Bailing out of 2008

From Dave Barry's review of the year that 2008 was:

As world financial markets collapse like fraternity pledges at a keg party and banks fail around the world, the International Monetary Fund implements an emergency program under which anybody who opens a checking account anywhere on earth gets a free developing nation. But it is not enough; the financial system is in utter chaos. At one point a teenage girl in Worcester, Mass., attempts to withdraw $25 from an ATM and winds up acquiring Wells Fargo. ....

The stock market plummets farther as investors realize that the only thing that had been keeping the economy afloat was the millions of dollars spent daily on TV commercials for presidential candidates explaining how they would fix the economy. As it becomes increasingly clear that the federal government's plan of giving hundreds of billions of dollars to dysfunctional companies has not fixed the problem, the government comes up with a bold new plan: give more hundreds of billions of dollars to dysfunctional companies. Soon the government is in a bailout frenzy, handing out money left and right, at one point accidentally giving $14 billion to a man delivering a Domino's pizza to the Treasury building.

Is it possible to regulate Fannie and Freddie?

We--the taxpayers--now own Fannie, Freddie, AIG, and some gazillion mortgages and more with the $700 billion bailout. Well, once we own them, somebody has to manage them on our behalf. They have to safeguard the "public interest" and also make money for us out of this mess. At least, minimize our losses. We will need technocrats--not politicians, please!--to do this.
Can it be done? I think not.
Why? Hey, I will use Warren Buffett's comments on Fannie, Freddie, and the complex investment transactions, and after reading them you tell me why we--the taxpayers--stand any chance of coming out ahead in this:

Mr. BUFFETT: Well, it's really an incredible case study in regulation because something called OFHEO was set up in 1992 by Congress, and the sole job of OFHEO was to watch over Fannie and Freddie, someone to watch over them. And they were there to evaluate the soundness and the accounting and all of that. Two companies were all they had to regulate. OFHEO has over 200 employees now. They have a budget now that's $65 million a year, and all they have to do is look at two companies. I mean, you know, I look at more than two companies.
...
Mr. BUFFETT: And they sat there, made reports to the Congress, you can get them on the Internet, every year. And, in fact, they reported to Sarbanes andOxley every year. And they went--wrote 100 page reports, and they said,`We've looked at these people and their standards are fine and their directorsare fine and everything was fine.' And then all of a sudden you had two of the greatest accounting misstatements in history. You had all kinds of management malfeasance, and it all came out. And, of course, the classic thing was thatafter it all came out, OFHEO wrote a 350--340 page report examining what went wrong, and they blamed the management, they blamed the directors, they blamed the audit committee. They didn't have a word in there about themselves, and they're the ones that 200 people were going to work every day with just two companies to think about. It just shows the problems of regulation.
QUICK: That sounds like an argument against regulation, though. Is that what you're saying?
Mr. BUFFETT: It's an argument explaining--it's an argument that managing complex financial institutions where the management wants to deceive you can be very, very difficult. Or even when the management doesn't know what's going on, and--just take Bear Stearns. Bear Stearns had--I read it,anyway--750,000 derivative contracts. Now, you know, I could clone Albert Einstein, you know, and--many, many times and have him work 12-hour days forme and he would not be able to keep track of what's going on in an institutionlike that. It's--the ones that are too big to fail may be too big to manage,in some cases. And they're particularly difficult to manage if they'repromising Wall Street and their investors that they're going to do things that can't be done.
(thanks to peter gordon's blog for the link to this transcript)

Fannie, Freddie, and the taxpayer

China with money more powerful than USSR with guns

More commentaries, in addition to my earlier blog, on the Fannie/Freddie takeover zoom into the Chinese angle: that when the Chinese and others bought billions of debt, they did so because the feds were guarantors. So, when Fannie/Freddie tanked, well, here is Tyler Cowen (via Megan Mcardle)

In essence we already agreed to the bail out some time ago. Have you ever spent $17,000 on a car and asked the dealer what the warranty for the car "really meant"? Well, the Chinese spent $340 billion on agency debt and probably asked the same question at least once or twice. They live in a world of secret agreements with leaders, not transparent democratic arrangements. So when it comes to the U.S government decision, we're not just starting from scratch here. How many phone calls do you think Hank Paulson has received from the Chinese central bank since August 2007?
"Are you *sure* that paper is safe enough for us to keep on buying?"
We'll never know exactly what kind of verbal dance Paulson concocted in response, but just look at the resulting flow of purchases and the relatively slight mark-up over Treasuries over that period of time. The Chinese (among others) thought we were standing behind the securities, at least in any world-state short of federal government quasi-bankruptcy. (In fact Paulson is in a total bind once that phone call comes in. He doesn't have much incentive to just say "tough luck" and precipitate a crisis when otherwise no crisis is on the horizon.)
So should we try this: "Oh, is that what you thought? Guaranteed? Did we use that word? Sorry, try reading our signals better next time. We love you. Great job with those Olympics. And when it comes to those Treasury Bills, we really do still mean it. And don't forget to support us on Iran and North Korea."

And we pretend that we are the world's sole super-power who can do anything we want. It is bizarre that China has more influence on our policies than the USSR ever did.

Money is more powerful than guns! No wonder that Putin too is going the same route of flexing his petroleum riches.

Krugman is awesome--when he doesn't do politics

In this column, Paul Krugman explains in simple terms the Freddie/Fannie take over by the feds. I liked the following the best:

As the economist Irving Fisher observed way back in 1933, when highly indebted individuals and businesses get into financial trouble, they usually sell assets and use the proceeds to pay down their debt. What Fisher pointed out, however, was that such selloffs are self-defeating when everyone does it: if everyone tries to sell assets at the same time, the resulting plunge in market prices undermines debtors’ financial positions faster than debt can be paid off. So deflation in asset prices can turn into a vicious circle. And one consequence of what he called a “stampede to liquidate” is a severe economic slump.

That’s what’s happening now, with debt deflation made especially ugly by the fact that key financial players are highly leveraged — their assets were mainly bought with borrowed money. As Paul McCulley of Pimco, the bond investor, put it in a recent essay titled “The Paradox of Deleveraging,” lately just about every financial institution has been trying to reduce its leverage — but the plunge in asset values has nonetheless left these institutions with more debt relative to their assets than before.

Greg Mankiw is not too happy with the bailout/takeover. He writes:

The problem is far from over, as the future of these institutions and a large segment of the financial system is still to be determined. The worrisome part is that this future will be determined by a political system that both created the GSEs and failed to provide sufficient oversight, even when many economists suggested reform was needed. To believe that the Congress will do a good job of it would be the triumph of hope over experience.