by
Michael S. Rozeff
The Federal Reserve is living up to its purpose, which is to enrich bankers at the expense of everyone else. Ben Bernanke, who chairs the Federal Reserve Board, is to be congratulated for his open call for the banks under his tutelage to receive billions more of our tribute. Let us understand the matter clearly. We have exited a significant boom period. During the boom, the bankers made large and very large profits. The managements took home very large pay and bonuses. The stockholders (including officers and managers of the banks) had, for a time, very large wealth in the stocks they held. The bondholders of the banks had, for a time, very secure debts. But the bankers over-reached for business in several ways. They extended a slew of bad loans during the lately departed boom. The stocks and bonds fell in price, reflecting the lower worth of the bank assets, these bad loans. And now that the boom is over, the bankers, led by Mr. Bernanke, want us to eat their losses. Bernanke urges Congress to absorb the bad loans. The details of his three alternative plans are secondary to the fact that they all ask that others pay for the losses that the bankers caused, or else they involve the government in a variety of complicated maneuvers by which the government ends up shoring up these banks and bankers while taking on various risks of owning portfolios of bad loans. The idea is for the bankers to offload their mistakes onto taxpayers. One plan has the government buy the bad loans. Why? Why don’t the bankers reveal what these loans are and sell them in the market? Such sales will reveal that their assets are worth even less than what the market now thinks. The insolvency of the banks will not only be revealed but it will trigger legal ramifications. The banks will have to be re-organized. This will mean breaking them up. It will mean that the holders of the securities of the banks will face large losses, even larger than are now being reflected in the current market prices. A government bailout does the following. It preserves the bank organization. It preserves the current bank management. It transfers taxpayer wealth to the security holders of the bank (bondholders, preferred stockholders, and stockholders). It transfers wealth to counterparties to other contracts that the bankers entered into. Why is any of this necessary? What is so precious about these banks? Haven’t they demonstrated a level of high incompetence? Shouldn’t that spell their doom? Heads I win, tails I win. That is the deal that Bernanke wants for the banks and these associated parties. Tails – they should be losing. No one else should be footing the bills. Citibank or Citigroup is emblematic of the whole tawdry affair. Why in the world should we be saving Citibank? I have been wondering about this for some time before Bernanke’s latest salvo. The government already made a complex deal involving over $300 billion of this company’s loans. What is so special about this bank, other than it has attempted to become a world-girdling enterprise and is failing badly in this endeavor? It even has an office two miles from where I write that usually looks barren. Why should we support the ambitions of a bank like this that is competing with a myriad of other banks in this area alone? The reasons given by Bernanke are absurd ("to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system,..."). Promoting overcapacity and singling out inefficient banks for the grace of taxpayer dollars does not promote a lasting recovery and it surely does not strengthen the financial system. Shifting the assets of Citibank, such as they are, to higher-valued uses through re-organization is a sound way to promote recovery and strengthen the economy. But this path would require that a lot of Bernanke’s favorites would bear losses. It would mean a rather different banking system might emerge that influential members of the Fed, who apparently shape its recommendations and bailouts, do not want. What cheek! What effrontery! What brazen thievery! How disgusting! The losses of the banks are already to a large extent reflected in the lower security prices of the stocks and bonds of the banks. However, investors do not yet know fully what these losses are because the bankers have not yet recognized and reported on them fully in their accounting or in any other way. If the government were not available as a possible trash bin, the banks would be forced into re-organization, and that is as it should be. Banks, in Bernanke’s world, are not only to have insured deposits that lead them to make risky loans, investments, mergers, and expansions into all sorts of lines of business, which are overlooked by regulators such as the Fed and even encouraged by them, but they are also to be bailed out by government financing when these investments turn sour! With the S&Ls, we had outright fraud engineered by S&L owners. With the banks, we have the equivalent bad incentives and the equivalent massive losses, but with the blessing and participation of the Fed and the government. It is a monstrous fraud in all but name, perpetrated in plain view. I wish the whole dreary episode were over, but instead each day I am punished by more dreadful trial balloons and suggestions such as the latest emanating from Bernanke. There seems no end to the extent of it. Obama, the candidate of hope, comes across to me as a clueless patsy in this affair. If he understands any economics at all, he surely does not show it, not yet. According to the Wall Street Journal, he wants the second half of the $700 billion so that he won’t be caught without emergency funds if financial markets weaken further. "In consultation with the business community and my top economic advisers, it is clear that the financial system, although improved from where it was in September, is still fragile...I felt that it would be irresponsible of me, with the first $350 billion already spent, to enter into the administration without any potential ammunition should there be some sort of emergency or weakening of the financial system." The model being used by Obama and his advisers is that one shoots dollars at bear markets and failing firms, which is what the weaker financial system really means, and that these dollars cure the losses in value. (These dollars are of course printed up.) The idea is that one cures lower asset prices by injecting dollars into the system somehow. This inane idea parallels the equally inane idea of FDR and his advisers when he took office in 1932 that the cure was to raise the prices of goods and services. Prices of assets fall because investors are forecasting worse business prospects and lower future cash flows of businesses. They are recognizing uses of capital that are not productive in a financial sense, that is, the recovery of one’s investment in terms of a cash flow return is too meager and too long-delayed to justify existing asset prices, and so these prices must fall. The injection of dollars into the system does absolutely nothing to cure the unproductiveness of capital. All it does is divert resources to still other uses that are unproductive. The decisions as to what is productive or not cannot be lodged in the hands of marshals in Washington loaded with six-guns ready to shoot billion dollar bullets every which way. They have no idea what the capital pricing should be or where capital should be shifted or what enterprises should receive new capital. They are politicians, economists, lobbyists, and lawyers. And, by the way, the title of economist does not by any means suggest that a person knows anything about the ins and outs of business or what businesses should receive capital or not. Academic economists often talk and act as if they know it all, but there is no evidence that they do. There is no evidence that any person or even group of persons is able to understand and direct an entire economy. Even in individual markets, the entrepreneurs closest to the action make frequent mistakes. Directing a "financial system" to a condition of stability and progress with $350 billion is a task beyond the scope of Mr. Obama and Mr. Summers or all the king’s horses and men. They can only throw sand into the gears. They need only look at the actions of their predecessors and the directives of past administrations who brought Fannie Mae and Freddie Mac into being, who encouraged subprime lending, who allowed insurance companies to endanger policyholders by writing credit insurance, and who recently have fallen into a $150 billion black hole with AIG. Closer to home, they might look at the long list of government actions in the past 15 months that have, more often than not, ultimately been associated with lower prices of stocks and corporate bonds.
The government’s attempts to stem these adjustments are futile and counter-productive. Its wealth transfers, which are nothing more than theft, resolve nothing. The economy will recover in spite of government action, not because of it, and be delayed in doing it at that. The Fed’s attempts to bail out its clients are worse than futile. They are blatant theft.
January 15, 2009 Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. Copyright © 2009 LewRockwell.com
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It
is obvious to all but those in government that the markets are attempting
to mark prices down to realistic values and that this will facilitate
recovery. The markets are attempting to weed out inefficient firms.
It is obvious that there is overcapacity in some lines of production
and some asset classes, and this capital must be priced out at market
and brought into uses that are economic at the new and lower prices.
It is obvious that the capital structures supporting many of these
investments likewise have to be marked down in price and a good
deal of it must disappear altogether. This is what deleveraging
means. It is evident that there are losses to be borne by those
who invested in these assets and those who hold this capital.