Arnold Kling  

Mussolini and World Equity Markets

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It's not a good idea to try to interpret stock market moves as if they were rational. It's also not a good idea to refer to the U.S. Treasury Secretary as "Mussolini." I'll consolidate both of these ideas in this post.

Under the new financial order of Il Duce and his overseas counterparts, shareholders have no rights. The new order works like this:

1. If you want to have a viable corporation, particularly in the financial sector, you need a government guarantee.

2. If you want a government guarantee, you have to accept government restrictions.

3. The government restrictions can be changed at any time. There are no rules.

Do you want to be a shareholder in that environment? Today, banks are allowed to pay dividends, but lots of people think that's not fair, given that taxpayer money is at risk. In any case, shareholders and managers can no longer determine dividend policy without at the very least wondering what Il Duce will think.

If Mussolini says "lend," then that is what banks have to do. If he says "Don't lend," then they'd better not.

When I was at Freddie Mac, we were keenly aware of "political risk." As long as we had our government guarantee, we could compete with depository institutions. See the duelling guarantee. This summer, though, investors started pricing Freddie Mac's debt as if it were not necessarily guaranteed. Ironically, this forced government to take over Freddie Mac (and Fannie Mae). Live by the guarantee, die by the guarantee.

Now, a huge proportion of the U.S. stock market faces political risk. When everyone depends on a government guarantee, and when the rules for keeping the guarantee could change at any time, shares of stock have questionable value.


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COMMENTS (14 to date)
Mrs. Davis writes:

It's El Dude, not Il Duce.

Sam Wilson writes:

I think you are hitting on what is the central problem with this new approach: one of the key problems was that Fannie and Freddie were able to borrow at cheaper rates than they should have because of the implied government guarantee. Now with real taxpayer dollars on the hook this is not an implied but a very real government guarantee.

How is this in anyway a departure from the approach that was taken before that some claim caused so many problems?

I think the concern with dividends is that we are putting government money into these institutions only to watch it go out the door in the form of dividend payments.

Personally I think the approach should be to require that banks use their dividend payments to first pay back the government investment and then pay dividends. An alternative would be to require that 80% (or some larger percentage) going towards first paying off the government debt.

Healthy institutions will still be able to attract private capital because they will be more likely to start paying dividends again sooner. It also gives them an incentive to pay back the tax payer first.

The risk to this approach is that institutions who pay off the debt more quickly will be seen as safer and this may pull capital away from struggling institutions that could use it, further compounding the problem.

scott clark writes:

I'm confused. Why is it not a good idea to refer to the SecTreas as Mussolini?

Your post suggests why its not a good idea to have a SecTreas that has the powers of a Mussolini, why you shouldn't have to call the SecTreas a Mussolini. But if the SecTreas is Mussolini and acts like Mussolini, why shouldn't you call it like you see it? Do you think you are being taken less seriously since you put that out there? I know some commentors at Marginal Revolution were shocked that that came out of your typing fingers. The one thing I questioned was that you mentioned rumors that the next Pres. would keep Paulson, but no link or no attribution to where you might have heard that, which sounds to me like totally out there, wild-ss conjecture, which is uncharacteristic for you.

Jesse writes:

When everyone depends on a government guarantee, and when the rules for keeping the guarantee could change at any time, shares of stock have questionable value.

Apologies if this sounds trite and obvious, but my objection to this Mussolini language and notion of "political risk" is that it seems to simply ignore the fact that the markets are down 40% in the last year, across the globe, and that several big-time financial institutions (AIG, Lehman Brothers, Washington Mutual) have been completely wiped out, TED spreads are through the roof, etc.

So... hyperventilating about Mussolini and the New World Order just makes you seems weird. There's also this implication that a guy who made nearly a billion dollars at Goldman Sachs and whose term as Treasury Secretary will end in two months is an evil villain mainly concerned with accumulating political power at the expense of capitalists, which also seems weird.

The free-wheeling capitalists running our financial system are so scared right now that they think that government "guarantees" may be the one thing that could save them. On the other hand, you seem to think that Paulson is some ambitious heavy-handed dictator who is messing up the beauty of our well-functioning financial markets because he is an ideologue who only cares about the reach of the federal government.

Weird weird weird.

Cliff writes:

The interesting weirdness in all of this is that the individuals whose business was the very heart of capitalism were so eager to throw capitalism overboard.

I think some part of the explanation comes from an essential aspect of capitalism that is invisible, namely that it is the system that emerges when individual rights, including property rights, are effectively guaranteed.

But it's as universal and permanent as greed that many people want others to pay for their own mistakes, and that need easily trumps rule of law, the sanctity of contracts, and rights. Especially when rights and capitalism are not connected in the minds of the actors.

One question I would like to see addressed is this: what made those big swinging dick capitalists experience themselves as so helpless?

By the way, Jesse, the truth is often, if not usually, weird. Arnold has nailed many aspects of this circus.

Jesse writes:

It's true that I don't really know what's going on, but my presumption about Paulson is that he's not really in it for the federal government power... you know, the same way I assume that the people writing this blog are writing what they truly believe, not just whatever works to extend their influence.

To the extent that Paulson is an ideologue, I doubt that he believes in centralized control of the financial system (at least, I doubt he believed this say, two weeks ago). So while he may very well be making massive mistakes right now, the talk about Mussolini just seems ridiculous.

Sam Wilson writes:

Well... whichever way you see Paulson leaning ideologically, he did manage to bring a lot of Goldman Sachs people into Treasury and he did then manage to get Treasury to not support Lehman Brothers but then did manage to back up AIG largely because of their critical role in the CDS market... a market in which Goldman Sachs was a major player and whose failure would probably have wiped out Goldman.

Perhaps it's not so much an ideological thing as a conflicts of interest thing. Look at who is in power at Treasury and then look at who is left standing.

Makes you wonder a bit about moral hazard.

Bill Stepp writes:

When I worked as a stockbreaker, the best analyst in our firm advised me never to get my clients into a brokerage stock. Why?, I asked. Because they're poorly managed, he answered. (Shortly after our conversation, he wrote a report booming Continental Bank, then near the end of its epic 4-year workout, at $4. It was acquired 3+ years later by Bank of America for $35.)
With a decade plus of hindsight, and armed with the knowledge of the ABCT (sorry, Bryan, but I'm sticking with it despite your valiant attempt to discredit it), it seems there's a more compelling reason to avoid these shares: the gargantuan leverage they pile on during periods of loose monetary policy (even before the capital/leverage regs were loosened in 2004) leads to an inevitable "payback" the market extracts from the hides of their shareholders.
Here's a data point for thought: according to a recent Fortune article (the issue with Hank Greenberg on the cover), there were a grand total of five (count 'em) U.S. mutual funds that posted postive returns the last year. They all avoided bank (and other financial) stocks. Meanwhile,
the worst performing funds loaded up on them. Enough said.

Today, banks are allowed to pay dividends,

Not if they signed Treasury's term sheet: "For as long as any Senior Preferred is outstanding, no dividends may be declared or paid on ...common shares." Page 3, TARP Capital Purchase Program, Senior Preferred Stock and Warrants, Summary of Senior Preferred Terms.

I think they mean that as long as the Senior Preferred is unpaid, no dividends are permitted, but that's not what it says.

Arnold Kriegbaum writes:

Thanks for a useful summation of the current problem that everyone is trying to put into words.

ws1835 writes:

Just a general comment on the situation.....

From my non-economist point of view (engineer by trade), the primary cause of the current problem is a perfectly natrual housing bubble. The wrinkle this time, was the extent to which the bubble ran and the creative ways in which the bubble affected equity was distributed through the financial market.

And from my point of view, the magnitude of the situation is mostly due to government imposed distortions of the market. A combination of loose monetary policy from the Fed, perverse pressure from Congress to loan to unworthy applicants, and the presence of Fannie/Freddie to package/guarantee the whole scheme.

But the 'solution' so far has been big piles of money, gross government intervention, and absolutely no action to remove the original causes. Congress has not rescinded mark to market rules, the community reinvestment act, broken up Fannie/Freddie, or any number of other actions that would actually change the dynamic. All I see so far is a stop-gap patch rather than a fix.

So what game is afoot? It appears that we are just limping the current system through rather than fixing anything. At the same time, government influence has expanded astoundingly. I would not personally go as far as to compare Paulson with Mussolini, but there are some spooky similarities between what is happening right now in Washington DC and what has happened in the past when socialist political elements took advantage of economic crises in other countries.
Nothing weird to me about citing the similarities.

In response to Jesse, capitalists know money. What you are missing is that big corporate capitalists don't have to play the game the way us 'rank and file' have to. Big business can make a ton of money in a socialist world by playing the politicians. It is referred to as 'corporatism'. Subsidies, bail-outs, advantaged loans, protectionism, etc all put money in the pockets of big business. Don't fool yourself into thinking that corporate capitalists will naturally oppose socialist government policy. For reference, take a quick look at the corporatism that evolved in WWII Germany or currently operates in France.

Just a thought......

John Fast writes:

Sam Wilson wrote:

Perhaps it's not so much an ideological thing as a conflicts of interest thing. Look at who is in power at Treasury and then look at who is left standing.
IMO *everything* bad in government and politics is either an ideological thing or a conflicts-of-interest thing. I'm not sure which is worse!

Milton Friedman (G-d rest his soul!) always said that the biggest enemies of the free market are intellectuals and businessmen. The former are against the market for ideological reasons while businessmen want special privileges (subisides, quotas, tariffs) to benefit themselves, and against their competition, or against consumers.

Howard Veit writes:

I posted basically the same concerns and observations a couple of days ago, albeit less eloquently than you. My concerns are the precedent this "takeover" sets. I'm keeping in mind that our unbiased media joined the horde demanding to be saved so there was nobody to articulately object with another "cure" that was equally effective and less intrusive. I'm mindful of the destruction of the Republican Party after Hoover refused to intervene in 1930 so that this time all politicians saw their positions threatened if "nothing" was done. We also had a Fed Chairman that specialized in "The Great Depression" and knew exactly what had to be done to ward one off, in fact he might not know anything other than 1929 disaster and saw a Great Depression behind every day the S&P went down. We had a castrated Republican Party that had long ago abandoned their so-called principals, had already paid a stiff price at the voting booth, and was about to be wiped out like the 1932 Republicans.

I think everyone everywhere was in a panic saying "something" should be done and that "something" is exactly what we got. Moving right along, when Congress decides "something" must be done about gasoline prices will they seize Exxon as that near moron Maxine Waters threatened a few weeks ago? If "something" must be done to "save" the American car business will they just bar imports, and if that fails shut down Toyota? And what about the Chicago Cubs? I mean, talk about needing Government help, the Cubs are the classic case.

In other words has the barn door already been left open so the biggest crooks in our society can stroll inside and take whatever they want?

Greg writes:

Thanks for the post. I think you nailed it on the head. I also appreciated most if not all comments to this post.

Like ws1835, I am not an economist (marketing MBA), but there certainly appears that a game is afoot. Although it could be called "corporatism", it's a well known strategy that socialists pick and choose the winners and losers - just what has happened in recent weeks.

Unlike Jesse, I don't think your comments are either "weird" or "ridiculous". If anything, your reference to Mussolini seems "spot on". Although Paulson made bank at Goldman Sachs, didn't Keynes make his money in the capital markets all the time he was a member of the Fabian Society and forwarded the socialist agenda? (See Keynes at Harvard by the Veritas Foundation.)

Paulson's work over the last few weeks seems more like "calculated planning" rather than "massive mistakes". Who could believe the audacity of Section 8 of Paulson’s original plan which stated: "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency"? ("Henry Paulson". Wikipedia. 19 Oct 2008).

"Facism, socialism, and communism are just like peas in a pod."

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