The world could have ended on September 18, 2008

Here is a calm explanation possible only on C-Span--far away from the shoutfest at the news channels.  There was an electronic run on the banks that day, and $550 billion was withdrawn from the money markets within two hours!  

It is a 6-minute clip--watch it with patience, and you will be stunned.    

Here is how the NY Times reported about the meeting that Paulson and Bernanke had with Congressional leaders:

It was a room full of people who rarely hold their tongues. But as the Fed chairman, Ben S. Bernanke, laid out the potentially devastating ramifications of the financial crisis before congressional leaders on Thursday night, there was a stunned silence at first.

Mr. Bernanke and Treasury Secretary Henry M. Paulson Jr. had made an urgent and unusual evening visit to Capitol Hill, and they were gathered around a conference table in the offices of House Speaker Nancy Pelosi.

“When you listened to him describe it you gulped," said Senator Charles E. Schumer, Democrat of New York.

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

“What you heard last evening,” he added, “is one of those rare moments, certainly rare in my experience here, is Democrats and Republicans deciding we need to work together quickly.”

Although Mr. Schumer, Mr. Dodd and other participants declined to repeat precisely what they were told by Mr. Bernanke and Mr. Paulson, they said the two men described the financial system as effectively bound in a knot that was being pulled tighter and tighter by the day.

“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said. “That hasn’t happened before. It’s a brave new world. You are in uncharted territory, but the one thing you do know is you can’t leave them frozen or the economy will just head south at a rapid rate.”

As he spoke, Mr. Schumer swooped his hand, to make the gesture of a plummeting bird. “You know we’d be lucky ...” he said as his voice trailed off. “Well, I’ll leave it at that.”

As the folks at Motley Fool write:

Britain we know came within 3 hours of utter collapse, and now we see that the U.S. came just as close a month prior! Indeed, the entire world economy came within a day of systemic failure. It makes you wonder... how many hours do we stand from such a scenario at the moment? Further, what warnings can officials from the new administration utilize to influence Congressional votes that could possibly trump those warnings of Paulson and Bernanke on that Thursday evening back in September? These are fascinating and perilous times, and I urge all Fools to keep watching intently. Our modern financial system is gravely ill, and may never recover... 

The C-Span link thanks to Andrew Sullivan for the link to Zero Hedge.  

The bailout bewilderment

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions' liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.

That is from economists Luc Laevan and Fabian Valencia who have a working paper on banking crises [pdf] out for the International Monetary Fund, covering 42 meltdowns in 37 countries since 1970. (via Reason).

It is so bizarre that there is some serious disconnect between economists and politicians. Actually, there seems to be extensive differences:

• among economists
• between economists and politicians
• among politicians
• among Democrats
• among Republicans

When such a level of difference exists, my read of the Ockham's Razor is that we have no clue about the problem, and even lesser an understanding of the solution. In that case, is it really wise to jump into a 700 billion dollar commitment after a measly couple of days of debates and discussions?

As always, The Daily Show explains everything very well :-)

Paulson's plans across the Atlantic

Interesting comments by Wolfgang Münchau in the Financial Times:

What about the lesson from the US to Europe? It is that bank bail-outs require a swift political response. When you look at the eurozone, it is not clear at all where this response could come from.
By the time European ministers have travelled for a meeting in Brussels, let alone reached or implemented a decision, the financial markets would have long melted.
Peer Steinbrück, the German finance minister, who last week told the Bundestag that the US would soon be finished as an economic superpower, should show more humility. He was lucky that last week’s crisis did not happen in Berlin or Paris or Rome. He and his colleagues would have been totally unprepared. ...
While the Americans need a better rescue plan, the Europeans need a lot more: a system that could produce a rescue plan in the first place.

And, in the same paper, Larry Summers writes,

[The] worst possible actions in the current context would be steps that have relatively modest budget impacts in the short run but that cut taxes or increase spending by growing amounts over time. Examples would include new entitlement programmes or exploding tax measures. The best measures would be those that represent short-run investments that will pay back to the government over time or those that are packaged with longer-term actions to improve the budget. Examples would include investments in healthcare restructuring or steps to enable states and localities to accelerate, or at least not slow down, their investments.

The end of laisser faire capitalism?

As we learnt from Francis Fukuyama's "The End of History", and later from John Horgan's "The End of Science?", it is not a good idea to talk about the end of anything, I guess. But, "the end of X" always works as an attractive title though, as this piece from the Financial Times shows. But, don't be fooled by the title--some pretty neat observations there. A few excerpts:

Europe is headed towards the end of laisser faire capitalism. Nicolas Sarkozy is only the latest leader to toll the bell on principles that have delivered, over the past 30 years, unparallelled global prosperity – and now a tremendous bust. “The all-powerful market which is always right is finished,” said Mr Sarkozy. Even Hank Paulson, former Goldman Sachs boss, has said “raw capitalism is a dead end”.
Before everyone dons Mao suits, however, it is not clear how raw that capitalism really was. The economic freedoms of the recent past were more of a tremendous party than a defendable principle, fuelled by cheap credit and state support.

That cheap credit and extensive state support is what has come back to bite us big time. I can imagine that the left will use this to bolster their argument that more state intervention (regulation) is needed, and the right will argue that too much of state intervention was why the markets got it so wrong. I tell you, ne'er the twain shall meet!

I want your money

The latest issue of the Economist has a cover graphic that says it all :-)

Excerpt from the lead article:

Spending a sum of money that could buy you a war in Iraq should not come easily; and the notion of any bail-out is deeply troubling to any self-respecting capitalist. Against that stand two overriding arguments. First this is a plan that could work (see article). And, second, the potential costs of producing nothing, or too little too slowly, include a financial collapse and a deep recession spilling across the world: those far outweigh any plausible estimate of the bail-out’s cost.

Interestingly, Paulson is "caped" in this Daily Show satire too :-)

Paulson a la Nixon, says Samuelson

Paulson's plan would not be the largest government intervention in the private economy since World War II. That distinction still belongs to Richard Nixon's imposition of wage and price controls in August 1971. True, Paulson would socialize unprecedented amounts of private debt, but Nixon asserted control over the entire economy. What's fascinating are the possible parallels between the two episodes, starting with a shared irony: Both came from administrations committed to "free markets."

Robert Samuelson offers an interesting observation, as always. He adds:

The rescue is being constructed so hastily that it may include all manner of flawed provisions: too much power for the Treasury secretary; authority for bankruptcy judges to modify mortgages. Congress faces a wrenching dilemma, imposed on it by financial markets and Paulson. If it dawdles, it may invite the panic that Paulson has brazenly predicted. But if it acts quickly, it may create a monster whose full implications emerge only with time.

An economic martial law in the US?

George W. Bush and Dick Cheney have not, as far as anyone can tell, been steering the ship. According to The Wall Street Journal, Bush was briefed on the rescue after it was in play. And even then, he was only "briefed." There's been no effort on the part of the White House to even advance the idea that Bush is an engaged participant who's actively signing off on these actions, possibly because suggesting his involvement in a crisis of this complexity would cause the stock market to run and hide in a corner.
Congress, too, has been cut totally out of the loop. The AIG bailout -- in fact, all of the bailouts -- have been conceived entirely without their involvement. Indeed, the Federal Reserve and the Treasury Department have been acting, over the course of this crisis, as if they are the sum total of the government. And that may be the correct approach: Neither the president nor the legislative branch possess the expertise or speed to be involved in the real-time crisis management that Bernanke and Paulson are trying to manage. They could, presumably, reverse decisions after the fact or change the contours of the law, but for now, the ship is being steered by the Chairman of the Federal Reserve, the Treasury Secretary, and an informal working group of Wall Street CEOs and banking powerhouses. And the government, as we normally think of it, has basically accepted their temporary authority. You've heard of martial law? We're currently in a state of market law.

That was EzraKlein Archive The American Prospect via Brad DeLong.

I am not at all ok with the idea that we are under some kind of an economic martial law. Paulson and Bernanke are the economic martial law administrators? There is something in this analysis that bothers me, but I can't quite figure out what exactly that is. Anyway, DeLong responds to that with the following comment:

This is how things have been since 1979--when Carter appointed Volcker to head the Fed, Volcker decided he was going to stop inflation no matter what the cost and would dare anyone else to try to block him, and congress and the president decided that challenging the Fed meant taking responsibility for inflation and thus blame if anything went wrong. Congress and the president occasionally show up to pass tax cuts--and twice, in 1990 and 1993, to take action to try to balance the budget. But otherwise the technocrats at the Fed and the Treasury run things.
This is the Age of Central Bankers.

Certainly not the Age of Aquarius!
But, aren't we granting too much of "war powers", so to say, to Paulson and Bernanke? Of course, they will not misuse it unlike the president who misused the war powers that Congress gave. But, are we putting too much of faith in Paulson, Bernanke, et al? Very troubling. Somehow this does not resonate well with how democractic societies are supposed to respond.
BTW, if we think that Paulson and Bernanke can steer the ship, how come the same people then distrust any form of "management" of the economy? The bottom line seems to be that government should let businesses rake in all the profits--legal and illegal--and not do anything about it. But, the same government ought to steer the economic ship when those same businesses run into icebergs. Aaaaaah!!!