Michael Perelman: How to Create a Crisis

This is from Michael Perelman's blog a US economist. Unfortunately the paper often of little or no real value creates real debt via the government bailout that involves borrowing that the US citizen must eventually repay. In fact the taxpayer is paying to rescue the people who brought about the crisis in the first place. Many of those same people are in charge of this bailout.


Matter and Antimatter: How to Create a Crisis: A Thanksgiving Rant
Posted November 27, 2008Filed under: economics
Skilled physicists do not know how to take nothing and turn it into matter and antimatter, but finance behaves as if it had the capacity to do something similar. Imagine a simple market economy about to create a bubble. I want to tell the story of this bubble, only to put the current, crazy stimulus package into perspective.
Somebody says to me they have a piece of paper worth $1 million. I can buy for half the price. I borrow the money to cover most of the cost. People are willing to lend me the money confident in the belief that my paper will increase in value. Other people are engaging in the same transaction, spreading confidence that these papers are now increasing in value, say to $600,000.
The seller of the paper now has a half-million dollars, having given up nothing but blank piece of paper. I have a capital gain of hundred thousand dollars. My lenders have a credit with a half-million dollars. We are all better off, even though nothing has been produced.
Feeling secure in the increasing value of our paper, I along with the other “investors” now start consuming more, spreading prosperity for the economy. Virtually everybody is enjoying the benefit of the bubble. Within a short period of time, people throughout the economy making decisions based on the increasing appearance of health and the economy.
At some point, people realize that this paper is nothing more than a blank sheet of writing paper. The bubble may have stimulated some investment that is capable of producing real economic benefits, but mostly it has induced people to consume and commit themselves to pay back debts.
Remember, this prosperity was built out of nothing. In the end, matter and antimatter collided. The lenders have lost their money. The speculators and consumers are in debt. Most lack the wherewithal to repay their debts. But in the case of the current bubble, the economy does not have the productive capacity to put everything together. The loans came from abroad and so did many consumer goods.
At the same time, the government loans are ultimately dependent on another set of loans, also largely from abroad. How will these loans ever be repaid? Will new loans keep coming as the bubble engulfs the rest of the world?
Should the government come in and give me a half-million dollars so that I can repay my loan? Should I be rewarded for my stupidity and naïveté? Will that policy really make the economy healthy? Or will it policy just facilitate the creation of even greater bubbles?
Obviously, the most sensible decision would be to put the money into making a more healthy economy, one less susceptible to speculation — something impossible under capitalism, but that is another question. Eventually, somebody will have to pay the piper. The policy today seems to be an effort to shield the very people who created the crisis, placing the burden on the most innocent.
The graphic picture of the stimulus package that I posted yesterday suggests a government response just as foolish as the speculations that set off the bubble in the first place.
Happy Thanksgiving.

James Galbraith on the Financial Crisis

Galbraith is a left leaning economist at U of Texas Austin. He plays down any Democratic involvement in the crisis through Freddie Mack and Fannie Mae. He suggests that the government needs to intervene even more to get the economy going through infrastructure development. However, this does not address any debt problem.

http://www.harpers.org/archive/2008/09/hbc-90003600Six Questions for James Galbraith on the Financial Crisis and the BailoutBy Ken SilversteinJames K. Galbraith teaches economics at the Lyndon B. Johnson School of Public Affairs, the University of Texas at Austin, where he directs the University of Texas Inequality Project, an informal research group. Galbraith has authored several books, among them The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too. I recently asked him six questions about the unfolding financial crisis and the resulting reaction from Washington, D.C. This interview was edited for length and clarity.[Image]1. It’s hard to get a handle on the scope of the crisis? Just how big of a problem are we looking at?If you’re on Wall Street you’re sitting in the middle of a disaster, and one of your own making. Wall Street took these toxic subprime loans from places like Countrywide and sold them to pension funds and sovereign wealth funds, keeping what they couldn’t sell in their own portfolios. Now those loans can’t be marketed. They’re not all utterly worthless but no one knows the value of the stuff and so the markets have seized up. That’s a big problem for the Wall Street firms involved in the crisis, some of which are basically bankrupt; the problem for the rest of the economy is that the driving motor of economic expansion–the extension of credit from the private sector to homeowners through mortgage and lines of credit–has dried up, and housing values are going to continue to fall. The Treasury Department buying up subprime loans won’t fix that. It will prevent the absolute elimination of the companies, but it won’t change the fact that the value of your home has fallen and now you owe more on it than it’s worth. And nothing has being done to address that yet; it will be the next administration’s problem.2. What are the political origins of the crisis?There’s a Republican talking point going around that lays the blame on Fannie Mae and Freddie Mac, and hence the Democrats. There were big problems in the way Fannie and Freddie were run, but they were very small players in the subprime market. And Fannie and Freddy had standards. They checked on borrowers’ credit and they weren’t giving out subprime, low-doc, or no-doc inflated appraisal loans. The overwhelming responsibility for the crisis is the failure to regulate financial markets, and that is a failure of the Bush Administration. They sent very clear signals that they were in favor of deregulating the industry. All of three weeks ago, Mitt Romney said at the Republican convention that we should take a weed whacker to regulation. Two weeks ago, Governor Palin told Charles Gibson of ABC that her philosophy of economic policy was to “get government out of our hair.” A few months ago, ancient history by now, McCain said, “I’m a deregulator.” That’s been a consistent Republican theme.3. Is a major bailout required?One can argue about the consequences of allowing a collapse to happen. I can see the reasons against it, the most important being that everyone’s pension fund and 401(k) is tied up in these assets and if there’s a disorderly collapse, everyone wakes up a lot poorer.What Congress can do is make sure the companies have to turn over any information that the Treasury wants from the companies, including the computer code4. What should a bailout bill look like?Oversight and accountability have to be included. The Treasury sent up a non-starter of a proposition, which was plainly unconstitutional in saying that its own actions could not be reviewed by any agency or court. Congress needs to put in tough disclosure requirements. Any firm that sells its assets to the Treasury Department should be required to make full disclosure–if you get in bed with the government, the public has the right to know who you are and how you value your assets. And it’s vital to know the price the Treasury Department is paying for the assets, that the firms get some cash but not so much that they don’t have any losses. There also needs to be a “No Cheney” clause; Congress needs to have all the documents and information it asks for, and there needs to be a conflict-of-interest clause. Henry Paulson has a huge fortune and probably owns a lot of Goldman Sachs stock in blind trust. He should be recused from the administration of this program. We need people who can act as tough counterparts to industry and advocates for the public interest, and not people who are likely to profit from the program or who have close ties with people who will.4. The Democrats say they are not going to give the administration a blank check, but there’s a lot of pressure to do something. What sort of conditions should be attached to a bailout?The Democrats have a strong hand. The voters weren’t born yesterday; they understand that it’s a Republican administration in power. Some of the problems are difficult to solve. Executive compensation is clearly a legitimate concern; it’s incredible that Lehman Brothers set aside a $2.5 billion bonus pool as it was going into bankruptcy. On the other hand, what do you do about it? If you tell these people they have to work for $400,000 a year–that’s a lot of money to you and me, but a lot of them are going to say, “See you on the ski slopes, pal.” But what Congress can do is make sure the companies have to turn over any information that the Treasury wants from the companies, including the computer code. If the government is going to buy assets of dubious value, it needs to know that the companies aren’t selling it the worst of the worst, just as you have the right to inspect a used car before buying it.5. How long is it going to take to fix the situation?There’s nothing that can put this right in six months. No bailout can achieve that, but the difference between three years and ten years is important. The Treasury is going to end up with a large portfolio of properties. The government needs to set up the equivalent of draft boards in communities to make a review of properties and see how to keep people in their homes: offering them sustainable payments or converting mortgages into rental contracts, or simply demolishing homes that have been wrecked or that have fallen into irreparable disrepair.6. And what about the bigger financial crisis?We’re not going to have another private credit boom, where economic growth is financed through mortgages and lines of credit, any time soon. So what is going to keep the economy going? The government is, if it knows what it’s doing. Public infrastructure has been neglected to the point that there are places in the country that look like Eastern Europe. With environmental protection, the energy problem, climate change–there’s a lot that can be done to generate a public and private response. It’s a 30-year project but we need to start down that road. There’s no new Internet boom out there waiting to happen, so the government is going to have to take a leadership role. If the Democrats believe they can recreate the Clinton credit boom, good luck. Conditions have changed._____________________