We are in Las Vegas for my conference. After over a decade in New York, I forgot how hot and dry the desert can get, even in late September. Anyway, when I got out of the shower this morning, Leslie and Didion were watching Sesame Street. Appropriately, the letter of the day is “Q”, which is the letter the stock market uses to identify companies in bankruptcy.
We have been trying to keep up with the rapidly changing status of the bailout package. (Leslie watched the failed vote and the subsequent market drop on the plane. I watched Bonanza reruns.) One thing we are trying to understand is the massive opposition from the public. I understand the distaste in helping those responsible. (Leslie wanted the government to step in last year; I was opposed to paying other people’s mortgages. We had many heated discussions about it.) But the current issue is not just about a few big Wall Street companies and their executives (or irresponsible home buyers) and hasn’t been for a while. The credit markets are frozen. Look at what is happening to interest rates: Rates on government debt are basically zero, while the corporate debt rate has skyrocketed. And this affects the debt regular people (like you and I) pay. Short term debt is what keeps the economy moving, whether you or I or the Republican Party think it’s not the way the American economy works is immaterial. “It is what it is,” and right this nanosecond, “it” needs intervention.
In a sidebar to a good summary of the situation from USAToday (!?), Axel Merk, portfolio manager at Merk Funds tells us “The problem is, the general public doesn’t understand this. Maybe we need to see a few payrolls fail at a few companies before they realize.” He continued, “This has a very direct impact on Main Street.”
Paul Krugman summarizes what has happened and notes that a slow down in the credit markets is the last thing a slumping economy needs.
The story so far: the real shock after the feds failed to bail out Lehman Brothers wasn’t the plunge in the Dow, it was the reaction of the credit markets. Basically, lenders went on strike: U.S. government debt, which is still perceived as the safest of all investments—if the government goes bust, what is anything else worth?—was snapped up even though it paid essentially nothing, while would-be private borrowers were frozen out.
Thus, banks are normally able to borrow from each other at rates just slightly above the interest rate on U.S. Treasury bills. But Thursday morning, the average interest rate on three-month interbank borrowing was 3.2 percent, while the interest rate on the corresponding Treasuries was 0.05 percent. No, that’s not a misprint.
This flight to safety has cut off credit to many businesses, including major players in the financial industry —and that, in turn, is setting us up for more big failures and further panic. It’s also depressing business spending, a bad thing as signs gather that the economic slump is deepening.
Bloomberg gives us the same story with an equally dire forecast about what this means for the future of the economy.
The extra yield, or spread, investors demand to own investment-grade debt instead of similar-maturity Treasuries widened to a record 4.65 percentage points yesterday from 3.17 percentage points at the end of August, Merrill data show.”
Financial company bond yields have jumped to a record 6.97 percentage points more than Treasuries on average from 3.64 percentage points at the end of August, Merrill index data show.
‘My goodness that’s unheard of,’ Lonski said. ‘In all likelihood financial institutions and banks will tighten lending standards even further. That will have the effect of practically guaranteeing some reduction in economic activity.’
I want to say a little about the myth of the free-market economy. On a basic pedagogical level, capitalism is synonymous with a free-market economy; communism, with a command economy. In practice, however, there is no such thing as a purely free market. The U.S. government intervenes everyday in the market. There is no invisible hand; on the contrary, the hand that is in the market is quite visible in the forms of corporate tax breaks, industry subsidies, tariffs (Yes, they flow in and out of favor.), and “bailouts.” Speaking to the bailout issue: If not for government intervention into failing financial entities, New York City would not have been able to see its boom in the 80s and 90s. Also, know anyone who drives a Chrysler? If so, you know someone who bought a car from a company that should have failed in the 70s, but Carter authorized federal aid to Lee Iacocca. If you have flown on a commercial jet since September 11, 2001, you have benefited from federal intervention.
But several Republican representatives yesterday stated their “Nay” votes on the bailout legislation was a testament to their belief in the free market. One Wisconsin representative even likened the bill to the communist ideals of the Bolshevik Revolution. This is ridiculous. Many of these same Republican politicians very much enjoy the largess of corporate donors who benefit from the aforementioned subsidies and tax breaks instituted (often with passionate Republican Party support) by the federal government. The Republican Party cannot have it both ways: look the other way at subsidies and the like when things are good, while hysterically and stupidly equating the current bailout bill to the Soviet economy when things are bad.
Now let’s talk about participation in the bailout legislation. Both Republicans and Democrats have clamored for bipartisanship. Well, as far as I am concerned, when both parties are equally represented in negotiations and work together through long hours to produce a bill, that is bipartisanship. Bipartisanship produced yesterday’s bailout bill. Period. The Republican vote, however, did not reflect this level of cooperation.
Proportionally, the Democrats make up 54% of the House of Representative, leaving 46% to the Republicans. A truly bipartisan “Yay” vote on the bill would reflect this same distribution. The Republicans ensured, however, that it did not. The Democrats made up 68% of the “Yay” votes; the Republicans, the corresponding 32%. John McCain rightly supported this bill. Why his party couldn’t support him is troubling, to say the least.
I want to emphasize that I do not support irresponsible or reckless spending by anyone, individual or corporation. The reality is that a lot of people all over the place and all through the financial and political hierarchies screwed up. I understand that part of the bailout bill that is distasteful to a lot of constituents—and, arguably, is preventing them from seeing the big picture—is the renegotiation of loan terms and even the lowering of principal for individual borrowers in an effort to keep them in their homes (Sec. 124. The hope for Homeowners Amendments). Believe me, this prospect is distasteful to me, too. I work extremely hard for the money I make. Leslie and I budget and live without a lot of fun and games in order to build for the future (an increasingly difficult task given the current economy), and I don’t like the idea of people getting a free ride on my back. However, I have not seen the details of this part of the bill, and I cannot believe that in practice it truly will amount to a windfall for borrowers who are in over their heads. Further, I know that keeping families in their homes protects the value of my home. It protects the safety of my neighborhood, and it protects the property-tax base. If fewer people own homes, the rest of us who do, no doubt, will be facing property-tax increases and lower home values. Initially, I might not want to pay for the bailout, but I know I cannot afford not to. Homeownership issues, though, are only a small part of a very complicated equation, an equation that truly is a “fundamental” of the American economy.
Finally, Leslie wanted to comment about the role of Freddie Mac and Fannie Mae in the subprime crisis and the ensuing failure of the derivatives market. I recommend checking out the July 14, 2008, Paul Krugman column on same. I know it is a popular conservative talking point to place the blame for the current problem on the shoulders of Freddie and Fannie (and the Democrats). That is too pat (and erroneous). You might also be interested in knowing where a big chunk of Mark Davis’s income originated over the last several years and an indicator of how long John McCain and Davis have been buddies. (We sat next to Davis at a bar in the Minneapolis airport. He, unsurprising, is a very intense, closed man. Leslie didn’t know who he was, but commented on his vibe. Of course, you can imagine her vindication when I filled her in on his identity.)
With this, I am off with my wife and son down to the hotel pool for a quick dip and some glorious desert sunshine. Then we are off to dinner and baseball viewing. I give my conference presentation tomorrow. I will be glad when it is done and I can enjoy the rest of the event.
