Arnold Kling  

Random Financial Commentary

Seasteading and Singularity... Incentives Matter: Prison Rape...

Razib points to a paper that supports my hormone-based approach to regulating financial risk.

Rocco Huang and Lev Ratnovski say that Canadian banks did relatively well because they relied more on deposits. To me, this says that securitization is not as wonderful as the American financial community makes it out to be. Pointer from the indispensable one.

The Financial Times reports,

The US government, by contrast, is sitting on a paper profit of almost $11bn on its 34 per cent shareholding in Citigroup...

The government said it had earned an annualised return of 23 per cent from its $10bn investment in Goldman Sachs under Tarp. In June, Goldman returned the $10bn and later paid another $1.1bn to buy back warrants attached to Tarp aid. Morgan Stanley, American Express and other banks have done the same, leaving taxpayers with substantial profits.

Pointer from Tyler Cowen, who says we should admit that the bailouts were a good idea.

Certainly, profits on the transactions would meet my test of whether the measures were addressing a liquidity crisis or just bailing out insolvent institutions. If AIG, Freddie, Fannie, and FHA all emerge solvent from this, then I absolutely have to shift my position in favor of the "insider" view that this was mostly a liquidity panic. I would probably be willing to make that concession even if AIG, Freddie, Fannie, and FHA together have negative net worth, as long as the deficit is under $100 billion for the four of them.

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The author at Belligerati in a related article titled writes:
    The FT, Tyler Cowen, and Megan Mcardle are saying that we may make a small amount of profit or lose very little on on the banking bailouts. Arnold Kling says that this would make him revisit his beliefs about whether... [Tracked on August 25, 2009 10:34 AM]
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John Hall writes:

Could you make this last sentence more clear. Even if AIG, Fannie, Freddie, and FHA lose $100bn you would still say it was a liquidity problem if they make money on their other bank bailouts?

In my view, if they let AIG fail, all the other banks probably would have been insolvent. Hence, this was a bailout of institutions that would have gone insolvent.

fundamentalist writes:

Tyler is guilty of looking at just the short run. Mises once wrote that the common businessman is much better at guarding the short run interests than is the economist. The economist's job is to force the businessman to occasionally look up and acknowledge the long run.

We got into the recent mess by following a long series of pragmatic policies that appeared to work in the short run. No one looked out for the long run, but it always comes.

Pierpaolo Sommacal writes:

I don't understand. By what yardstick do we measure success, by the government revenue, or by the productivity of the economy?

The good argument against bailouts was never that they couldn't be profitable. When the US government guaranteed the lifesavings loans to Chrysler in 1979 the granted options turned out to be profitable. Was it a liquidity panic?

I would reason this way: either the bailout help clearing bad investments or it does not. If it does, in what way is it different from bankruptcy or liquidation? Crowd psychology?

If it does not, even if it is profitable, it does not increase efficiency.

Where's my error?

Phil writes:

An annualized return of 23% ... isn't that pretty crappy? The stock market has returned much more than that since March. If stocks are up 30% in six months, that's a 69% annualized return.

I know of investments that offer a 23% return with (what seems to me to be) much less risk than Goldman Sachs was at the time.

Shayne Cook writes:

Perhaps I'm overly pessimistic, but I consider it highly premature for the "averted a catastrophe" crowd (Bernanke, to "declare victory" at this point.

At best, what are available are interim results from the actions of the Fed and Treasury, and I'm not convinced that referring to a select few of those interim results is a valid standard of either victory or "catastrophe aversion". Doing so brings to mind the image of George Bush standing on the deck of an aircraft carrier back in 2003 declaring "victory in Iraq".

It may as well be premature to concur - or even establish the conditions of concurrence - with one side or the other in the liquidity vs. solvency debate.

Bill Woolsey writes:

One day, the prices of single family homes will pass their previous peaks. Ignoring the need to pay interest, all of the loans will eventually be sound.

And so, the appropriate interest rate is the key issue. Will the interest rates that government backed financial institutions have to pay be low enough so that the collateral will eventually regain its lost value and then grow enough to cover all of those interest costs during the intervening period?

Isn't changes in the value of the stock of financial institutions based upon expecations of how well that will work out? (I think it is obvious that creating money and lending it at low interest rates to certain financial institutions, depreciating the value of money and raising the nominal value of the collateral can bring them out of any hole.)

In the real economy, the "insolvency" involves too many houses being build over the last decade, and too few other goods. The value of the other goods was more than the houses. However, because houses are so durable, too few houses will be built over the next decade, so that demand catches back up to the existing stock. That frees up resources to produce other goods now and for the next few years. The timing of the production of the houses was wrong--well, that is the theory. And those who invested in the homes, and those who lent to them, should be taking losses to reflect their entrepreneurial errors and the misallocation of resources--over time. But because it is a matter of time--when the houses were produced, it proper interest rate is the key consideration.

It seems to me that using government guarantees to funnel money into financial institutions at low interest rates is a red flag that waste is being rewarded.

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