The negative reaction of the market to the bailout
Oct
06
“In theory, there is no difference between theory and practice, but in practice there is a great deal of difference.”
This is in my mind the basic lesson we learned this week from the negative reactions of the markets to the bailout.
Given this, do you think we should revisit the bailout and maybe give the money directly to people who are struggling with their mortgages (maybe buying 1/2 of their mortgages and homes) instead of using the money to buy the financial instruments that represent these mortgages?
Sadly yours
Dan
The Upside of Irrationality, explores some positive and some negative ways that irrationality plays out in our lives.
Dear Dan, I have come to the conclusion that the stock market has been looking for an excuse to adjust equity prices downward. The catastrophe in the credit markets is the catalyst. Stock markets can stay overvalued (or undervalued) for extended periods of time. They have a tendency to revert to fair value abruptly when shocked. It is like a supersaturated solution, which can stay in an unstable state indefinitely, until a seed is introduced — all of sudden crystals come crashing out of solution.
Please don’t assume that the short-term reaction of the stock market is a message that the “bailout” is the wrong medicine. The bailout is designed to prevent the global financial system from seizing up. For many years, the U.S. government has been pursuing grossly irresponsible fiscal policies. The chickens would eventually come home to roost. We have been living on borrowed time, but the consequences of our actions (as reflected in equity prices) are finally becoming manifest.
Giving money to the people sends the same message: big daddy is here to help you if you screw it up. Why should we all pay for the poor financial decisions of others? If house prices need to fall even further, so be it, but more intervention will only delay the inevitable suffering. I’m afraid quitting cold turkey is the only way forward if we want all the players to learn that actions have consequences.
Giving money to financial firms sends the same message: big daddy is here to help you if you screw it up. Why should we all pay for the poor financial decisions of others? If share prices need to fall even further, so be it, but more intervention will only delay the inevitable suffering. I’m afraid quitting cold turkey is the only way forward if we want all the players to learn that actions have consequences.
Wait… what?
Or maybe the 168 academic economists who signed a letter opposing the bailout were right: massive government intervention to deal with the problems caused by massive government intervention (the only thing less free market than the mortgage industry is the military) was and is a lousy idea.
Why are giving people money directly and giving people money indirectly the only options? Could we not give people money?
The Austrian school economists called this crisis several years ago. Their approach to theory is interesting, and can sometimes seem like rationalism. Yet their theory always seems to work — to predict things reliably. Laissez-faire capitalism actually works tremendously well, and would have eliminated many of the factors contributing to the crisis.
One factor remains though — the proliferation of irresponsibly structured and misrated mortgage-backed securities, credit default swaps, etc. That’s the only factor where I see no apparent government intervention or distortion involved. Of course, maybe these instruments would not be problematic if not for the jump in bad mortgages in the system — and that jump is clearly the result of numerous government interventions, subsidies, moral hazards, government control of the money supply/interest rates, etc.
JD
On the rationality of acceptance
Maybe it’s time to accept loses, pay the debts, save a little bit more than past years and keep waiting for better times. Very often we feel the need to do something that seems to give us the appearance of keep in control, but it is only a mirage. And it seems that all the government actions in most countries are guided by the need to say people that they are in control and have the answers to fix the problem. And the only thing that we are doing is to delay and increase the problem.
Financial crisis and coping with traumatic events
Related to acceptance, psychotherapists have well documented the phases that people go trough to adapt to some traumatic live events. First we deny the problem, second we feel anger and the need to blame someone (and maybe revenge), after that we feel depressed and then we elaborate on the new situation and finally accept what have happened to us. Don’t you think that there are some parallels with the reaction to the crisis of financial markets?
Dan -
Did you really just ask ‘should we just pay for 1/2 of people’s mortgages who can’t pay them’?? Wow.
Maybe I should stop paying my mortgage so someone will pay half of it off for me… After all, where’s the incentive?
Or, maybe…just maybe…we let experience be the teacher. The lesson: Thou shalt not buy houses you KNOW you can’t pay for, or you don’t get to keep them.
Nothing new here except maybe common sense and some expectation of personal responsibility. Try it sometime.
Since these mortgages were bought and resold at a discount in derivative form in many cases, the possibility that they wouldn’t be paid back was already factored in.
This is my understanding anyway – the large blocks of mortgages weren’t bought at 100% of their value.
So instead of bailing anyone out, why don’t we just ask the derivatives buyers to fess up to how much they actually paid for the mortgages, and then ask the homeowners to pay that price, rather than the inflated market price?
Everyone was gambling, and I agree that we shouldn’t come in and save them. The supposed loss to the financial institutions is based on all these homeowners having to walk away – when nearly all of them could pay something in order to remain in their homes.
I say we reassess the actual value of these homes and the actual price these big companies paid for the mortgages, and start over in that way – rather than giving people the mistaken impression that gambling is okay, and that big gumment will take care of you no matter what.
The longer the economic turbulance continues the more I’m convinved that the way we, and more importantly, the media talk about it is half the problem.
All I see is a complete lack of trust and confidence. Which is understandable since the root cause of everything were the highly dubious (if not downright dishonest) practices these financial institution were operating.
The people who have run these financial institutions are clearly near the top of the blame list – but I’m not trying to apportion blame. I want a sensible route forward. That is what is required so that everyone is better off. Important in that is that we all buy in to the fact that unprecedented actions need to be taken for the greater good.
So why do we (and the media) insist on calling the rescue package a Bailout? For me a bailout says ‘these fat cats at the banks have messed up but it’s ok we’re going to sort them out’. It says its about them and not about me or us. The success of the package is when everyone accepts that this is an economy saving package so that things can settle down & then we can slowly get about the process of fixing things. But when we get BAILOUT splashed across tv screens, BAILOUT leading the radio news, BAILOUT in the papers & BAILOUT blogs the message I keep receiving is about the crooks at the banks – and it’s not about them it’s about all of us.
So I think the label is wrong. I think it continually reinforces the wrong emotion – we need to collectively stop using it.
Now is the time when the thinking begins… What should we call it instead.
I think the reaction after the bailout was really a reaction to an administration that yelled, “Fire, but it’s o.k, I know how to put it out,” four times. The fourth “I know how to put it out” (the bailout) was much more vague than the first 3. I don’t know about the rest of The Market, but I concluded the firemen are incompetent.
Why is any solution considered to be worth while when the root cause of the whole problem (with the CRA) enacted through Jimmy Carter remains entact and unchanged?
There should be NO bailout for Anyone. Investors made bad decisions buying a bad financial product and Homeowners made bad decisions buying houses they couldn’t afford. Since when did we reward bad investment decisions with taxpayer money? Let the market unravel itself. File bankruptcies, move into smaller homes, cut back on purchases and all will settle out in the wash. Giving this money to anyone will form an expectation of another future bailout which will be factored into risk models and used for advantage to cause the same issue Again! We are not a socialist country and we must have personal responsiblity.