The Next Round of Bailouts: The States

So with all these bailouts, one of the effects they are having is greatly increasing the moral hazard throughout society. One of the reasons why we are in the mess we are currently in is that a huge moral hazard was created via the implicit guarantee of Fannie Mae and Freddie Mac. Investors correctly felt that the institutions would be bailed out if they got in trouble and this allowed the two firms to borrow money at a below market rate and pump an excessive amount of capital into housing. So apparently not learning from our lessen, we’re now doing exactly that again with banks, auto makers, your uncle who’s delinquent on his credit card and so on.

So the next one on the list is bailing out state governments. Senator Schumer has stated that his state of New York will likely be getting $5 billion in increased transfer payments via the Obama administration's proposed stimulus package. It has also been suggested that California is to be bailed out. One of the beauties of State governments is that unlike the Federal Government, they cannot borrow endlessly. This is mixed with the fact that if they raise taxes to too high of a level residents and businesses will move out. These two forces combined place a check on State budgets and this forces them to be fiscally responsible and relatively efficient. These two mentioned states, along with many others went on spending sprees in the most recent good years without regard for long-term planning. California’s budget grew almost 30 percent in the past 3 years. But now that the Federal government will step in and bail them out, the moral hazard of over spending has increased greatly for years to come. The California legislature is being resistant to spending cuts currently. Perhaps it’s because they know if they wait long enough, they will be bailed out? Now every state legislature knows it does not need to keep spending in line or create rainy day funds for use in recessions, because every time we get into one, they are going to be bailed out.

This creates the obvious problem of promoting irresponsible behavior on the part of the States, which ends up being paid for by the Federal taxpayer. Beyond that however, is the continued erosion of the notion of the States being sovereign bodies. Rather than being independent levels of government, if the budget processes are now created with the assumption of Federal help, the States become more similar to the French Departments, merely administrative districts rather than separate governments. Power therefore only becomes more centralized and less in touch with constituents. Furthermore, how come New York and California are the ones in which the bailouts are being designed? Why not Rhode Island, Virginia or Arizona, which have huge budget problems themselves? Could it possibly be that both these states are heavily Democrat (and therefore the same party as the current controlling government) with influential Congressmen representing both of them, including the Speaker of the House, the Chairman of the Ways and Means Committee, and a woman soon to be Secretary of State? Bailouts just become another mechanism of corruption and party hackery. Just as soon to be former Senator Stevens was allowed to get away with his abhorrent pork projects because his party controlled Congress, so will those who now have favor with the current government.

-EJB


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It certainly seems like, in this new culture of bailouts, there ought to be an increased risk of the moral hazard that EJB mentions. After all, it stands to reason that if the Federal Government is willing to bailout banks for bad business practices - and now, apparently, some States for their failure to adequately plan for their future - other sectors of business (and indeed, other States) would feel comfortable knowing that their fiscal shortcomings will be federally insured. I'm not sure it's just that simple though. Look especially at the recent automobile bailout. Officially, I guess it is a bailout but the bill never got through Congress; Bush had to semi-legally divert funds to GM from the original "stimulus package." I think it's safe to say that a large contingent of the population (and of Congress) is tired of taxpayer bailouts. This shifting of public will may not allow for further bailouts. Furthermore, all it takes to soften the blow of the moral hazard is one major bailout proposal rejection. We may have seen that with the auto bailout. If the Federal Government refuses to bailout a company or State that is asking for money, other entities won't be so quick to assume that they'll be guaranteed any sort of insurance.

Now to the California and New York stuff. Again, I think it's sort of facile to point out that NY and CA are liberal states and thus, wink wink nudge nudge, they're getting bailed out. I'm not saying there isn't some truth to that, but EJB points out later in the post that Rhode Island isn't being bailed out. Is there a more liberal State than Rhode Island? I've lived there. There is not.

Also, I bet we could discover all sorts of plausible rationales for the bailing out of New York and California. My first thought was to note that these are two of the largest States, by population, in the country. In fact, they are first and third in that category. Thus a State business bailout or a capital injection that props up Medicaid in New York helps more people than a similar plan in Arizona. Perhaps Obama, curtailed by a sinking economy, is implementing a fiscal triage.

But maybe you don't buy this strict utilitarian explanation. Fine. I think another relevant factor in the bailing out of California is the fact that the State is literally out of money. As much as I'd like to back EJB's moral/philosophical argument about moral hazards and learning important lessons, it's probably vitally important to first make sure that each State has enough capital to continue its operations. Otherwise we're simply winning the battle to lose the war. Or perhaps we'd be throwing the baby out with the bathwater. All I know is, there must be some folksy idiom that applies here.

As for NY, another possible explanation for bailing it out is that this could be a very good move for the national economy. NY ranks fifth amongst the States in GDP per capita. Thus it seems logical to conclude that more business is done in NY. Complete the syllogism and it points to the fact that bailing out NY is more economically beneficial for the Federal Government than bailing out Alabama.

So anyway, I'm not sure why they're doing this. Perhaps EJB is correct and this is merely a political pork move. I think there's probably some truth to that. But I propose that there are other, more legitimate, reasons for the NY and CA bailouts.

~JSK

The Next Dick Cheney?

So whether you agree with it or not, we are all aware of the office of the Vice Presidency greatly expanding its role under the Bush administration. Cheney was a key player in many of the major policy decisions of the past years and was privy to information and authority in many areas on par with the President. Though it appears that Biden may not have as a powerful role (symbolically, it has already been announced he will not get a daily national security briefing when the President does), we may be seeing a similar advancement happen elsewhere.

Where that may be? The Hillary Clinton State Department. The New York Times reported that a Clinton aide explained that Clinton wishes to expand the role of the State Department regarding the current economic crisis. She is even hiring one of Bill Clinton's old budget directors to by a deputy on economic issues. This is interesting because this is a role in which the State Department has in the past only been indirectly involved. Trade agreements are negotiated by the US Trade Representative and there are a list of other agencies that deal with foreign aide. Foreign activity dealing with the recent economic crisis has largely been dealt with by the Treasury Department and the Federal Reserve.

But more interesting to me is the idea that this may just be an early sign of things to come. It's commonly known and even joked about on Saturday Night Live over how much Hillary wanted the Presidency, and this is not a weak personality (think Cheney). Armed with connections all over Washington from the Clinton presidency, compared to the relative Washington newcomer, Obama,(once again think Cheney) she may be in a place to greatly increase the power of her office. If she can't have the Presidency in name, perhaps she can have it in effect. Time will only tell.

-EJB

Summing Up the Total So Far

So pretty much everyone is aware of the $700 billion “bank bailout” and the pending “auto bailout,” but what most people don’t realize, is that these are only a fraction of the total government expenditures and guarantees that have gone on so far over the past year. Government agencies and the Federal Reserve, which get less media attention and have no legislative hurtles have gone about instituting many other programs on their own.

So I was reading a WSJ article this week that has outlined that the Federal Reserve’s balance sheet has exploded in recent months, ballooning from about $800 billion to about $2.2 trillion since September. For the most part, the Fed has essentially printed $1.4 trillion dollars to purchase or borrow other assets. If this is kept in the system for too long once a recovery begins, we will be seeing inflation like we haven’t seen for years. The Fed says that it will tighten its policy when needed, but given their recent track record, I wouldn’t put much faith in that. And the market seems to agree with me as gold has been inching up recently.

But this whole thing got me thinking and I went about grabbing other info I have accumulated recently and came up with a list of all the various programs created over the past year. I’m probably missing a few small ones, but here is what I came up with.

(If amount allocated is yet to be used in it's entirety, the amount used thus far is in italics.)

Federal Reserve - $4.75 Trillion

Commercial Paper Funding Facility - $1.8 trillion ($312 billion)
Buys short term notes from private firms

Term Action Facility - $900 Billion ($415 billion)
Auctions off loans to banks

Term Securities Lending Facility - $250 billion ($190 billion)
Allows financial firms to borrow treasury bonds in exchange for low quality debt

Money market Investor Funding Facility - $540 billion ($0)
Buys assets from financial companies that support money market funds

Credit Extension to AIG - $123 billion ($87 billion)

Citigroup Bailout - $291 Billion
Guarantee of toxic assets

Discount Window - $92 billion
Banks directly borrowing cash from the Fed

Discount Window II - $50 billion
Extends direct bank lending function to securities firms

Commercial Paper Program II - $62 billion
Loans money to banks to buy commercial paper from mutual funds

Bear Stearns Bailout - $29 billion ($27 billion)
Guaranteed assets in brokered JP Morgan buyout

Overnight Bank Loans - $10 billion

Other Assets - $606 billion
Includes treasury bonds purchased with printed cash in order to help finance the government

FDIC - $1.55 Trillion

Temporary Liquidity Guarantee Program, Secured Debt Guarantee Program, Transaction Account Guarantee Program, increase of deposit insurance limit and other interbank lending guarantees - $1.4 Trillion
Various insurance programs backing debt between different parties

GE Capital Bailout - $139 billion
Debt Guarantee to General Electric's lending arm

Citigroup Bailout - $10 billion
Guarantees Citi’s toxic assets

Treasury Department - $947 Billion

Troubled Asset Relief Program - $700 Billion ($336 billion)
Originally for purchasing distressed assess; now for buying equity positions in companies

Stimulus Package - $168 billion
“Rebate Checks” of earlier this year as well as some other minor tax credits

Bank Tax Credits - $29 billion
To compensate for the government wiping out Fannie and Freddie securities held by banks

Treasury Exchange Stabilization Fund - $50 billion
Designed to manipulate currency markets - now used to insure money market funds

Federal Housing Administration- $300 Billion

Loan guarantees for refinanced mortgages for struggling and delinquent home owners

Nationalization of Freddie Mac and Fannie Mae - $5.2 Trillion

Capital Injection - $200 billion ($25 billion)
Government buys preferred shares and opens up line of credit

Mortgage Debt Guarantee - $5 Trillion
Government acquires the guarantee on all mortgage securities sold by the two GSE’s

Total Earmarked: $12.45 Trillion - Used So Far: $8.74 Trillion
Spent: $4.09 trillion
Loans: $1.49 trillion
Guarantees: $6.78 trillion

Likely to be passes soon:
Auto Bailout: $75 to $125 billion
Stimulus Package: $500 to $850 billion

(Sources: FDIC, US Treasury, FHA, Federal Reserve, Washington Post)

Keep in mind too that these are only the new or expanded programs. This list does not include preexisting “normal” expenditures like increased unemployment compensation or the FDIC deposit insurance. Even without these, the totals are mind boggling. With the likely auto bailout and upcoming stimulus package, various government bodies will have spent, loaned out or insured somewhere around $13 trillion in less than a year! To put this into perspective, the entire output of the US economy in a year is about $14.4 trillion. The amount of $13 trillion is larger than the annual economic output of China, India, Brazil and Indonesia combined, the four largest countries not including the US, which include over 2.9 billion people. This amounts to about 30 percent of all financial wealth of all US households combined. Or it translates into about $43,000 per US resident or about $108,000 per household! So this is your piece of the pie so far.

Now all of this isn’t spent money. The majority is either loans or insurance, so all the money will not be lost. Likely, most of the loans will be paid back and not all the insured assets will go bad (though a lot of them will). Furthermore, much of the spent money went to buying assets that will likely have at least some value to sell back later on.

I guess my point however is to show exactly how large and unprecedented this is, and that is goes far beyond the “bail out” bills. At the macro level, the government has essentially taken control over the entire financial system. In broad areas, capital is no longer largely allocated to areas that investors believe are most profitable and therefore most productive, but rather to what areas government has deemed it to go to. And much of this has been done by agencies and the Fed using extremely loose legal interpretations of their powers. The amount of raw power and authority the Fed, FDIC, and Treasury have been allowed to wield without Congressional approval is unbelievable. Distortions are done directly by the partial nationalization of the financial industry (soon to be done with the auto as well), or it’s done by placing guarantees on various assets, incentivizing more capital to flow into these over other alternatives that government bureaucrats deem less worthy. Event the stock market of recent months reacts little to earnings reports and instead has violent swings based one expectations of various government actions.

We are now in a political economy. The gigantic “stimulus package” soon to be passed is going to be the largest pork barrel project in history as every mayor, governor, and special interest down to a city councilman’s cousin who owns a paving company is lining up to the trough for a piece of the handout. This is the closest thing to a command and control economy that this country has faced since WWII. And all this done under the watch of a President whose critics have attacked him for being a “free market ideologue.” If this is what a champion of free market capitalism brings us, I don’t even want to know what the next administration and Congress is going to do. Maybe buying gold is looking good right now.

-EJB

This Would Be Even Funnier If It Weren't So True

-EJB


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"America needs the money hole!"
"I love the money fires."

Brilliant, yet tragic...though the idea of people arguing over whether the free market can discover the best way to destroy money warms my heart.

~JSK

More on the Fed and the Housing Bubble

I ran into this article today. It's a bit more technical then what I've previously linked to in the past, but if your willing to read through it, its worth it. I had previously posted about how loose monetary policy had been a large contributor to our housing mess. This argues along the same notion. From the article, here are a couple of relevant charts.

Fed Funds Rate














Growth of Subprime Loans















Notice the correlation with subprime growing starting in 2001 and accelerating through 2005, the periods when the Fed held very low interest rates stoking a bubble in housing investment. Whats just as important is realizing that this mess want just subprime, but an explosion of housing lending in general, which is discussed more in t e article. The growth began to slow as the Fed raised rates and then started to fall as the housing bubble popped.

-EJB

More on The Financial Mess

So I posted a while back on how despite all the political rhetoric and anti-business bashing going on, that our current economic woes were not simply due to "greed" but rather in large part due to a set of polices that changed market incentives. I talked relatively in depth about the role that monetary policy had in creating the housing asset bubble.

So, here is an article that I would not have been surprised to have found on the editorial page of the Wall Street Journal, but was completely shocked to find it in the Washington Post. Apparently even their editorial board, not normally a bastion of free market thinking, agrees with this premise and is attributing much of the blame to poor governmental market intervention.

...the problem with the U.S. economy, more than lack of regulation, has been government's failure to control systemic risks that government itself helped to create. We are not witnessing a crisis of the free market but a crisis of distorted markets.

Though I don't agree with its entirety, the article is a good brief overview. I found the comparison to Canada, which I was not familiar with, particularly interesting.

-EJB

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Since the early days of the crash, EJB and I have discussed the matter of blame extensively - via phone, email, text message, pony express and even carrier pigeon. He has done much to convince me that the free market was not entirely to blame and that, in fact, private entities were simply taking advantage of a system which incentivized their risky behavior. Of course, it goes without saying that in events like these, it is impossible to blame any one factor entirely. There were multiple causes, with varying degrees of blameworthiness.

To that end, I point you, the reader, to the blog of one of my favorite people in the world - Richard Posner. I don't always agree with Judge Posner - especially with his attempt to analyze the tort system in purely economic terms - but he has a theory of what happened during the crash that deserves some consideration. The article is essentially Posner's attempt to explain why the warning signs of the crash were ignored or misunderstood. The crux of his argument is this:

Which brings me to the last and most important reason for the neglect of the warning signs, because it suggests the possibility of responding in timely fashion to future risks of financial disaster. That is the absence of a machinery (other than the market itself) for aggregating and analyzing information bearing on large-scale economic risk. Little bits of knowledge about the shakiness of the U.S. and global financial systems were widely dispersed among the staffs of banks and other financial institutions and of regulatory bodies, and among academic economists, financial consultants, accountants, actuaries, rating agencies, and business journalists. But there was no financial counterpart to the CIA to aggregate and analyze the information--to assemble a meaningful mosaic from the scattered pieces. Much of the relevant information was proprietary, and even regulatory agencies lacked access to it. Companies do not like to broadcast bad news, and speculators planning to sell a company's stock short do not announce their intentions, as that would drive the stock price down, prematurely from their standpoint.

Sort of like EJB being surprised to see a free market defense in the Washington Post...I'm utterly shocked to see this argument put forward by the creator of the law and economics movement. But, when one carefully examines the argument, one realizes that Posner is not advocating for government regulation - he is advocating for government oversight. This, I think, is a key difference that has been conflated by the media. Like Posner says, there is no agency that could "aggregate and analyze" scattered pieces of market information. These are important words - aggregating and analyzing information does not include the creation of rules and laws that would constitute regulation. It simply means, there ought to be an agency that gathers information already available to the public, which that agency could then analyze to discover what types of risk or how much risk any given market is prone to. Posner calls this the most important reason for the failure to detect the impending crash and I completely agree. The SEC does not fulfill this important role. A new agency must be created - one which cannot issue regulatory rules, but can only compile and analyze global market information. It should perform a risk assessment function and report its findings to the relevant authorities. Posner, I think you nailed this one.

~JSK

Financial Bailout Act III

So I earlier posted on the financial bailout and among other things talked about how in our panic, the purpose of the $850 billion bill was quickly evolving, and that Congress basically gave the Treasury an open ended check. First it was to buy bad mortgage securities, then it was to buy equity stakes in banks, eventually forcing nine institutions to sell part of themselves to the government. Now, as lobbying forces descend on Washington armed with the precedent of government bailouts, other industries are lining up for their share.

Insurers, automakers and American subsidiaries of foreign banks all want the Treasury Department to cut them a piece of the largest government rescue in U.S. history.

The betting is that many with their hands out will be successful, especially with financial markets in a stomach-churning dive and predictions the economy is about to tumble into a deep recession.

Lobbying efforts are intensifying.

The Financial Services Roundtable wrote Treasury officials on Friday requesting that the initiative to buy $250 billion in bank stock grow to cover insurers, auto companies, securities dealers and U.S. subsidiaries of foreign companies, including banks.

Who's going to be next? Lets just socialize all risk in the economy and make the government part owner in every industry? I've lost some money in the stock market recently. Where's my bailout?

-EJB


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I must preface my response by noting that there is a certain, noticeable, interior inconsistency between the first and second parts of my blabbering. This is because the first part (in which I defend the policy) is premised on the idea that the bailout was intended to remedy the current credit freeze. The second part, which seems contradictory, is only so if one rejects the premise underlying the first part; namely, that the bailout is not going to increase liquidity and stimulate bank loans, but will, instead, simply act to reshape the relationship between industry and government.

I think allowing other industries to accept some of the bailout money is actually a pretty good idea. The open-endedness of the bailout plan allows for a high degree of flexibility in its approach to dealing with the financial crisis. If the 850 billion came conditioned upon its use for one or two narrowly defined purposes, then the Treasury would be unable to alter its plan in the event that lawmakers and economists discover new and better ways to help ease the crunch. I think it's also important to note that the article does not assert that these industries are asking for a larger bailout. Thus, the bailout amount would stay the same; however, different portions of it would go towards various uses which had not been originally discussed.

Now I see that part of EJB's argument is a type of slippery slope idea and it's probably a valid one. Allowing different industries to take a piece of the government handout would, perhaps, set a dangerous precedent for the future - should the economic condition worsen.

However, the credit market is absolutely frozen. I supported the bailout because, originally, it was intended to improve the liquidity of these major banks - thus allowing them to loan and borrow more money. The article EJB links to seems to suggest that allowing these other industries to take a piece of the pie will also help to unfreeze the credit market:
"The institutions that are excluded play a vital role in the U.S. economy by providing liquidity to the market," Bartlett wrote Neel Kashkari, the Treasury Department official running the bailout program.

If that were true, I'd have to fully support the move (especially since I'm crossing my fingers that my law school loans come through for one more year).

Unfortunately, there's this news from the NY Times. It turns out banks aren't actually using the new money to make new loans - they're simply buying out smaller banks. I was going to make a separate post about this, but I figure this is as good a time as any to break the bad news. Under the guise of "improving liquidity in the market by incentivizing new bank loans," the Treasury has essentially begun to fund a new round of bank consolidations.

This is not good. Instead of targeting the crippling credit freeze, the government has decided it would rather try to reshape the banking industry. I'm not bothered by the pro's or con's of this move - I'm bothered by the fact that I don't know the pro's or con's of that move because we never heard any debate on the issue. The government's ulterior motive was never discussed ex ante. We ought to have been fully informed so that Congress could have had a meaningful debate on the subject.

So, linking this back to EJB's initial post. The article he links to seems to claim that letting other industries in on the bailout money would help to improve liquidity and would require no extra tax-payer money. The truth of that proposition, though, must be seriously scrutinized in light of the fact that "improving liquidity" by helping banks to make new loans has seemingly ceased to be a governmental priority. EJB asks, "Where's my bailout?" Until this week, I could have responded that he doesn't get one because bailing him out would not significantly help improve the status of our credit market. But, apparently, no part of the bailout is doing this anyway. Nuts.

~JSK

"War [Crisis] is the Health of the State"

Yesterday, the Treasury announced that it will embark on an historically unprecedented semi-nationalization of a major industry. With the continuing evolution of the “bail out” package, the Treasury will now force nine major financial institutions to sell $250 billion in preferred stock to the government.

I don’t wish to discuss here the economic argument for and against this or whether it will help us in our current situation. Personally, I think there is some merit in this in the short run for stabilizing the economy, but I want to address the broader picture.

What really bothers me is the long term implications of this action with regards to the role of government, the preservation of freedom, and the very system that this country was founded upon. It was famously said by Randolph Bourne, that “War is the health of the state.” I think in general "crisis" is more accurately the health of the state, because in our panic we tolerate the enhancement of unprecedented government power. The problem is, that almost always these extended powers never get removed after the crisis ends. There are a number of areas with this recent action where I have some concerns and questions.


1. What does this mean for property rights? Even though some of these institutions are more then willing to participate in this deal, others are having this forced upon them. By issuing more shares to the government, even if they are being bought, this necessarily dilutes the stake of existing share holders, reducing the percent of the company that they own. In effect, they are having a portion of their property forcibly taken from them. Paulson allegedly told the officers of these nine firms that “they needed to participate in the program for the good of the national economy.” Having this rationale in the wake of the recent Kelo decision, where the Supreme Court ruled that a local government can seize property for the sole purpose of “economic development,” begs the question is there anything fundamentally sovereign about property rights anymore? Do we as individuals only have rights to property in so far as government does not see a better use for it? This completely falls in the face of the principles of no unreasonable search or seizure of the 4th Amendment, where with the exception of eminent domain and punishment for crime, property is protected. Will this set the precedent that government can take your personal property for any reason it sees fit?

2. This only expands the corrupt and disastrous merging of corporate and government power into a Corporatist system. Much of our problem with Fannie Mae and Freddie Mac was its hybrid public/private nature. The government backed private risk taking. These private firms were some of the largest campaign donors to the very people who are charged to oversee them (including our fellow PC alum Chris Dodd, chairman of the Senate Banking and Finance Committee). There were accounting scandals in 2004 that would have been punished by courts in the private sector but largely overlooked because of political influence. Essentially now, the Federal Government has a huge conflict of interest in partially owning a private industry, while at the same time the private industry will be able to wield tremendous power in the halls of government.

3. What happened to personal responsibility? Despite having many incentives to engage in risky lending in recent years, some banks such as Wells Fargo largely avoided this. Now they are being punished for their prudent action. What is the incentive for participants to act responsibly moving forward? What is the disincentive to not act recklessly in the future?

4. This is a major increase in the power of the state and the executive in particular. The “bail out” bill essentially gave a 700 billion dollar blank check to the Treasury Secretary to use as he sees fit. And the purpose of this seems to be changing by the day. First it was to purchase bad mortgage securities via a reverse auction from willing institutions. Then it was extended to include all forms of debt. Then, as the Democrats in Congress wanted, the Treasury COULD buy equity stakes if the firms voluntarily agreed to it. Now the government is forcibly buying equity stakes in these firms. What will it be tomorrow? The forced nationalization of the entire industry? Furthermore, there is no requirement regarding when the government must sell these shares in the future. They could simply keep them indefinitely.

I feel like I need to read my copy of Hayek’s The Road to Serfdom again. I suggest those who have never read it get a copy.


-EJB

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While I agree with your concerns, EJB, I believe I'm less worried about this Congressional act than you might be. Thus while I concur with your basic argument, I must write separately to point out a few things.

First, the comparison to Kelo. Now, as those of you who know me know, I am a strong supporter of private property rights and a staunch opponent of eminent domain (to the point where I would suggest abolishing it in all cases). I've even been thrown out of my Constitutional Law class for telling Supreme Court Justice Stephen Breyer that his decision to join the majority in Kelo makes him partially responsible for the fourth worst Supreme Court case in history (closely behind Plessy v. Ferguson, Korematsu v. US, and Buck v. Bell). I also recognize that you are NOT equating the two cases...you are NOT arguing that the bailout is just like Kelo.

However, you do make the argument that: "By issuing more shares to the government, even if they are being bought, this necessarily dilutes the stake of existing share holders, reducing the percent of the company that they own. In effect, they are having a portion of their property forcibly taken from them." This is not exactly the case. Nothing is actually being taken from shareholders, because the preferred stock that is being sold to the Treasury is being created for this specific purpose. Yes it dilutes the value of the stake of the shareholders, but that's all it does. For eminent domain purposes, it would be similar to the government putting a prison right next to your house...it would certainly decrease the value of your property, but it would not constitute a taking. Unless your argument is that the AMOUNT of stock is not the property, but the VALUE of the stock is - however, nothing like this has ever been upheld by the Supreme Court and, in fact, Palazzolo seems to expressly close that avenue of argument.

Similarly, you make the point that the government paid for these shares. This is crucial in any examination of a Takings Clause violation, because takings are allowed if the property owner is "justly compensated." This is why I hate our current Takings Clause analysis. What is "just compensation?" Does it include idiosyncratic value or subjective valuation? (No.)

It's also interesting that you mention the Fourth Amendment. Nowhere in that Amendment is there mentioned an explicit right to private property. But I agree with you that Eminent Domain and other unjustified takings violate the spirit of the Amendment! Does this mean you recognize an implicit fundamental right to both private property and privacy!? I can't believe this is the same EJB that I knew in college!

I completely agree with #2 and #3.

Finally, a few comments on #4. First, "a 700 billion dollar blank check," is logically impossible, because a blank check, by definition, includes no written value. But that's technical. To your point about the drastic increase in executive power, I will say that I'm not as alarmed about that as one might be if this were the executive acting AGAINST the express will of Congress. In Youngstown, the inherent power of the President was examined because Truman tried to take over the steel industry when its workers went on a mass strike during the Korean War. Justice Jackson's concurring opinion is, to this day, the lodestar for such analysis. Basically, the Executive's power is at its strongest when he acts according to the express or implied authority of Congress. His power is at its weakest when he acts contrary to their express or implied will. And there is a middle zone that gets murky when we're not sure what Congress has said on the issue. In this case (the banking crisis), I feel slightly more comfortable with this increase in executive power because it was expressly authorized by Congress. These two forces are naturally opposed to one another, so the fact that they are working in tandem should probably evidence the fact that the increase in power is necessary to quell a pressing problem. Perhaps your "parade of horribles" argument is right and this is the first step towards the nationalization of industry. But with Youngstown firmly in place, I trust it will never come to that point.

~JSK

The Federal Reserve's Role in the Housing Crisis

As is usually the case in discussing economic policy, public debate rarely focuses around facts or theory and usually devolves into overly simplistic notions based in jealousy and frustration. The current housing crisis is no different. Both major presidential candidates, in an attempt to appeal to populous sentiment have chalked up our entire problem to be nothing more then the "greed" of Wall Street and therefore come to the conclusion that the "free market failed." The remedy is then by default more "regulation" which is never defined or explained by those advocating for it.

The reality is that there were a number of factors that have contributed to the housing bubble, the mortgage market collapse and the associated economic downturn. I therefore plan on starting a series of posts that will try to address some of these issues. This first one looks at the role the Federal Reserve had in creating, or at least contributing to, the housing bubble's rise and eventual popping. I bring your attention to the chart below:

The blue line is the ratio of the average price of a home based on an index to total GDP. It was scaled so that 1992 =1. The green line is the Federal Funds rate, the interest rate that the Federal Reserve manipulates when it is reported that interest rates have been "cut" or "raised." This is the rate at which banks lend to each other. The red line is a weighted average of mortgage interest rates.

Normally, house prices only grow as fast on average as GDP does, which correlates with the average incomes of buyers. This makes sense; as incomes rise, there is more demand for housing, and prices rise.

However, you can see how this proportional relationship of the two in the 1990's, shown by a relatively level line, began to change around midway through 2000. This is by no coincidence around the same time that the Fed cut the Fed Funds rate to a very low rate and kept it there for a very long time, particularly relative to the previous recession in 1991-1992. This had the effect of lowering mortgage rates to historically very low levels as seen in the red line. Around 2000, when mortgage rates started falling, home prices started rising as the cost of a mortgage payments went down and therefore the quantity of housing demanded went up. Likewise, the bubble was "popped" around 2006, right when the FED had now raised its rates and mortgage rates started to rise.

Essentially, it was not the "free market" or "greed" that caused this bubble, or at least not in of itself. The Fed, a non-free market institution had a very important role in creating or at least exacerbating the bubble and therefore ultimately our housing and economic woes. This chart (current through June) shows that in order to come back into equilibrium, prices have to fall a good amount further.

For a more detailed explanation, one good example can be read here.


-EJB


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Well, I must confess that, originally, I was one of those calling for the end of the "free market." My belief was that investor greed and market inefficiencies were entirely to blame for the collapse. Clearly, as you have eloquently stated, they were not. You even have a chart which lends itself nicely to your point...and I cannot argue against a chart. Believe me, I have tried...typically the argument ends with me yelling at it and the chart just sitting there...mocking me in its silence.

However, a few quick points. The chart and the statistics that it represents could never be understood by a vast majority of voters. If Obama or McCain were to drag an easel onto the stage and unveil this chart, I can guarantee that their poll numbers would drop.

I also think it would be a mistake to condemn the government entirely. The State's goals were amicable. I think we can all agree that increasing the amount of homeownership, especially among lower income families is a good thing. However, clearly the Fed messed up in choosing what means to follow in order to reach that end.

Furthermore, it would be misguided to ignore the important part that greed did play in the crisis - and I do not mean to suggest that EJ ignores this factor, he simply hasn't gotten to that part of his analysis yet. But to preempt him a little, at the height of the sub-prime mortgage crisis, there was absolutely no way that investors could claim that they did not see a crisis on the horizon. Everyone, including the CEO and CFO of Fannie Mae, recognized that the securitizing of these high-risk loans, coupled with the creation of negative externalities on the part of such organizations as Fannie, was a recipe for future disaster.

The candidates would do well to elaborate on their definition of "regulation," because, clearly, regulation is not the antidote. The important distinction between "oversight" and "regulation" is getting lost in the fracas. Congress, the SEC and the Treasury did not fail in its ability to "regulate" but actually failed to adequately oversee the market. Increasing the SEC's ability to oversee trading of this kind would be a perfectly reasonable response to the crisis...but it would not involve strengthening mandatory disclosure provisions or any other sort of harsh government regulation.


~JSK

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I agree with you that this is too complex for candidates to bring up, but more analysis could be done, or in particular why isn't the media in its endless opinion shows talking about this kind of stuff? I know I for one had a special place in my heart for those charts Ross Perrot used to always bring up to the stage with him. :)

One thing with the Fed and affordable housing though - there were and still are many government polices that were created to increase home ownership and your right that I will get to those in the future, but the Fed had little to do with that by design. The Fed kept rates so low not to increase home ownership, but because they were worried about deflation at the time and wanted to aggressively inflate the money supply. They overdid it though. And it isn't necessarily Greenspan's fault either, but is is because the Fed suffers from the shortcomings of any central economic planning attempt that has been tried. Mainly, it is impossible for anyone to have enough accurate information at their disposal to be able to manage or manipulate an extrmely complex organism as a national economy correctly. There are always unintended consequences of intervention.

-EJB