Freitag, November 06, 2009

Further Data Points For The Trend XIV...

Two links today, neither of them very pleasant, both from the WSJ.

First of all, this.

Gasparino is correct: the unindicted co-conspirator in the financial meltdown was, is and continues to be the Federal government, dedicated to throwing money at problems, especially now that money, due to effectively no interest rates, is basically "free".

Here are some key points:

The conventional wisdom as perpetuated in the media is that these bailout mechanisms are unique, designed to ameliorate a once-in-a-lifetime financial "perfect storm." They are unique, but only in size. ...

The first mortgage market meltdown of the mid-1980s, spurred by the Fed's supply of easy money, was among the most painful market upheavals in the history of the bond market. The pioneers of the mortgage bond market, Lew Ranieri of Salomon Brothers and Larry Fink of First Boston (the same Larry Fink now considered a sage CEO at money management powerhouse BlackRock), lost what were then unheard-of sums of money. (Mr. Fink concedes to losses of over $100 million.)

"What happened then was a dry run of what was to come," Mr. Fink recently told me, as he looked back on the market he created, which would eventually lie at the heart of the most recent financial crisis. Wall Street took excessive risk in mortgage bonds amid the easy money supplied by the Fed—and lost. When the crisis began, the Fed under then Chairman Alan Greenspan slashed interest rates—as it would do after Orange County, Calif., declared bankruptcy in 1994 because of bad bets on complex bonds; and again in 1998 when the hedge fund Long-Term Capital Management (LTCM) blew up; and of course in the bond-market crisis of 2007 and 2008. The lower rates each time lessened the pain of the risk-taking gone awry, and opened the door for increased risk down the line.

The risk thus adverted didn't go away: at best, such systemic risks go into remission when money is thrown at them, but it increases the moral risk that we have raised, basically, a generation of bankers whose concept of risk is heavily distorted by the inviolable fact that the upside risks were all theirs but the downside risks were all carried by the taxpayers.

This is a fundamental moral hazard that has led us here: it's also one that was at best carefully hidden and at worst deliberately obfuscated.

Easy money wasn't the only way government induced the bubble. The mortgage-bond market was the mechanism by which policy makers transformed home ownership into something that must be earned into something close to a civil right. The Community Reinvestment Act and projects by the Department of Housing and Urban Development, beginning in the Clinton years, couldn't have been accomplished without the mortgage bond—which allowed banks to offload the increasingly risky mortgages to Wall Street, which in turn securitized them into triple-A rated bonds thanks to compliant ratings agencies.

The perversity of these efforts wasn't merely that bonds packed with subprime loans received such high ratings. It was also that by inducing homeownership, the government was itself making homeownership less affordable. Because families without the real economic means to repay traditional 30-year mortgages were getting them, housing prices grew to artificially high levels.

In other words: the markets were distorted, deliberately so, by those whose political gains were manifold and whose political risks were ... completely ignored, as they represented a black swan event. Well, black swan events are a bit like asteroid strikes: they don't happen very often, but when they do, everything changes.

This is where the real sin of Fannie Mae and Freddie Mac comes into play. Both were created by Congress to make housing affordable to the middle class. But when they began guaranteeing subprime loans, they actually began pricing out the working class from the market until the banking business responded with ways to make repayment of mortgages allegedly easier through adjustable rates loans that start off with low payments. But these loans, fully sanctioned by the government, were a ticking time bomb, as we're all now so painfully aware.

A similar bomb exploded in 1998, when LTCM blew up. The policy response to the LTCM debacle is instructive; more than anything else it solidified Wall Street's belief that there were little if any real risks to risk-taking. With $5 billion under management, LTCM was deemed too big to fail because, with nearly every major firm copying its money losing trades, much of Wall Street might have failed with it.

Fundamentally, this is what happens when you mess around with markets, try to game them. what do I mean? Gaming a market means trying to have the market results behave the way you want them to: if you want more poor people to own homes, then force the banks to give them loans. When these loans don't perform - poor people can't afford houses, no matter what your politics may be - then it's the fault of the policies, not the market.

I've said here again and again that markets don't care. Markets are implacable, ruthless and cold: markets are the mechanisms by which supply and demand are resolved, and if you try to game the markets - which is what past Administrations (especially Democratic ones) did and continue to try to do - you always make things worse. Always.

But just like a bad engineer who has taken a good plan and "improved" it by paring away safety margins, fiddling with the programs that distort markets doesn't solve the problem: after making it painfully obvious that they do not understand anything about markets, the Administration decides that a new plan to force the markets to behave will work. They have not realized the fundamentals, that the Gods of the Copybook Headings are taking their toll now and that there is no way to game markets, to force markets to change their behavior to meet political goals.

You see, that is the real problem.

With so much easy money, with the government always ready to ease their pain, Wall Street developed new and even more innovative ways to make money through risk-taking. The old mortgage bonds created by Messrs. Fink and Ranieri as simple securitized pools had morphed into the so-called collateralized debt obligations (CDOs), complex structures that allowed Wall Street banks as well as quasi-governmental agencies Fannie Mae and Freddie Mac to securitize ever riskier mortgages.


All of which brings me back to Mr. Fortsmann's comment about policy makers helping turn a cold into cancer. What if the Fed hadn't eased Wall Street's pain in the late 1980s, and again after the 1994 bond-market collapse? What if policy makers in 1998 had allowed the markets to feel the consequences of risk—allowing LTCM to fail, and letting Lehman Brothers and possibly Merrill Lynch die as well?

There would have been pain—lots of it—for Wall Street and even for Main Street, but a lot less than what we're experiencing today. Wall Street would have learned a valuable lesson: There are consequences to risk.

Not for politicians there isn't: politicians take the stance that there are no consequences to the risks that have been taken, taken over the last several decades, starting with the Great Society programs and heading downhill ever since. I won't believe that there are risks for politicians until Nancy Pelosi and Barney Frank are defeated at re-election.

You see, that is part of the problem. Lack of political accountability. Right now it is clear that government attempts to game the markets have gone so completely, totally bat-shit-crazy wrong that anyone with half a functioning brain should realize that you can't game markets.

Pretending that it works because the effects didn't show up immediately is part of the reason why we're in the situation we're in, compounded by dishonest economists who should never be working in their profession because they obviously don't understand that you can't game markets.

The second link is not unrelated: it's about how recent administrations - Obama and Clinton - have set us up.

And are lying to our faces about it.

Fundamentally, any tax that isn't indexed to inflation will increase over time as inflation increases: that is simple math.

But math that the Congress critters who write such laws apparently think we're too stupid to understand. By continuing to do so, by deliberating failing to index to inflation, politicians can create the perfect deal: achieve a goal while lying about it at the same time.

The goal: increase revenues to fund pet projects (and I include health care reform as a pet project),

The lie? That this will only be paid for by the rich, or that you'll only be affected if you make over any given amount. All the common folk will get benefits without having to pay for them.

The reality is that inflation will drive people into those higher brackets, and that success will be punished. Make more money and we'll take more of it away, accelerating the rate at which we take money from you (that's called a progressive tax system and that's exactly how it works).

When it comes to tax revenues, setting a tax without indexing it for inflation is downright dishonest at worst and simply sneaky at best: more and more will move into that tax bracket without being told from day one that this was the goal, the whole point of the scheme: how to separate you from your money without actually having to tell you that was the plan, simply by "forgetting" to index a tax to keep track with inflation.

This gets worse when you realize that one of the easiest and safest ways of getting out of deficits and debt is to inflate your way out. It's also the worst and riskiest way of doing it. Contradictory? Nope: it's the easiest and safest for the politicians, but the worst possible way and the riskiest for everyone else involved.

See the pattern there? Risk avoidance at the cost of transferring the risk from one group to another?

I'm not the kind of guy who easily takes up a populist hue and cry about rotten, corrupt politicians. I know a few, and they've been pretty much upstanding folks who are willing to take responsibility for what they do.

But then again, they're not Democrats.

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