Shake, rattle and roll: more on the current financial market crisis

Posted on | September 23, 2008 | 1 Comment

I’ve told you before that I am not an economist. I’m not an investor, either — at least, I’m not a Wall Street investor, a point which I’ll come back to in a few minutes.

So, I’m having a bit of trouble wrapping my mind around what has happened in the financial markets over the past week or so.

On the one hand, I read things like this article from the NY Times’ Paul Krugman and this guest piece in The New Republic by Roger Lowenstein, and each of them make several notable points.

From Lowenstein:

A manager with a big money management company confirmed that if Citigroup, Goldman, and the rest want to unload their securities, his firm has money to spend. “We just can’t spend as much as Paulson,” he noted.

The only conceivable purpose of Treasury intervention is to buoy the market (using taxpayer funds) by paying higher-than-market prices. After all, if the government merely intended to match the market, what would be the point?

Lowenstein also points out that the current “crisis” is a financial market crisis, not a general economic crisis. In spite of all the guff he’s gotten about it since, John McCain was basically right: the fundamentals of our economy are pretty strong.

Unemployment is only 6.1% right now. I can figure out why anybody who is at least as old as I am would freak out about that; by historical standards, that is quite low. At the moment, the gross domestic product is still in the black, although many expect that to change within the next 12 months.

But I have to ask how much the experts really think the economy will contract? During the Great Depression, as Lowenstein points out, output was down by 45% and unemployment was 24%. Take a deep breath and try to imagine that, if you can.

What is going on here is basically a crisis of confidence. That’s one thing. There is the vast numbers of American families who are conceivably facing foreclosure. That’s important and certainly needs to be dealt with. And there’s all the pension money that is tied up in investment banks, too, and the impact that is going to have at this worst-of-all-possible-moments, when Baby Boomers start retiring.

Krugman (and Lowenstein, too) points out that what Treasury Secretary Paulson has essentially proposed is a huge windfall for the financial companies (and their shareholders) that caused the mess in the first place, at taxpayer expense.

The logic of the crisis seems to call for an intervention, not at step 4, but at step 2: the financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

The potential problem for the rest of the economy is that the financial institutions that are in trouble have enough of a liquidity crisis that they don’t have the money to needed for the commercial borrowing that would keep the rest of the economy growing. You need access to capital if you’re running a business, as any microbusiness owner could tell you.

So, one of my fundamental problems here is that the folks who brought us this mess have made a lot of money because a part of the way they created the mess was to inflate their profits by over-leveraging their institutions. They’ve gotten their bonuses and whatnot and now that those investments are threatening massive losses, taxpayers are being forced to take the hit.

As a parent, I try to teach my children about basic concepts of action and consequences. Under the circumstances, I sure can’t use this real-world situation to illustrate the point. That bothers me. When people do dumb things, they are supposed to suffer the consequences of doing said dumb thing. If they don’t, there’s no reason to imagine they won’t do the same dumb thing again.

History appears to want to teach us that, when it comes to large sums of money, nobody should assume that people will readily learn that lesson. So, in spite of the philosophical opposition so many seem to have to financial market regulation, somebody needs to ride herd on greedy people who do dumb things without thinking of the consequences to either themselves, their institutions or the overall economy.

At the same time, it’s worth noting that while Secretary Paulson proposes bailing out the financial markets with that $700 billion the Bush Administration is proposing, one of the safest investments going (always has been from what I can tell) remains small businesses.

My grandfather, probably like a lot of other people at the time, was able to calmly watch the Great Depression happen to a lot of other people while he got on with his life relatively painlessly — because he was a blue-collar worker for a small business. No job loss, no plunges from skyscrapers by his boss, no soup kitchens needed to feed my infant mother.

Under the current circumstances, scarcity of capital for small businesses will be an issue that should be carefully watched and promptly addressed, because that is where the stability is in this economy right now. I just hope somebody in Washington notices, remembers that fact — because this is precisely the sort of situation in which small and microbusinesses tend to be forgotten.

Comments