nothing anyone could have done.

But now is not a time to ask such questions. Instead, everyone ought to just be greatfull that our governments care, and are trying to do something to fix the economy. After all, it’s the thought that counts.

18 February 2009

Canadian economy bites the dust

So much for the theory that Canada's economy was going to go right on sailing the high seas when the US tanked. Yet another nail in the coffin of the de-coupling theory. If anything, the bubble in Canadian real-estate has been even more spectacularly insane than that of our neighbours to the south.

As I've said for a long time, the economic fall-out from the global credit bubble is going to be far worse in most other nations than in the US.

Economic problems in the U.S. have always been keenly felt in Canada. But
until last fall, Canada looked positioned to weather the storm better than its
southern neighbor. Low corporate and consumer debt levels, no subprime-mortgage
crisis, and surpluses in the federal budget and trade balance placed it on
sounder footing. Economists expected slower growth but no recession.

Last fall, as economic problems multiplied in the U.S. and elsewhere in
Canada, Alberta's oil-and-gas industry briefly remained a bright spot. Then the
bottom dropped out of the oil market, as the global downturn suppressed demand.
Tightening credit compounded the problem. Almost overnight, oil companies
started postponing investment plans.

Rick George, the chief executive of Calgary-based Suncor, which in January
postponed site-expansion work worth C$14 billion, estimates that 35,000
temporary workers employed around the Fort McMurray oil sands will be reduced to
fewer than 10,000 by the end of the year. Given how frenetic the boom was, he
says, "we needed a correction. What we didn't need is a collapse in the banking
system and the world economy to get it."


12 February 2009

financial bail-outs just add to deflationary pressures

Ironically, the latest attempts to jump start the US credit markets are actually just adding to over-all deflationary pressures by increasing debt. Debt must be repaid, and leads to major economic contractions in downturns as we have seen in 2007 and 2008. All these efforts to create even more debt policy makers are just driving us towards an even deeper decline of asset valuations and an increase in the purchasing power of the dollar.

I guess the new US administration hasn’t heard about the Hippocratic oath.

In the new consumer-lending program, the Treasury provides $100 billion of
capital and the Fed uses that as a cushion against which it could make up to $1
trillion of three-year loans aimed at jump-starting markets and spurring
consumer lending.

08 February 2009

Economic Crises Stimulate Community and Interdependence

When times are good, we are quite happy to share in the rewards of prosperity, willingly accepting more in bonuses and pay than they may have actually deserved. We even spend money we don't yet have, based on optimistic valuations of our homes and other assets, not to mention projected future income. We don't need to rely on friends or family or unions because we feel self-assured that we can get another job easily and pay for whatever services we might require without the inconvenience of reciprocating. We somehow feel we can afford to neglect nurturing our relationships to family and neighbours.

As times get worse, we have less money and feel more insecure about the future. New jobs are scarce as many employers layoff workers while others hire new workers at the lower wages of an increasingly competitive labor market. We look for ways of supporting each other by sharing time and resources and helping our neighbours. Suddenly, we can't count on paying for all of our needs with cash and must rely on our relationships with friends, neighbours and relatives. A natural, healthy community spirit becomes essential.

While we draw nearer to our own select communities, we become less tollerant of others that we deem to be outside of our community and who we perceive to be encroaching on our prosperity. We become more nationalistic. We spend more time with our neighbours, but vote for protective tariffs to discourage trade with "others." We criticise immigrants, especially illegals, because they are willing to work harder for less compensation than we are. Instead of recognizing that jobs and wealth are unlimited in the world (if not, then all new entrants to the world since Adam and Eve would be unemployed) and that all humans have equal value, we fall into fallacious economic assumptions about a zero sum game (jobs and wealth are arbitrarily limited and must thus be distributed among us) and actively cultivate categorizations of "us" versus "them."

Many of us are suddenly unwilling to accept the possibility of failure and considerable loss, even though we were quite willing to accept the unreasonable prosperity of recent times. We rejoiced when our investments miraculously rose by 50% over a brief period, but find it somehow intollerable that they should fall by the same amount. We want to savour the benefits of free markets without accepting the associated risks.

Political propositions of security, where the government promises that nobody will be allowed to suffer too much or fall too low become very attractive. During crises, security trumps potential future prosperity and people are willing to trade the latter for the former. Alas, freedom comes with responsibility. Like the farmer, if we want to reap the rewards of his bumper crops we must also accept our lot in times of drought. Voluntary associations can ease the risks, but ultimately, we cannot have freedom without responsibility.

Institutional Instincts Deepen Crises

As we move deeper into the current economic crisis, it is becoming increasingly clear how instinctive responses to the crisis can be counterproductive, both at the national and institutional levels.

At the national level, officials move towards protectionism when their intent is to expand trade and economic activity. Protectionism, including "buy American" policies, reduces trade and production by inducing trading partners to restrict our goods from entering their markets.

Governments also try to encourage easy credit and aggressive consumer spending when those are precisely the reasons for the economic crisis in the first place. The cure for excessive borrowing and spending is saving, but while savings help long term economic growth, they discourage near term consumption.

Individuals and families naturally save more and spend less when they feel that their assets are declining in value or that their sources of income are at risk of decline. The governments are actively discouraging this natural instinct because it means a decline in consumption in the near term which causes declines in perceived economic strength and hence government popularity. Without savings, however, there is less capital available for creating new companies and providing productivity-enhancing capital to workers in the medium to long term.

Because individuals cannot be easily discouraged from saving when they sense economic troubles, governments resort to taking the money individuals invest in government bonds and spending it for them. Instead of these savings going into the most productive industries and investments, it is turned into government make-work projects like bailing out poorly run companies and inefficiently building unneeded infrastructure projects. In short, these savings are diverted from achieving their natural role of encouraging long-term economic growth into short-term make-work projects.

The same short-sighted mistakes are made at the institutional level. Rather than simply reducing spending and production, organizations often choose to provide a lower quality product, thus diminishing their reputation and hurting their long-term growth. This is especially true of service organizations like private schools and colleges where it can seem more attractive to accept lower quality applicants who can pay full tuition than it is to offer scholarships or simply lower tuition so as to enable more high quality students to be able to attend. This latter requires some belt tightening, but it ensures that the quality of the product is maintained or even raised. Above all, customers demand value for their investment during crises. Schools and similar service-based organizations need to both reduce their prices and raise their quality.

Whereas the individual instincts to save money and look for better value during crises are very healthy, institutions and governments with short term economic objectives tend to make decisions which seem to be compelling in the short term, but which ultimately diminish the health of the country or organization. The role of crises is to improve value and savings, and resistance these ends will only protract and deepen the economic suffering.