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Bank Nationalisation and You.

by r------ Thu Feb 19th, 2009 at 02:47:53 AM EST

The Anglo-American banking system is collapsing all around us. Each day brings a new revelation. Insane executive pay packages to reward substandard management practices, leading to predictable systemic financial failure and implosion of the businesses they poorly led. Credit then freezes, as no one in a position of fiduciary trust trusts anyone else in such a position. Since credit is the grease which has smoothed the edges of the present global expansion, the credit freezes squelches economic activity far and wide, leading to mass lay-offs, or if you are "lucky," wage cuts, reduced pensions and benefits, and an all around increased sense of vulnerability.  

No one is immune. The Americans and their Anglo-allies in London may have driven this credit boom predictably off off a cliff, but theirs was, as in transportation, a hub and spoke operation, and it isn't only the hub taking a beating. So are the many spokes, with unpredictable effects far afield from the collapse itself. It is therefore not surpising, in retrospect, that the Japanese and the Germans also pursue the same logic of downwardly spiraling economic prospects.

And, of course, none of our elites are accountable for their crimes, war or economic.

So you're saying, "sure Redstar, I get all this, I read the news same as you. It's Anglo-disease or so other neo-liberal rot, but what are we to do?" The short answer, increasingly finding a refrain in the words of Nobel Prize winners Stiglitz and Krugman, not to mention Doctor Doom himself, is one word: Nationalisation.

"Sure," you're saying, "I heard that too, but I don't have a pig in the pot, little debt, I rent my place, the banks aren't my problem. I mean, sure, I want the bastards to give back the money they stole, but how does this effect me other than my rage? Let `em go bust and the hell with them. It's not in (insert name of your country)'s cultural values to nationalise anything, that's so mid-20th century.  

In short, the reason why you should care whether the government runs the banks: your job depends upon it, as does that of a number of those close to your.

Here's why.

from the diaries - afew


During the credit-fuelled boom of the 1980's till 2007, and expecially since the mid-1990's, a concurrent boom in corporate debt drove asset prices, business valuations and consequently, business balance sheets through the roof. Big corporations went to debt markets to "find the optimal capital structure," (a business euphemism for lowering the corporation's taxes), and Alan Greenspan's monetary policy, mimicked throughout the neo-liberal world, made it ever cheaper for corporations to do so. Greenspan's friends, the investment bankers on the Street or in the City, underwrote it all, enriching themselves ever more in the process, and smaller pockets of hyper wealth funneled their cash into the game, via so-called "Private Equity," buying up whole swathes of the neo-liberal economic base, companies large and small, on the promise of cheap, bountiful credit, bi-partisan (in US and UK, at least) approved strategies of tax and social-responsibility avoidance. In the process, revenue and EBITDA multiples representing the price the wealthy were willing to pay each other to take assets off each other's hands, went through the roof. A same company worth $30 million in the US in 2002 could easily fetch thrice this five years later, financed, of course, through highly levered deals by a willing banker somewhere. Not unlike certain California or Marbella real estate.

You see, it wasn't just real estate that had a bubble.

Where does your job come in? Simple. Each time a bank loans a company money, it attaches strings. Those strings are called Covenants in English (and, actually in French too, since the City has overtaken all of our finance words). There are three common covenants: Leverage Ratio, Interest Coverage Ratio, and Fixed Charge Ratio. Without getting overmuch into the details, the general upshot is that each require steadily improving, or at least, stable, profit margins. Which is hard to do when the economy is expected to decline by 5-10% in 2009 in most of the OECD.

So, how can the managers of your company, and the shareholders they exclusively represent, address tightening covenants in a collapsing economic environment?

Well, they can just break those covenants. But, the problem here is that, the bank therefore contractually can call the loan and, at the very least, not even operating advances will be extended.
If you cannot renegotiate the loan for a hefty price in upfront fees and increased interest payments (and, as a company with decidedly declining profitability prospects, why else would you have broken the covenant?!, this is like refinancing your mortgage right after your spouse lost his job), there's always bankruptcy. Or, they could always buttress their balance sheets, as the banks are doing with your tax dollars today, by going back to wealthy shareholders who, though they are still insanely rich, are smarting from how much they've already lost in 2008.

Needless to say, that's not Anglo-Saxon corporate management's style. There's an easier way to avoid this problem, and that's by not breaking the covenant in the first place. "Great," you're saying, "well let's get about it then". The problem is, there's only one viable way for most companies to not bust their covenant terms. By firing you.

This, as much as anything else hitting the news today, explains wave after wave of may layoffs hitting every industry in the neo-liberal world today. That's right, the banks who are taking your tax money are also squeezing the companies you work for and in the process, leading to your future (or maybe already present) unemployment.

I'll let you guess how generous your government will be with your unemployment benefits. Hint, your balance sheet won't get the same stabilization funds as RBS or Goldman Sachs. Not under the present regime, anyhow.

There is only one way. Thatcher had it right. There is no alternative.

Unfortunately for her legacy, she badly got the system wrong.  

Nationalise the banks, change the management, forgive all covenant transgressions until the end of the crisis, and above all, when it's all over, keep them nationalised.

Display:
Minor point of administrative confusion, I almost accidentally posted this thing as a story.

That doesn't mean what I think it does, does it?

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Mon Feb 16th, 2009 at 05:30:46 PM EST
No. :-)

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Mon Feb 16th, 2009 at 05:39:03 PM EST
[ Parent ]
Would have surprised me, needless to say, very greatly.

The Hun is always either at your throat or at your feet. Winston Churchill
by r------ on Mon Feb 16th, 2009 at 05:40:58 PM EST
[ Parent ]
I sure don't understand anything about this exchange.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
by Cyrille (cyrillev domain yahoo.fr) on Thu Feb 19th, 2009 at 04:50:25 AM EST
[ Parent ]
You must be a blogueur d'en bas.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu Feb 19th, 2009 at 04:51:48 AM EST
[ Parent ]
that's just spin to make you believe you're part of the elite :)

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Feb 17th, 2009 at 04:55:30 AM EST
[ Parent ]
Blogueurs d'en haut?

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Tue Feb 17th, 2009 at 08:03:09 AM EST
[ Parent ]
Blogueurs are d'en bas by definition.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Feb 17th, 2009 at 08:53:30 AM EST
[ Parent ]

Nationalise the banks, change the management, forgive all covenant transgressions until the end of the crisis, and above all, when it's all over, keep them nationalised.

Put all the assets and liabilities into a Custodian entity, and put the Bank company shares into trust on behalf of the staff and management. Then let this Bank company (Labour) share revenues proportionally with the Investors (Capital).

Any losses of Capital (defaults) are shared proportionally between Investors, whether existing (Private) or new (Public).

It's not Rocket Science: but this Capital Partnership is IMHO a form of nationalisation that actually has a chance of working sustainably.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Feb 16th, 2009 at 07:16:14 PM EST
That's not nationalisation, it's collectivisation.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Tue Feb 17th, 2009 at 02:22:09 AM EST
[ Parent ]
....and do you think it would be more likely to deliver a good service than nationalisation, Comrade?

Because I do.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Feb 17th, 2009 at 04:31:37 PM EST
[ Parent ]
That's no fun.

I think we should put all of the heads of insolvent banks in a dunk tank and let the public throw balls at them.  $1 per dunk until Big Shitpile is paid off.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Tue Feb 17th, 2009 at 08:02:21 AM EST
[ Parent ]
Big corporations went to debt markets [...], and Alan Greenspan's monetary policy, mimicked throughout the neo-liberal world, made it ever cheaper for corporations to do so.

I'm surprised. I thought you think Greenspans cheap money was better than an Austrian tight money approach.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Mon Feb 16th, 2009 at 09:45:02 PM EST
Tight money is fine, as long as working people are guaranteed a job and a pension and an equal shot as anyone else at a formative role in society.

But, that's not the world we live in.

Credit in this world is a necessary evil; we'd do best to move beyond, but until no one, child or adult, is at serious risk of homelessness, hunger and mental or physical abuse, I'll be all for anything which causes the least immediate damage.

And until the church gets a lot more funding, that's the world we live in.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Mon Feb 16th, 2009 at 09:57:28 PM EST
[ Parent ]
What has it to do with the church?

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
by Cyrille (cyrillev domain yahoo.fr) on Thu Feb 19th, 2009 at 04:56:24 AM EST
[ Parent ]
In the olden days the Church used to run hospices, asylums, shelters, soup kitchens and orphanages.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu Feb 19th, 2009 at 05:03:45 AM EST
[ Parent ]
Well yes but surely that's not what we want (ie, one important word is "olden"? Surely we don't want to delegate those key features of society to an organisation of institutionalised superstition and sectarism, funded by all without regards for their consent?

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
by Cyrille (cyrillev domain yahoo.fr) on Thu Feb 19th, 2009 at 05:31:11 AM EST
[ Parent ]
And which provides those services spottily and rather selectively to boot.

That the church institutionalises superstition, frequently bordering rank stupidity, would offend my sense of aesthetics, but if it were that or quote-unquote "market solutions," I suppose I could live with it. It's the fact that it institutionalises discrimination that's the real deal-breaker.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Feb 19th, 2009 at 10:26:39 AM EST
[ Parent ]
Each time a bank loans a company money, it attaches strings. Those strings are called Covenants in English (and, actually in French too, since the City has overtaken all of our finance words). There are three common covenants: Leverage Ratio, Interest Coverage Ratio, and Fixed Charge Ratio.
Thank you for this, Redstar!  It is not too hard to imagine why I cannot recall seeing anything about this in the US media I have followed nor in any of the coverage of the recent Congressional hearings at which bank CEOs testified.  It seems to be one of those little insider details that surely us lesser mortals would not find interesting.  Is there a source I could cite for the ubiquity of such covenants?  Given what you have set forth, it is certainly clear why having adequate capital reserves is the essence of business survival these days.  

This certainly casts in different light the take over pressure that the financial markets placed on any public company with lots of cash and a healthy cash flow during the preceding several years.  If they don't fall of their own accord they can always be pushed!

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Feb 16th, 2009 at 10:50:37 PM EST
are just obligations to do things and to not do things.

Those that redstar mentions are coverage ratios, which can be used in two ways: when providing the loan, to size the loan (ie, you do a budget of future cash flows, and say that you want no more than 2/3 of that money to be used to reapy the laon (principal and interest), and you calculate how much debt can be carried that way), or during the loan, to trigger defaults.

It's the second kind that redstar correctly describes as covenants, we also call them coverage ratios. I am not keen defaults based on coverage ratios in my deals, because they are fundamentally pro-cyclical and worsen things at precisely the worst moment.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Feb 17th, 2009 at 04:51:31 AM EST
[ Parent ]
Jérôme is of course 100% correct here, and most covenants contained in a credit agreement are logical things like right of first refusal on further equity issuances, required assent in further debt issuance, annual limitations on capital spending, entering into certain contractual agreements, industry-specific requirements like limitations on plate spend in publishing or on programming spend in television, and so forth. Logical things a bank does to protect the level of risk at which they issued the initial debt.

This being said, when the CEO of the company you work for is, today, talking about covenants, she's talking about the coverage ratios. The rest are, especially now that debt and equity markets have largely shrivelled up and investment is way down, less relevant and, in any case, rarely cause an involuntary default. It's this latter thing corporate masters are most fearing today.

And, as Jérôme says, financial ratio covenants tend to be highly cyclical, and so, in the case of the US and the UK, we see highly cyclical monetary and fiscal policy accentuated by private market behavior.

And not enough stimulus, and the wrong kind.

Things are goign to get ugly over here, that's what my gut is saying.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Tue Feb 17th, 2009 at 09:56:58 AM EST
[ Parent ]
One very sensible covenant that should be part of any government bank bail-out should be a requirement for bank forbearance on previous coverage ratio covenants so as to undercut the pro-cyclical nature of their effects.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Feb 17th, 2009 at 10:35:18 AM EST
[ Parent ]


Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Tue Feb 17th, 2009 at 02:18:34 AM EST
Not only will they all take it, but they'll take it up the 'you know what'.

Hey, Grandma Moses started late!
by LEP on Wed Feb 18th, 2009 at 08:03:30 AM EST
[ Parent ]
I was stunned.

Did they really bought bank preferred and warrants from the holding companies?  No new issue?  And no control?  Anyone who has a slightest idea about M&A knows what that means.

They knew this was an once in a lifetime opportunity to make billions out of complete business failure. And Geitner is still struggling about what to do... all because of their antisocialist ideology. Americans need Trotsky to save them.

I will become a patissier, God willing.

by tuasfait on Tue Feb 17th, 2009 at 11:48:00 PM EST
If Paulson profits in any way from this....

The FDIC only resolves the bank and typically pushes as much as possible back to the holding company for them to deal with.  Knowing this....it's clearly malfeasance.  

Utterly outrageous.  Not an attempt to solve the problem. Just shovel money to his buddies.  Can someone explain why I am wrong?  And why this should not be unwound and why Paulson, Bernanke and Geithner should not go to jail?

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Feb 18th, 2009 at 12:26:06 AM EST
[ Parent ]
NYTimes.com: The Bailout Is Robbing the Banks (Op-ed by JOHN C. COATES and DAVID S. SCHARFSTEIN on February 17, 2009)
It would seem obvious that helping banks, not holding companies, would be the most direct way to stimulate bank lending. But when TARP purchased preferred stock and warrants, it bought them from holding companies, not their bank subsidiaries.

While TARP has been generous with bank holding companies, these companies have not been so generous with their banks. Four large holding companies -- JP Morgan, Citigroup, Bank of America and Wells Fargo -- initially received a total of $90 billion in TARP money in the fall, but by the end of 2008 they had contributed less than $15 billion in equity capital to their subsidiary banks.

The holding companies seem to have invested most of their TARP money in their other businesses or else retained the option to do so by keeping it in deposit accounts, even as the capital of their banks decreased. At the same time the banks, which provide the majority of loans to large corporate borrowers, drastically reduced lending to new borrowers.

Gah

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Feb 18th, 2009 at 03:42:32 AM EST
[ Parent ]
LEP, was that 2 for tuasfait intentional, or a slip of the mouse?
by afew (afew(a in a circle)eurotrib_dot_com) on Thu Feb 19th, 2009 at 02:37:39 AM EST
[ Parent ]


The Hun is always either at your throat or at your feet. Winston Churchill
by r------ on Thu Feb 19th, 2009 at 10:34:16 AM EST
[ Parent ]
Now even Greenspan is in favour (though not the "keep them nationalised" bit):

Greenspan backs bank nationalisation | FT | 18.2.2009

The US government may have to nationalise some banks on a temporary basis to fix the financial system and restore the flow of credit, Alan Greenspan, the former Federal Reserve chairman, has told the Financial Times.

In an interview, Mr Greenspan, who for decades was regarded as the high priest of laisser-faire capitalism, said nationalisation could be the least bad option left for policymakers.

"It may be necessary to temporarily nationalise some banks in order to facilitate a swift and orderly restructuring," he said. "I understand that once in a hundred years this is what you do."

by gk (gk (gk quattro due due sette @gmail.com)) on Wed Feb 18th, 2009 at 03:16:38 AM EST
A big objection to long term bank nationalization is that it would increase the potential for patronage and cronyism to an enormous degree. Or to put it differently the overall upside is IMO significantly lower than the downside of what would happen when folks like Cheney and 'Heckuva job' Brownie get their hands on it.
by MarekNYC on Wed Feb 18th, 2009 at 10:55:19 PM EST
Are you saying patronage and cronyism in Wall Street and the revolving door to the Treasury are not at its maximum possible extent already?

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu Feb 19th, 2009 at 03:36:39 AM EST
[ Parent ]
Yup, it is my contention that direct control by the likes of the previous administration would be a significantly worse state of affairs than what we've seen.
by MarekNYC on Thu Feb 19th, 2009 at 01:47:14 PM EST
[ Parent ]
For all intents and purposes, they were the same. Wall Street wrote policy, both via the administration and via Schumer's committee.

But, there is a concept of alternance too, though it's debateable whether it functions in the US, eg Paulson for Geithner/Summers, whether we've really seen change in the US. Same observation in the UK.

Note, I'm not limiting my analysis to the US. There are democracies in the west which are markedly less dysfunctional than the US system of "governance". And Jérôme's observation of the French, largely nationalised banking system applies, whether left or right were running the show.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Thu Feb 19th, 2009 at 02:01:33 PM EST
[ Parent ]
For all intents and purposes, they were the same. Wall Street wrote policy, both via the administration and via Schumer's committee.

True, but that's not what I'm talking about here. What you are referring to is the financial industry's ability to push it's own class/corporate interests. What I'm worried about is a full on patronage and cronyism system a la Italy's old Christian Democratic machine, but even worse.

by MarekNYC on Thu Feb 19th, 2009 at 02:06:50 PM EST
[ Parent ]
Understood.

But, I am also recognizing the cronyism and corruption at the heart of US capital markets, which anyone who's worked on an IPO and seen what it takes to get in at strike price, to name but one example, will tell you.

If there wasn't inherent cronyism in the present system in the US, it would fall down. In fact, part of what is happening now if that cronies no longer trust each other.

The present solution to this crisis of confidence is to flood the market so as to get those people trusting one another again. But, another solution would be to remove the cronies.

This, for me, is the longhand for when economists like Duncan Black decry the fact we are counting on the same people who got us into the mess to get us out, the fact that the same cadre of people run US capital markets and continue their revolving door into and out of government. One need only look at the people Geithner brought in with him, their lobbying and Wall Street background, to see what I mean.

When banks are nationalised and your democratic institutions aren't hopelessly corrupted (the two are related) then there is a process to remove the cronies. Such a process does not obtain in the US or the UK, to be sure, but financial market reform is but one of many reforms which should be on the table.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Thu Feb 19th, 2009 at 02:16:57 PM EST
[ Parent ]
The only path I can see for the USA that would not increase the systemic political problem is to close the banks that are insolvent in such a way as to inflict maximum damage on those culpable, vigorously investigate and prosecute all fraud and pass campaign reform based on generous federal funding of all federal races.  The present crew is doing all they can to minimize the damage to those who caused the problem and appear not to care about consequences to the rest of society except as they impact the bank holding companies and their buddies.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Feb 19th, 2009 at 06:29:47 PM EST
[ Parent ]
France did fine between WWII and the late 80s with an almost fully nationalised banking sector.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Feb 19th, 2009 at 04:23:03 AM EST
[ Parent ]
But then again, France didn't have an entire major political party whose only domestic policy was re-introducing feudalism...

Whether the banking sector is nationalised or not is, I guess, in the long run secondary to whether the American body politic is purged of the oligarchs and their apparatchiks.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Feb 19th, 2009 at 10:31:45 AM EST
[ Parent ]
A short mention in Eurointelligence this morning:

German nationalisation law draws fire

"Any economic debate in Germany is ideologically first and foremost, and it should therefore not be surprising that the discussion about bank nationalisation has widened into a debate about the future of the market economy, which the opponents now see acutely threatened after the government agreed on a law to allow nationalisation in specific case. The only case where the governments wants to apply the new law, is Hypo Real Estate, the real estate speculator, whose capital base has been eroded. But critics fear that the law would open the floodgates to nationalisation of many banks."

 http://www.eurointelligence.com/article.581+M5eecf1d8a19.0.html

Any thoughts? Any Germans here at ET? Back in October, Herr Finance Minister Steibruk made a comment that "state-run banks will likely play a big role in the future [because of the current crisis]". As opponents of the law fear, this may be opening that door...

by glacierpeaks (glacierpeaks@comcast.net) on Thu Feb 19th, 2009 at 03:16:31 AM EST
State run banks already now play a big role. Sparkassen, Landesbanken and the KfW make up a third of German banking or so. And judged by the Landesbank performance, I doubt that state owned banks will do better than private banks.
Postbank is privatised and sold to Deutsche Bank, but the biggest shareholder of the Post is still the federal gov't. And the Post got 10% stake in Deutsche (Germanies biggest bank, balance 2007 2.020 trillion Euro) for the deal.
The second largest German bank, the newly fusioned Commerzbank with Dresdener bank (together a balance of 1.1 trillion) has now a 25% federal gov't stake, as Commerzbank couldn't afford the fusion and needed federal money.
The third largest bank is already LB-BW with a balance of 0.44 trillion.

For the law. Yes, it is ridiculous, a bank that needs public money to survive obviously has zero value, and therefore nationalisation doesn't take away anything from anybody. But beside every economic debate being ideological, in Germany every economic debate is dominated by totally uninformed people.

I doubt, the law will actually be used, and if, for sure in exactly one case, the one of HRE. The only other system relevant bank, in which the state doesn't already have controlling share is Deutsche, and that bank is too big to be nationalised. You really don't want their liabilities as national debt, when it turns out, they have accounting as good as Lehman's. Then better a normal insolvency.

In general it maybe more interesting, if the goal is, to keep all those stakes in the banks, or if in a couple of years everything is privatised again. That's not a done deal yet.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Thu Feb 19th, 2009 at 09:24:38 AM EST
[ Parent ]
For German speakers:
Interview with Mr. Flowers, biggest shareholder of HRE.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers
by Martin (weiser.mensch(at)googlemail.com) on Thu Feb 19th, 2009 at 01:07:58 PM EST
[ Parent ]
These troubles have the deliciousness of having a wet dream before being gullotined
by donosti on Thu Feb 19th, 2009 at 07:21:40 AM EST
Banks have done silly things, but they are not the core problem. At the core are the land prices. When land prices rise, all suffer, except the land owners. When all investment capital has gone in to the land, one way or another, in the hope of capital gains, the production and the use of labour will quickly come to an end. "Crash" and "credit crunch" follows.
I wonder how is the land ownership organised in China? Does the government still own there all the land? If they can capture all the rent incomes to the state, they can keep taxes on labour and capital low. That means the end of western economy.
by kjr63 on Fri Feb 20th, 2009 at 12:38:23 PM EST
I believe that land ownership has been privatised to some extent, but I'd have to check to be sure.

However, speculative bubbles on a scale like these don't form without at least tacit government approval. Popping them before they grow catastrophically large is very easy - there is a variety of tools at the government's disposal that can be used to that end.

That's the political point here: Bubbles don't just happen. They're a political choice.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Feb 20th, 2009 at 03:01:56 PM EST
[ Parent ]
"However, speculative bubbles on a scale like these don't form without at least tacit government approval. Popping them before they grow catastrophically large is very easy - there is a variety of tools at the government's disposal that can be used to that end.

That's the political point here: Bubbles don't just happen. They're a political choice."

They are indeed. There is a tool: land value tax. Otherwise i don't really see how you can prevent land bubbles. When economy grows, land values rise and they should rise. Other means, except LVT, would mean preventing the rise of land value. That would mean lower infrastructure, lower population density etc. Or smaller economy overall. I don't believe that there really is a "variety of tools."

by kjr63 on Fri Feb 20th, 2009 at 04:09:01 PM EST
[ Parent ]
Of course one can try to control the capital flows to land market. And that way try to keep prices within margins. That would, i believe, need quite a sophisticated controls and perhaps something like that would actually work.
by kjr63 on Fri Feb 20th, 2009 at 04:26:42 PM EST
[ Parent ]
While I disagree with JakeS - speculative bubbles do just happen, the reasons well described, I think by Minsky - in this case the gov't had its hand in play. LVT do exist in the US to quite a large degree. If I'm informed correctly schools are mostly financed by property taxes.
But the FEDERAL gov't has blown into the bubble a lot. Not making it worse, might have helped already to some degree.

  • the tax deductibility of mortgages is an incentive to keep little equity in the house.
  • together with the ability in some important states to jingle mail, this is even more incentive, to keep the equity in the house as close to zero as possible
  • renters didn't get the same benefits as home owners
A rant related to this points from Willem Buiter in the link.

  • widely lauded figures of the gov't that could be expected to give reasonable advice, such as Alan 'bubbles' Greenspan publicly stated it would be a great idea to have adjustable mortgages, instead of longer term fixed ones. This adjustability has a strongly procyclicle effect. I would argue as Fed share, his public statements were gov't interference.
  • the gov't ran a large public deficit in the same time, as the private sector went into more debt, so again a procyclical policy, that helped keeping the bubble longer running than otherwise. Note, that with the money little public investment was financed, but mostly unproductive war.

Other active measures against the bubble would have been
  • higher transparency for borrowers about what adjustable mortgage rates can mean in difficult times
  • limits on the possibility to sell credits and collaterised debt obligations
  • tighter monetary policy
and for sure a lot more

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers
by Martin (weiser.mensch(at)googlemail.com) on Fri Feb 20th, 2009 at 04:47:39 PM EST
[ Parent ]
I don't believe that there really is a "variety of tools."

Going from mildest to harshest, the ones I can think of are:

  1. Moral suasion

  2. Bubble-specific taxes (land taxes in your example, but bubbles can form in other asset classes too)

  3. Regulation of bank loans (due diligence regulation, anti-trust regulation, restricting variable-rate and interest-only lending, general government oversight, etc.)

  4. Anti-speculation taxes (Tobin taxes, stamp duties)

  5. General counter-cyclical taxation policy (steeply progressive income taxes, wealth taxes, property taxes (including land taxes), capital gains taxes)

  6. Counter-cyclical monetary policy.

- Jake

Friends come and go. Enemies accumulate.
by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Feb 21st, 2009 at 01:01:26 PM EST
[ Parent ]
Credit creation by credit institutions for the purpose of acquiring title to existing assets is what causes bubbles.

Nothing else.

Restrict credit creation and you restrict bubbles.

Replace secured debt with an alternative form of property investment that works, and bubbles will be history.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Feb 21st, 2009 at 05:36:11 PM EST
[ Parent ]
You can run a Ponzi scam just fine without formalised credit creation.

The fallout will be limited, because it won't lead to a general contraction in the money supply, which means that it (probably, and if it's not too big) won't lead to major parts of your economy being without liquidity. And it would change the balanced between creditor and debtor, because when you use equity financing, the creditor takes a haircut along with the debtor, unlike debt financing where the debtor gets wiped out before the creditor is even touched.

But there is nothing in curtailing credit that inherently prevents people from overpaying for an asset in the hope that a greater fool will come along and overpay even more.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 06:27:41 AM EST
[ Parent ]
JakeS:
You can run a Ponzi scam just fine without formalised credit creation.

Ponzi scams are not necessarily related to bubbles. A Ponzi scam in simple terms consists of paying income out of capital.

 JakeS:

The fallout will be limited, because it won't lead to a general contraction in the money supply, which means that it (probably, and if it's not too big) won't lead to major parts of your economy being without liquidity. And it would change the balanced between creditor and debtor, because when you use equity financing, the creditor takes a haircut along with the debtor, unlike debt financing where the debtor gets wiped out before the creditor is even touched.

But there is nothing in curtailing credit that inherently prevents people from overpaying for an asset in the hope that a greater fool will come along and overpay even more.

I stand corrected, in that it is indeed possible for assets to be over-priced into a Bubble without credit/leverage. The Dot Com Bubble is an example where leverage played a relatively small role.

Having said that, all Real property bubbles, and most other bubbles eg the Private Equity Bubble now collapsing to give swathes of unemployment, were caused by credit/leverage.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Feb 22nd, 2009 at 07:48:18 AM EST
[ Parent ]
Technically a Ponzi scam consists of paying income out of income.

Money markets are inherently and unavoidably Ponzi-ish - stock prices can only increase when people throw money at them, which means more money is entering the system, which means that payouts can appear to increase.

As long as there's some connection to real wealth creation, this can work, for a while, although it's not a healthy way to run things.

As soon as markets switch to speculation and a bubble appears, cash floods in - and then mysteriously disappears as the bubble pops.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Feb 22nd, 2009 at 08:29:37 AM EST
[ Parent ]
ThatBritGuy:
Technically a Ponzi scam consists of paying income out of income.

Say ten people each invest £100,000 because they are promised 20% return per year and nothing else happens (ie the £1m is kept under the bed or invested at 0%)

Say the manager takes out the usual hedge fund 2% management fee and 20% of the 20% fake "profits".

At the end of Year One the punters get £200k, and the manager gets 2% of £1m plus 20% of £200k ie £60k.

So £260k is distributed, and all of it is Capital.

Same in Year Two

Same in Year Three

The shit hits the fan at the end of Year Four when it's all gone.

But I cannot see how such a Ponzi scheme (the above being my understanding of a Ponzi scheme) is anything other than paying Income from Capital....

ThatBritGuy:

Money markets are inherently and unavoidably Ponzi-ish - stock prices can only increase when people throw money at them, which means more money is entering the system, which means that payouts can appear to increase.

Money created by credit institutions as interest-bearing debt is arguably as dubiously based as Ponzi schemes, yes.

ThatBritGuy:

As long as there's some connection to real wealth creation, this can work, for a while, although it's not a healthy way to run things.

As soon as markets switch to speculation and a bubble appears, cash floods in - and then mysteriously disappears as the bubble pops.

I would argue that the key difference lies between

(a) credit creation for the purpose of building new productive assets - where bankers such as Jerome fulfil a valuable role; and

(b) credit creation for the purpose of purchasing existing productive (or hopefully productive) assets, which is where Bubbles and Ponzi schemes come in.


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Feb 22nd, 2009 at 10:32:20 AM EST
[ Parent ]
(b) credit creation for the purpose of purchasing existing productive (or hopefully productive) assets, which is where Bubbles and Ponzi schemes come in.

Surely that should be net credit creation, right?

If I borrow a hundred thousand € to buy stock on the margin, and the dude I buy it from uses that 100k € to re-pay a broker's loan, then Nothing Happens(TM) to the money supply.

The problem is when the dude I buy the stock from rolls over the loan and uses the money to buy other stocks - because then new money is infused into the stock market, which causes stock price inflation (unless a commensurate amount of real value is added to the stock market through IPOs).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 10:40:59 AM EST
[ Parent ]
Okay I should have said a long-running Ponzi scheme consists of paying income out of income. :)

I think the difference is more that speculation is - jargon aside - designed to make a quick buck from thin air.  

The commodity that's being traded isn't income or ROI, it's faith in possible income which may - speculators hope - be created by the perception of possible profit by other investors.

In other words it's a stampede of greater fools, all of whom hope that they're not the ones buying at the top.

Buying and/or investing in existing assets isn't inherently speculative if it's managed in a sane way, and expectations of returns are reaonsable.

Someone I was talking to recently was regretting that she hadn't spent 20k on an existing cheese deli business which had been doing well on her high street.

There's no bubble there - just a business with an unspectacular but steady turnover and which should, recessions aside, repay an investment in a reasonable time, and then produce a profit.

A bubble would happen if the store became incredibly fashionable and decided to cash in by selling cheese deli futures.

With the right PR, the futures would spiral into the stratosphere and then crash. The buying and selling of cheese would be irrelevant - the actual commodities driving the price of the futures would be hope, optimism, guile, greed and wishful thinking.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Feb 22nd, 2009 at 11:40:24 AM EST
[ Parent ]
Ponzi scams are not necessarily related to bubbles. A Ponzi scam in simple terms consists of paying income out of capital.

That's true, of course: Not all Ponzi scams are related to bubbles. But I'd argue that all bubbles have the characteristic features of a Ponzi scam.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 10:42:41 AM EST
[ Parent ]
"Bubble-specific taxes (land taxes in your example, but bubbles can form in other asset classes too)"

Yes there are bubbles, but they are usually not so serious. IT bubble hurts some investors, but this money is still, after all, gone to some kind of technology and something that is produced (although bad production) and creates capital. Land bubble is the serious one. It just sucks money from the whole economy and produces nothing.

by kjr63 on Sat Feb 21st, 2009 at 06:56:32 PM EST
[ Parent ]
Not really. Sure, some of the money went into IPOs (just like some of the housing bubble money went into building new houses), but the bulk was just trading on the secondary market. That's not investment, it's just squabbles over who gets to own the possible future revenues of the traded entities. And when, as happens at some point in all bubbles, the price of the stock no longer reflects the value of the underlying cash flows even this already tenuous justification for calling the secondary market "investment" disappears entirely and you've reached the stage of pure gambling.

The Great Crash of 1929 happened on the stock market, not in the real estate market. It could have happened in the collectible postage stamp market, for that matter, if only enough people were to buy into the belief that collectible postage stamps were a smart investment.

It's just that real estate markets have been politically expedient to create bubbles in for the last couple of decades, because real estate is the asset class that Main Street owns and feels comfortable with.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 06:22:13 AM EST
[ Parent ]
"Not really. Sure, some of the money went into IPOs (just like some of the housing bubble money went into building new houses), but the bulk was just trading on the secondary market. That's not investment, it's just squabbles over who gets to own the possible future revenues of the traded entities. And when, as happens at some point in all bubbles, the price of the stock no longer reflects the value of the underlying cash flows even this already tenuous justification for calling the secondary market "investment" disappears entirely and you've reached the stage of pure gambling."

Yes, but when the stock becomes overvalued, it does not hurt the underlying real economy. Overvalued stock even helps investments in true capital.

"The Great Crash of 1929 happened on the stock market, not in the real estate market. "

There are also opinions, that this was also about land market.

"It's just that real estate markets have been politically expedient to create bubbles in for the last couple of decades, because real estate is the asset class that Main Street owns and feels comfortable with."

Of course they are comfortable, because land values always rise. As long as there is education, developing infrastructure and population growth. No Einstein is needed to cash in land market. What makes real estate (or in fact land market) a whole more serious is that the money gained is economic rent, not lottery money from other gamblers. Just a payment from production to privilege (nothing really happens). These bubbles leave labour and true capital in debt for decades. And take down all the production in the whole economy.

by kjr63 on Sun Feb 22nd, 2009 at 12:58:36 PM EST
[ Parent ]
"It's just that real estate markets have been politically expedient to create bubbles in for the last couple of decades, because real estate is the asset class that Main Street owns and feels comfortable with."

I just add that not all "Main Street" owns Real Estate. I believe that in fact it is quite a selected group that really owns land and takes the "rent" from economy. Of course average Joe likes to see his/hers real estate value grow, but in both cases, it is in the end economic rent they cash in.

by kjr63 on Sun Feb 22nd, 2009 at 01:11:47 PM EST
[ Parent ]
The Main Streeters who don't own real estate are unlikely to be buying into other major asset classes either - whether because they have no money, or because they're firm believers in the Bank of Serta. So in terms of separating people from their wealth, they're not as interesting.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 01:19:36 PM EST
[ Parent ]
kjr63:
And when, as happens at some point in all bubbles, the price of the stock no longer reflects the value of the underlying cash flows

Even without bubbles it's astonishing how rarely stock prices reflect trading fundamentals.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Feb 22nd, 2009 at 01:26:36 PM EST
[ Parent ]
Markets are manic-depressive...

But usually they reflect at least some tenuous approximation of the fundamentals. You don't get a company with a hundred million in assets and liabilities of 90 million with a market cap of two hundred million unless you have a bubble. It might have a market cap of a fifteen million one day and eight million the next, because stockholders can't decide on how to value the hard-to-value bits on the balance sheet. But there are limits to the craziness in normal times.

P/E ratios, for instance, have historically not been all over the place, except in the run-up to a panic.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 01:54:26 PM EST
[ Parent ]
Yes, but when the stock becomes overvalued, it does not hurt the underlying real economy. Overvalued stock even helps investments in true capital.

Overvalued stocks do real damage to the real economy in several ways:

  • They make it easier to finance projects that are not productive, because stock prices (including of IPO'ed stock) becomes disconnected from the productivity of the underlying company. This happened quite a bit during the .com bubble - where heckletsgiveitago.com could raise millions of dollars on their shiny name and the fact that the Nasdaq could only go up. This money was often, as John Stuart Mill put it, "betrayed into hopelessly unproductive works."

  • They create a sense of irrational exuberance in which embezzlement, Ponzi scams and all other kinds of - ah - irregular financial activities become much easier. As long as the money keeps coming in, nobody takes a hard look at the bookkeeping. See, for instance, Enron, WorldCom and Madoff. (This also affects the political climate, making scams like Bush the Lesser's initial election campaign bid to replace federal retirement funds with private stock market portfolios sound superficially plausible.)

  • They employ a lot of people in hopelessly unproductive functions created and maintained solely to facilitate speculation - running a stock market is not cheap in terms of man-hours, and the people who spend time speculating could have spent it on productive work instead.

  • If stock is being bought on the margin - that is, if the speculative bull market is being financed in whole or part by borrowed money - the banks who lend the money are going to find themselves with holes in their balance sheets when the bubble unwinds. There are only two places they can find the money to plug such holes: The first is to give the shareholders a haircut, and the second is to withhold money from the real economy. And since the shareholders are the ones who own the banks...

There are also opinions, that this was also about land market.

A great depression is a bastard of many fathers, and I would be surprised if persistent stock price inflation didn't also inflate real estate prices. But the major contraction in the money supply and the major contraction in aggregate demand both arose from stock writedowns.

Of course they are comfortable, because land values always rise. As long as there is education, developing infrastructure and population growth. No Einstein is needed to cash in land market.

Face values go up, but inflation-adjusted prices don't necessarily go up. And even when they do, you won't necessarily be better off buying than renting. That depends on tax codes, interest rates, rents, inflation and a lot of other variables. One such analysis can be found here, courtesy of the always great khanacademy.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 01:47:57 PM EST
[ Parent ]
"Face values go up, but inflation-adjusted prices don't necessarily go up."

Not in the long term. But you can't always say the same from a certain stock. Also playing "waiting-game" always wins in the land market. You don't lose market share (or wealth) doing it. But when we talk about "bubbles", land market is always a true "Eldorado" for banks and speculators.

"And even when they do, you won't necessarily be better off buying than renting. That depends on tax codes, interest rates, rents, inflation and a lot of other variables. One such analysis can be found here, courtesy of the always great khanacademy."

If you seek quick profits, of course you never rent anything. In this article is a graph about land and housing prices from last years:

http://www.moneyweek.com/investments/property/house-prices-expect-the-worst.aspx

by kjr63 on Sun Feb 22nd, 2009 at 02:03:21 PM EST
[ Parent ]
Not in the long term. But you can't always say the same from a certain stock. Also playing "waiting-game" always wins in the land market.

Only if you can afford to wait that long. Real, inflation-adjusted land prices may easily be higher today in many parts of the US and UK than they will be again within my lifetime.

When prices do a random walk, if you can wait long enough you can recoup any loss of book value. That's just another way of stating the Gambler's Ruin: If you have the (sufficiently) bigger bank, you can't lose unless the game is systemically tilted against you.

But very, very few people in the real world can afford to wait for arbitrarily long lengths of time. As Keynes famously said, "the market can stay irrational longer than you can stay solvent." In other words, even when there is a bias in your favour, you may not always be able to wait long enough to make a profit. Nevermind the case where prices are a random walk.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 02:28:04 PM EST
[ Parent ]
"Real, inflation-adjusted land prices may easily be higher today in many parts of the US and UK than they will be again within my lifetime."

Real land prices (land values) can only be higher today than tomorrow, if productivity drops, infrastructure gets worse and/or population declines. Market price naturally changes. If you can afford to put money in the bank, you can afford to sit on your land assets. There is only usually just some 1% property tax. Already the average growth in productivity covers that "risk". The problem with Keynes is that he doesn't make the difference between "capital" and "land", even these are very different in nature.

by kjr63 on Sun Feb 22nd, 2009 at 02:50:13 PM EST
[ Parent ]
Price and value are not the same thing. Value may increase and prices drop at the same time, if the asset was previously overvalued (or becomes undervalued).

And in fact, housing has, in the US and UK, been grossly overvalued. And that bubble just popped. So prices will go down, and likely stay down for quite a while.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 22nd, 2009 at 03:12:01 PM EST
[ Parent ]
Looking at this graph:

I posted last week, it is easy to see how insane Bubble's Great Land Bubble has been.

BTW:

I would love to see a graph of the annual percentage rise of US real estate versus the annual percentage increase in the US labor force.  Bet a doughnut there'd be a strong correlation.  

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sun Feb 22nd, 2009 at 02:10:16 PM EST
[ Parent ]
"I posted last week, it is easy to see how insane Bubble's Great Land Bubble has been."

That is the home price index. Look the link to the article i posted above. There is the graph of the actual land prices. (In UK)

by kjr63 on Sun Feb 22nd, 2009 at 02:16:23 PM EST
[ Parent ]
US land prices are not a good indicator of residential housing cost -- for the US.  There are large swatches of the US dedicated to agriculture and internal migration make US/UK land use patterns comparisons problematic.

Or maybe I'm talking through my hat.

My intimate knowledge of UK land prices, policies, and patterns comes from some friends who, in the late 60s, bought a farm well away from everyone to get away from everyone only to wake-up and find themselves surrounded by housing developments lo these many years later.  

Not happy they are.

Wishing to leave, they do.

Be damned if they'll sell out to Yet Another Developer to rape the countryside, they declare.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sun Feb 22nd, 2009 at 02:38:36 PM EST
[ Parent ]
Well, they may find comfort in the fact, that their farm is now much more valuable than 40 yrs. ago. If a "country land" becomes a "city land", it's value gets a good swing upwards.
by kjr63 on Sun Feb 22nd, 2009 at 02:57:03 PM EST
[ Parent ]
forwarded earlier today.

http://www.dailykos.com/story/2009/2/21/161928/193/174/698523

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Sat Feb 21st, 2009 at 04:21:00 PM EST


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