Day: August 30, 2011

Missed Opportunities

Missed Opportunities

Even Hayek said something to the effect that there are no good solutions in the bust phase of the market.? Opportunities to avoid the bust come in the bull phase of the market.? How?

  • Fiscal authorities could lessen the advantages of financing with debt, leading to a decrease in debt employed.
  • Monetary authorities could keep monetary policy tight for longer, allowing bad debts to fail, rather than refinancing them with lower interest rates.? Let recessions do their real work of eliminating marginal economic concepts.

The Fed is supposed to take away the punch bowl when the party is getting too wild.? Greenspan (and to a lesser extent Bernanke, because he inherited Greenspan?s profligacy) did the opposite.

Instead of letting markets find their own level in a panic, they aided in the refinance of dud assets.? This led to a buildup of personal debts, particularly those financing housing.

But let?s consider the individual situations.? Start with 1987.? Alan Greenspan, new Fed Chairman reacts to the crash in October by promising loans to back up the market.? Wrong.? Let some market players fail, revealing the bad risks they had taken.? But no, this is the beginning of the Greenspan Put, and all of the malarkey that allowed risk-taking to extend? to every market because it seemed the Fed would rescue every crisis.

The stock market should not be an interest of monetary policy.? Focus on banks, and have them cut their links to the stock market.? Bonds are fine, that is lending.? Banks should not engage in speculation, if their deposits are guaranteed by the FDIC.

Then we come to the Commercial real estate crisis of the early 90s.? More projects needed to fail, but the Fed lowered rates to what were then unprecented levels, and enough marginal projects that should have failed survived.? The recession should have gone longer, and reduced overall debt levels.? But no, we end up with more debt and a reduced marginal productivity of capital.

In 1994, the residential mortgage market imploded because of perverse bets on the volatility of residential mortgage prices.? The rout led to a self reinforcing rise in interest rates, and then the Fed loosened too soon, once again.

By this time aggregate debt levels had risen dramatically since 1984.? With lower interest rates, the interest burden was lower, but the principal burden was higher, because people refinanced, and began to take money out.

Also in 1994, speculators on Mexican Cetes were partially rescued by the US Government through a set of loans to the Mexican Government.? This led to a greater sense that the US Government would back up speculators if they were big enough group.

In 1998, the Fed could have let investment banks sweat over Long Term Capital Management and Russia, but no, they forced them to cooperate while injecting a lot more liquidity into the system.

As a result, bad loans persisted and the marginal efficiency of capital fell, as companies and people refinanced.

In 2000, the Fed had its last chance to right the system in the midst of the tech bubble.? Instead of leaving rates high, because the general economy was not under that much threat, the Fed loosened down to unimaginable levels, mainly to force a bubble in US Housing, which would lead the economy out of the recession, which it did and then some.

In doing so, the Fed pushed debt levels relative to GDP far higher than they were during the Great Depression.? Because overall debt levels create depressions, I sometimes wonder that the supposed scholar Bernanke, and the toady Greenspan did not consider that they were setting up the seeds of destruction.

By 2007, the situation is too far gone, as the Fed tightens, it reveals systemic weaknesses as debt is too high relative to GDP, and we find ourselves in a structural depression, as opposed to a cyclical recession.

In 2008, if the Fed had not loosened, maybe things would have been worse in the short-to-intermediate run.? I expect that if deposits were protected, and losses of senior unsecured capped at 25%, the system would have survived.

But no, the Fed acted to increase leverage more, again.? In this new era, since 1984, that?s all it can do.

When does the day of reckoning come?? I trust the masses more than the elites.? Where is the bailout for the masses?? The elites got more than their share recently.? Is the helicopter of happiness going to fly over the homes of average people anytime soon?

If Bernanke ever believed in Milton Friedman?s view of the economy, it does not show here.? There is no increase in inflation, at least in the assets that need it.? There is only inflation in the prices of assets that are healthy, and little in those that are sick.

There should be no surprise here; it is impossible to reinflate a dud asset, except at high cost.

My point is this: who pushed for greater austerity when it would not have hurt our republic?? Few.

Instead, the debt grew exponentially as the Fed created the Great Moderation, which in other terms would be eventually be called a liquidity trap.

Though the US government is guilty for its deficits, and fostering a culture favoring debt over equity, the Fed is more guilty for not keeping interest rates higher, letting moderate recessions do their good work of eliminating malinvestment.? That might have prevented this current crisis.

There are no good solutions now.? Bail out this, bail out that.

Eventually there will be a fail of some sort.? I just don?t know what, when or how.

Book Review: Debts Hopeful and Desperate

Book Review: Debts Hopeful and Desperate

This book review is different.? It was written back in 1963, and has not been reprinted.? If you want to buy it, you will have to buy it used.? My copy used to be a part of the Newport, Rhode Island Public Library.? It is a short recounting of the economic history of the Pilgrims.? The total pages allocated to the main text are less than 60 pages.

But a good 60 pages they are.? Michael Milken once self-servingly said, ?America was built on Junk Bonds.?? If we were talking about the Pilgrims some might say their effort was financed by loan sharks, but really, it would be fairer to say that they were financed by venture capitalists, which occasionally worked on an equity basis, and also on a debt basis.

The author does not dwell on the religious views of the Pilgrims, aside from the effects it had on the financing of the colony.? Given that this was written in 1963 that is not a weakness, because writers in that era had better historical knowledge than most in the present era, in my opinion.

Though the book has only two chapters, it breaks down into 5 phases:

  1. The decision to emigrate from Leyden (in Holland) to the New World, obtaining an initial patent, gaining financial backers who were less than reliable, to the formation of a Joint Stock company.
  2. Leaving England and arriving at Plymouth, Massachusetts which was not their intended destination.?? Disaster happens with their Winter arrival, with many dying.? The initial ability to service the debt is poor, which leads to squabbles among the financiers.? The joint-stock company breaks up, and the Pilgrims agree to buy out the financiers at a price that gives the financiers a profit, but leaves the leaders of the colony in debt to a new set of financiers.
  3. Socialistic policies lead to disaster, until residents get their own land to till, leading to relative local prosperity.? In order to pay down debts the Pilgrims enter the fur trade, though with difficulties.
  4. They get a new patent, and find that their agent, Isaac Allerton, was not fully trustworthy.? Disputes over accounting embroil the Pilgrims and their financiers, probably to the detriment of the Pilgrims.
  5. Their financiers quarrel among themselves, after which an agreement is struck, where the amounts of goods that the Pilgrims delivered are adequate to pay off the debt.

The book doesn?t deal with the aftermath.? Anyone that has read Bradford?s writings on Plymouth Plantation would recognize that at the end, Bradford was dispirited, because almost all of those who came and survived, had moved further west to get more and better lands.? The religious motives of the colony were sufficient for its founding, but proved inadequate for its continuation.? After 25 years, the debts were paid, but for the most part, the colony had evaporated.

The collective financiers earned a handsome return, between 20-40%/year, maybe.? We don?t have enough details to be certain.? All I know is that the heavenly reward of the Pilgrims was far greater than their earthly toils to pay back their financiers.

Quibbles

The book could have dealt a little more closely with the motivations of the pilgrims, and their willingness to take deals that were against their interests.? Yes, the pilgrims were not as financially savvy as those that financed them, but they weren’t stupid either.? They were desperate to get out of the Netherlands and Britain.? That desperation drove some of the bad deals they took, and made them look like a bad risk, which narrowed down who would deal with them.? Leaving that aside, financing for most colonial ventures was stiff.

Who would benefit from this book: If you want to understand the economic struggles that the Pilgrims undertook, you will like this book.? If you want to, you can try to buy it here: Debts Hopeful and Desperate: Financing the Plymouth Colony.

Full disclosure: I bought the book with my own money.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

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