Should creation of money stay in private hands?

March 9, 2009 1:11 AM

Professor and economist Richard Werner proposes a solution for the current banking crisis, under which "... national debt and interest liabilities will not increase, but credit creation will."

He begins by giving a rather novel perspective on some basics: "It is a little-known fact that there is no such thing as a 'bank loan.' Banks do not lend money. 'Lending' refers to transferring control of the lent object to the borrower. If I lend you my car, I can't at the same time drive in it. That's not what banks do when they issue a 'bank loan.' Instead, they are allowed by the current regulatory framework to create new money out of nothing--which is called 'credit creation.' The collective decisions of commercial bank staff thus determine how much money is created, who gets the newly created money and for what purpose."

His proposal involves the issuance of 'United States Notes', such as the ones President John F. Kennedy authorized to be issued in 1963.

posted by woodblock100 (49 comments total)

Interesting article, but I have to differ with several points.

Further, the banking and economic crises as we are witnessing today are nothing new. Their frequency had already increased to record numbers in the past 30 years before the start of the current crisis. Indeed, the world has seen an apparently endless string of recurring banking crises and connected economic cycles, with all their costs and distortions.

He's correct in that we've seen lots of bubbles in the past 30 years. But record numbers? Not so sure about that, I'd like to see a cite. Regardless, the history of finance shows us we see a bubble, on average, about once a decade, and have for since the 1600's or so.

Sometimes they overlap, like the ones that are deflating now. Just the way those things happen.

Bubbles are an inevitable part of the human psyche, the way we speculate and interact with the capital markets. We're getting better at detecting and controlling them, things that blew up in the past don't blow up - in precisely the same way, if at all - but we do see bubbles in other areas, in other asset classes.

Part of the problem is telling the difference between a true bubble and a surge in asset prices driven by an underlying structural chance is difficult, and quantitative tests applicable to one asset class (e.g., commodities) aren't always applicable to other asset classes. But we (folks that study bubbles) are learning.




Mainstream economics assumes that the best possible outcome will be achieved, if banks are left alone in making their decisions about how much money should be created and to whom it should be handed over for whatever use.

This isn't true at all. Banks don't decide how much money to be created, they operate according to dictates regarding economic and regulatory capital imposed on them by the regulators e.g., BOE, The Fed, ECB, etc. at the national level, and Basel II at the international level.

He's right about the private lenders battening down the hatches; we're still seeing about a 100bps (i.e., 1%) difference between government rates and market driven metrics such as LIBOR.

LIBOR is the first thing I look at every morning (followed by gold, oil and overnights for a few Asian markets to get a view on the action before Europe kicks off for the day) and while its tightened somewhat (the spread was about three hundred basis points once) its still not good enough.

I don't particularly like his view that the Central Banks should take non performing assets on their own balance sheets. The Fed has already increased the size of their balance sheet

I won't have access to a bloomberg terminal for another hour or so, but the spreads on CDS' protecting against a US default were recently trading close to record highs. They've narrowed a little since last month, but still very high, meaning the market doesn't like what The Fed has been up to.

Interesting article - thanks for posting as I no doubt would have otherwise missed it.
posted by Mutant at 1:33 AM on March 9, 2009 [5 favorites]

Credit is how Clinton got out of his mess. However, with the massive bailout spending and controversial war funding of Bush, we are again in the same situation. I don't find credit to be the true solution to this. We should simply allow the banks fail, eliminate the culprit of our dollar woes, which would be the Federal Resolve, and allow the free market to reign once again with a strong dollar bill. This what limited government requires. Downsizing toward a limited government is the solution.
posted by android09 at 1:41 AM on March 9, 2009

Well, and technology. I give Clinton a lot of credit for what he did, but he also had help from forces neither he nor his administration could control -- namely, the tech boom.
posted by spiderskull at 2:06 AM on March 9, 2009

^ This chart of the global USD money supply (M3) says it was expanding credit.

The late 90s were a perfect storm of falling oil prices, Windows 95 and the internet giving mainstream computers a wider productivity role than desktop publishing and number-crunching, and, most importantly IMO, China's coastal economic zones coming into their own as offshore production options.

I guess the flat times of the early 90s were a collective "breather" allowing consumers to build up capital and need (to buy new goods to replace the stuff bought in the 1980s).

A virtuous cycle of increasing domestic productivity, global communications, Chinese production capacity (and favorable exchange rate), the rise of big-box retail, declining transportation costs drove the 1990s expansion I guess. The Asians were willing to save while we spent, and M3 was allowed to increase in response to this increasing trade flow.

With the rising M3 came savings, and the savings (Bernanke's "Global Saving Glut") seeking returns. Wall Street innovated products to package real estate loans, and we were off to the races in financing the 2003-2006 real estate asset bubble.
posted by troy at 2:55 AM on March 9, 2009

This what limited government requires. Downsizing toward a limited government is the solution

Google Ron Paul!

This from the fpp:

Whenever credit is created and used to increase the amount of goods and services provided, it will be noninflationary: more money comes about, but also more goods and services

resonates with me. "Good" credit increases wealth-creation plant, "bad" credit just pumps up land valuations (and valuation is not wealth).

An economy pays its way with wealth creation, with wealth being stuff that satisfies human needs and wants.

To address the "limited government now!" sentiment above, it's my general impression that a free market economy is a path-dependent goal-seeking process, and any path-dependent process can run itself into blind alleys with no obvious or possible move out. Able government, can, theoretically, provide an extra-market catalytic impetus to move the market into a more profitable channel (one that it can't transition to on its own accord), from whence the magical goal seeking toward ultimate efficiency can recommence. This is basically the Keynesian argument.

We actually elected, more or less, a limited government in 2000 -- they were the able team that brought us a $600B adventure in the mideast, status-quo hydrocarbon-based energy policy, non-policing of the financial markets while it was cooking up a toxic sludge of derivative WMDs, and of course the Katrina non-response. We need good government, not limited government.

Whether quantitative easing -- monetizing peoples' debt -- is a good idea is debatable. What we really need is wage inflation, but to get that we need to both bring more jobs back home and limit how many illegal workers successfully take them.

It is a curious problem.
posted by troy at 3:32 AM on March 9, 2009 [6 favorites]

I like his analysis of how banks create credit. This is spot on and rarely discussed in the media. The solutions however I am not so sure of.
posted by caddis at 3:47 AM on March 9, 2009

This is pretty bad. Am I reading this wrong, or is he simply arguing that the fed should have kept interest rates higher in the past?

Also, this is just wrong:

...fiscal policy, if not backed by credit creation, will crowd out private demand dollar by dollar.

See here. And Krugman's more abstract explanation here.
posted by dsword at 4:54 AM on March 9, 2009 [1 favorite]

Google Ron Paul!

Had you told me that this would, by 2009, become the lefty version of "Keep on ragin' against that machine there buddy", I would have laughed.
posted by Pope Guilty at 5:22 AM on March 9, 2009 [2 favorites]

from article: Thus one also needs to ask why those institutions that could have prevented the bubbles have singularly failed to do so, although they had been given unusually strong powers with little accountability to democratic institutions: the central banks. Never have they been as independent and powerful as today.

This suggests that the very independence and lack of accountability of central banks has been a factor in allowing the creation of credit bubbles and the propagation of the current crisis: the central banks' erroneous belief in the infallibility of free and unfettered markets remained unchecked. Thus from now on, central banks should be made to monitor credit flows and made more directly accountable to democratically elected assemblies for the results.

To my unsophisticated mind, this is spot on. And it brings into question just why so much money has been pumped into banks, yet lending is still tight. I've heard several stories now about small and medium-sized businesses, who still have steady business (example - a successful upscale restaurant), who have had their lines of credit halved or worse, and interest rates raised.

To me it would seem that if you want money to circulate, to "infect" the market with liquidity, you put it in the hands of those most likely to spend it: consumers. Oversimplified example: - instead of giving $1 trillion to the banks, you give it to people. Estimating US population at 300 million, each person would get $3,333. A family of 4 would get $13,333. Would this not jumpstart spending? Would it not reduce the amount of mortgage defaults? $13k is almost the price of a car; wouldn't this prop up the automakers?
posted by Artful Codger at 5:25 AM on March 9, 2009

> ...allow the free market to reign once again ... Downsizing toward a limited government is the solution.

Back under your rock, you.
posted by Artful Codger at 5:41 AM on March 9, 2009 [2 favorites]

Yes, go.
posted by Kirth Gerson at 5:52 AM on March 9, 2009

Artful Codger -- To me it would seem that if you want money to circulate, to "infect" the market with liquidity, you put it in the hands of those most likely to spend it: consumers. Oversimplified example: - instead of giving $1 trillion to the banks, you give it to people. Estimating US population at 300 million, each person would get $3,333. A family of 4 would get $13,333. Would this not jumpstart spending? Would it not reduce the amount of mortgage defaults? $13k is almost the price of a car; wouldn't this prop up the automakers?

Excellent point and let's take it further; Silvio Gesell proposed the idea of money with an expiration date. So that way no matter who received the money it would be use it or lose it.


Another interesting idea we've seen floated in academic literature occasionally is one time money; in other words, allow banks to create money to float a loan (for productive purposes), like they do now, but after repayment the money is removed from the system. Sun from Queen's University has a freely available paper [ .pdf ] that discusses this in a little more detail.

Not sure how this would work out in practice - seems like economic capital requirements would be dynamic rather than static as they currently are.

Very fascinating topic.
posted by Mutant at 5:53 AM on March 9, 2009 [1 favorite]

you put it in the hands of those most likely to spend it: consumers

Japan is doing this, as we speak. After months of wrangling in Parliament, the bill passed a few days ago, and disbursements are now being made. Every citizen (and resident) gets 12,000 yen (around $120), and kids and seniors get 20,000. It's a staggering amount of money in total, but once spread around that thinly, doesn't really seem like enough to make a difference to the overall functioning of the economy ...

There is a lot of resistance to the plan ...
posted by woodblock100 at 5:54 AM on March 9, 2009

The problem with just handing out money to people in this economy is that they will mostly just save it. Which is certainly good for them but won't stimulate the economy in the short term.
posted by delmoi at 6:29 AM on March 9, 2009

Isn't the problem is that we (as a country and a culture) have become accustomed to - entitled to - to a standard of living (in terms of unnecessary consumer goods) that was based largely on fictitious assets (bubble assets, unsecured credit, etc.?). In the long run we need to get back to being comfortable with what we can really afford based on our real net worth. This will take considerable cultural adjustment. Granted, I don't see this happening, but regardless, the current problems will not be achieved through creating even more easy money.

Of course, IANAE
posted by carter at 6:43 AM on March 9, 2009 [3 favorites]

The problem with just handing out money to people in this economy is that they will mostly just save it.

Not quite true. You're correct that this wouldn't be ideal, in macroeconomic terms, but what most people will actually do is pay off debt. This is even worse than savings -- savings is money that can be spent in the future, debt retirement is paying for spending that's already happened.
posted by eriko at 6:44 AM on March 9, 2009

Credit is how Clinton got out of his mess.

No, credit is how Clinton bought time until he got reelected. It's like you lose your job and start using your Visa card to keep the lights on. It works this month, but if you don't find a job soon then you are going to owe a shit load to the credit card company.

Clinton, Reagan, Bush, and Bush pushed the massive debts they rang up off on us with cash from China but none of them did anything about making sure we had any means to make money to pay it all back, you know, by doing things like shoring up infrastructure, education, and the social safety nets. Now we've got the repo man at the door and nothing to pay him off with. The cash our cousin Larry loaned us (the tech boom money) is long spent on hookers and blow (Iraq and F-22's among other things).
posted by Pollomacho at 7:03 AM on March 9, 2009 [4 favorites]

It seems to me that the fundamental problem is the type of consumption that takes place. Its all about the velocity multiplier that money undergoes. Meaning, if consumers buy a good or service that allows them to produce more, then that investment adds its own value plus all downstream values to the economy. If however, as has been the increasing (cite wanted but no time - a strong feeling though) trend, if someone buys a good or service that produces nothing, the downstream effects are minimized. Contrast the purchase of a computer with the spending of the equivalent amount on a theme park. This is why I think the idea that tax cuts for the rich as so fallacious. The rich buy (gross generalization) luxury goods or save the money. A Ferrari adds little relative value to the economy versus 10 minivans.
posted by sfts2 at 7:12 AM on March 9, 2009 [3 favorites]

I think sfts2 nailed the core issue : your money only has the multiplier effect if you buy useful stuff. We expect that Obama's infrastructure improvements, and hopefully national healthcare, will offer incredible economic benefits. Defense spending otoh creates relatively little pay off.
posted by jeffburdges at 7:29 AM on March 9, 2009

I think it's easy to confuse "growth" with "health". Or perhaps confusing the economy's health with our own. What results from that confusion, in bad times, is jargon gymnastics like this article.

If you confuse growth with health, then it kind of follows that "spending" means finding stuff to pay cash for. But if health is your wellness indicator, in a home economy or any other, then spending means paying some money to satisfy a need, when cash expenditure is the best means of satisfying that need. Long-term security is one of those needs, which is the justification for saving.

Give me that 3,333, and I'll hang onto it because that's what would be healthiest for my household. If that's inconsistent with economic growth, so what?

Why is it so easy for us to make that confusion? Most other life forms have no trouble with it. They grow only when they are healthy enough.

I don't think bailing out the banks or the defaulting borrowers will help our society in the long run. But then, I'm neither a banker or a defaulting borrower.

On preview: sfts2, I think you're driving at the essense of Richard Werner's error, which is very common. He does not differentiate between an economy whose size is is a function of its host society's health versus an economy that grows at the society's expense.
posted by maniabug at 7:33 AM on March 9, 2009 [2 favorites]

^nor and is
posted by maniabug at 7:36 AM on March 9, 2009

> The problem with just handing out money to people in this economy is that they will mostly just save it.

First, exactly what are the banks doing with it? It's worse than saving/investing; they're simply hoarding it and as their stocks tumble, they're using it for their own survival. I can't see how we could have done worse with taxpayer money than GIVING it to the banks.

eriko worries that people would pay off debt with it... well if it keeps someone's house from being foreclosed, the debt instrument that's based on that mortgage is no longer worthless, and the property market has one less devalued property being sold under power-of-sale. And personal debt is part of the problem.

Anyway, even if the average save rate was 50%, that's still $500 billion TO THE BANKS as savings/investments and the other $500 B in play.

IANAE either, but I cannot see how simply giving money to the banks, AIG, the big automakers works better than putting it in at the bottom. On both psychological and fiscal levels, money to the consumer would give a better bang for each buck.

I agree that consumers have to stop living on credit, save more and become more personally responsible. I suspect that most of us have got the message, and have tightened the belt a couple notches. Still, we have an immediate crisis to overcome, and pouring money in at the top isn't doing it.
posted by Artful Codger at 7:36 AM on March 9, 2009

The problem with just handing out money to people in this economy is that they will mostly just save it.

In other words, the banks which are just having liquidity problems would have lots more incoming cash available to lend out and more incentive to lend it, and the banks which are actually bankrupt would still be bankrupt?

That sounds a lot like the first bailout to me, except with fewer poor people, fewer coke parties for crooked bankers, and less likelihood of seeing another bailout of banks-on-life-support next year. Granted, it's still probably not the best plan we could have come up with even on short notice, but it would have been better than what actually passed.

Too bad it could never have made it through Washington. Congressional Republicans would never have voted for "fewer poor people", Congressional Democrats would never have voted against "for crooked bankers", and you would have lost President Bush at "fewer coke parties".
posted by roystgnr at 7:53 AM on March 9, 2009 [1 favorite]

So, if I basically understand this guy's solution, it's that central banks are the problem, so they should collect the debt but write it off with special money that looks like our money but isn't the same.

That really seems like wishful thinking, and it seems like a massive abuse of fiat currency concepts. You can't just "create" a currency out of thin air to pay off debts accumulated in another currency that you print. That's the fiscal equivalent to paying off one credit card with another. And honestly, who cares if the interest rate on card #2 is 0% in his version of things -- you still owe the principal, and someone's still going to have to pay that.
posted by dw at 7:53 AM on March 9, 2009

or save the money

Here's someone else talking about savings as if it was a bad thing... but doing so right after bemoaning our insufficient productive capital investment! How do you think the rich (or even the lower middle class) save money? It usually doesn't get stuffed under a mattress, it ends up lent to someone who buys infrastructure that will allow repayment with interest later.

Of course, even when money does get hidden under a mattress, that's not always the worst thing in the world. Busts come after bubbles. Bubbles happen when people think that something will always be worth more dollars this year than it was last year. People smart enough to save their money for the inevitable end up making the boom smaller by holding back dollars and making the bust smaller by spending them. It may be too late for stuffing dollars into a mattress to be a good idea now, but there have been a lot of "investors" in the last few years who should have been told to stuff it.
posted by roystgnr at 8:04 AM on March 9, 2009

I'm not sure, either, that just giving every man, woman, and child in this country part of $1 trillion is really any better. The average consumer debt load in this country is over $8000. And we're not even discussing mortgages. Dumping that money into the economy almost guarantees inflation, which is good from a debt payoff perspective but terrible for an America where wages have been in mean decline since the 2001 recession. Oh, and you're also agreeing that housing prices, as they stand, are perfectly fine, something those of us in cities running behind the decline would disagree with.

Plus, what happens when the money is gone? Did all this money inflate a whole new bubble?

Most people took the 2008 stimulus checks and paid down debt, then saved what was left.

If people do gorge themselves on consumer goods, then what will they do? Buy China. Who will then immediately turn around and put that money into T-bills, increasing our national debt a little more (and pushing the CDS on USA bonds up a few more bps).

I do agree that pouring it in from the top wasn't going to work because we wouldn't ever be able to inject enough credit to make the banks feel like they didn't need to hoard capital. I'm not sure pumping it in from the bottom helps, though. It seems fraught with all sorts of pitfalls. Most of what we've given banks is basically still sitting there, and the money that hasn't been vanished in writeoffs.

I've been thinking that the solution is some sort of RTC/"bad bank" setup. But I can't seem to solve the biggest problem -- there's just too much bad debt there that is unsalvageable. Trillions will have to be written off.
posted by dw at 8:13 AM on March 9, 2009

"It is a little-known fact that there is no such thing as a 'bank loan.' Banks do not lend money. 'Lending' refers to transferring control of the lent object to the borrower. If I lend you my car, I can't at the same time drive in it. That's not what banks do when they issue a 'bank loan.' Instead, they are allowed by the current regulatory framework to create new money out of nothing--which is called 'credit creation.'

I'm sorry, correct me if I'm missing something, but this sounds like the banks are essentially file sharing money. Instead of the new [band the kids listen to] album being 'stolen' by having a new copy created somewhere else, it is money being 'given' by creating another copy in your account/wallet.

So the banks are, literally, loaning their money and having it too?
posted by paisley henosis at 8:27 AM on March 9, 2009

> Most of what we've given banks is basically still sitting there, and the money that hasn't been vanished in writeoffs.

... but it will, won't it? It will be whittled away by operating costs, then finally vapourized when a bank goes under, or is forced to writedown toxic assets it couldn't unload to the government.

I'd love to be convinced otherwise, dw; how do you think the bank bailouts will eventually help?

What's your take on the "Sweden" solution, where banks were forced to take the writedowns before the government stepped in?
posted by Artful Codger at 8:34 AM on March 9, 2009

I was hoping his solution would be more like Jonathon Swift, and less like every single other serious "solution" to the financial crisis...

...although, it's hard for me to take anyone's solution seriously when they don't address what I feel to be the underlying cause of this whole bust-out.
posted by fuq at 8:56 AM on March 9, 2009

Direct Credits for Everybody
By Alfred Lawson

CHAPTER 6

How Everybody Is Milked

Everybody does not understand finance any more than everybody understands physics or chemistry.

Finance is a special study in itself that requires the concentration of mental effort for years to master, especially the crazy finance that enslaves the world today.

Therefore, the author does not intend to befuddle everybody, for whom this treatise is written, with technical language or arguments, or long tailed figures to prove anything. He simply intends, with ordinary language and positive facts, to show the inefficiency of the present financial system and offer a genuine, and up-to-the-minute remedy for it.

A few big figures will have to be shown, however, so that everybody will get a general idea of the subject. In this way everybody will be able to grasp the principle outlined without having to wade through technical details.


posted by clavdivs at 8:58 AM on March 9, 2009

We should simply allow the banks fail, eliminate the culprit of our dollar woes, which would be the Federal Resolve

fuckin lol

and allow the free market to reign once again with a strong dollar bill.

this is p brilliant actually i can't believe no one thought of this

Downsizing toward a limited government is the solution.
posted by android09 at 1:41 AM on March 9

similarly, i was able to kick my methadone problem by shooting up black tar heroin eight times a day
posted by Optimus Chyme at 9:13 AM on March 9, 2009

Estimating US population at 300 million, each person would get $3,333. A family of 4 would get $13,333. Would this not jumpstart spending? Would it not reduce the amount of mortgage defaults? $13k is almost the price of a car; wouldn't this prop up the automakers?

Never happen. If the government were to give us back our money to spend as we pleased, what would we need them for?
posted by ZenMasterThis at 9:22 AM on March 9, 2009

Yeah, really! Our army, navy, air force, space program, national highway system, Social Security, foodstamps, welfare, and unemployment all suck. That's the way to economic vibracy: leave our country defenseless, concede space to other nations, starve the poor, make everyone ride horses because we have no more roads, when people lose their job they get to starve too (kids included), and when people get too old to work, they get to starve or freeze to death too. Yeeha, a perfect society. Logan's Run here we come! That dastardly government is just getting in the way of that perfect society.
posted by jamstigator at 9:32 AM on March 9, 2009 [1 favorite]

Another big problem is that the ubiquity of information leads many people to think that they understand this stuff, growing cynicism makes people not trust what public figures are saying, and our ever-developing egalitarian instincts lead people to think that all opinions are useful and valuable. The fact is, they are not. Too many stupid, ill-informed opinions driving political and the attendant economic decisions.

Here's an idea. Lets start trusting the people who understand and study issues such as these and work really hard to execute what they tell us, be patient, and everything is going to be fine.

I'm donning my Nomex suit now.
posted by sfts2 at 10:18 AM on March 9, 2009 [1 favorite]

Most of the money that has gone out the door has been loaned out by the Federal Reserve Bank. This isn't a government agency, it's a quasi-governmental entity. What that means is open to interpretation. The funds lent directly by the Fed, using questionable assets as collateral, is roughly 3 or 4 times the 700 billion from the TARP.

Equating the actions of the Federal Reserve to the actions of the US government is problematic, as the US government exercises control of the actions of the Fed in a very indirect manner. There hasn't been any public disclosure, that I am aware of, concerning the exact amounts that have been lent out by the Fed, or the assets that they got in collateral for these loans. Yet the US taxpayer is essentially on the hook for any of these loans that go bad.

Interestingly enough from the Wikipedia article:

"The punishment for making false statements or reports which overvalue an asset is also stated in the U.S. Code:[27]

Whoever knowingly makes any false statement or report, or willfully overvalues any land, property or security, for the purpose of influencing in any way...shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both."
posted by jefeweiss at 10:28 AM on March 9, 2009

Related: A Bank Bailout That Works

**
I agree with Mr. Werner that "the households saddled with uneconomical mortgages" should have their debts "wiped clean," but of course this can't happen "before government money is injected into the banking system" for an obvious reason: government money has already been injected into the banking system.

**

The next steps in my opinion should be:

a) stop the AIG loans: a lot of the AIG "loan" money (perhaps as much as $80 billion) has been going out AIG's back door (without any real oversight) and into the banks (both foreign and domestic). AIG is the textbook example of a company that gambled away its credibility through the cancerous, unregulated speculative bubble known as CDS: When you look back with the benefit of hindsight, it is truly amazing how outsized A.I.G.’s insurance commitment was, at $440 billion. After all, in 2005, when A.I.G. put many of these swaps on its books, the market value of the entire company was around $200 billion.

b) make Credit Default Swaps illegal. Period.

c) create stricter banking regulations and new rigorous banking and investment laws, and open up the Fed books to provide transparency and show where all the money (TARP, TALF, and non-TARP, etc) is going. Open probes/investigations into corruption in the "shadow banking system" and misuse of Federal money on Wall Street.

d) Stop through law the ability of hedge funds to tap into the FDIC's TLGP

e) Put the major banks into temporary receivership (i.e. temporary nationalization), and fire all of their executive staffs. BTW, if the CEO of GS is against nationalization, against nationalization, it's a good indication that nationalization is the way to go. Re-structure the banks like the Swedes did theirs. Stop doing this bailout in the current piecemeal fashion.
posted by ornate insect at 10:33 AM on March 9, 2009 [1 favorite]

I'd love to be convinced otherwise, dw; how do you think the bank bailouts will eventually help?

You seem to think I think they'll eventually help. I'm really unsure of that. If this were a short-term problem and the issue was just getting credit unfrozen, then the bailouts would have been a slam dunk. And in a sense, they were a short-term solution to a very short term problem. Had the system completely stopped, then we'd be looking at complete collapse of the global financial system. But TARP was never going to save the system. The TARP was only a stopgap measure to prevent the "too big to fail" from failing. Lehman spooked everyone. Strangely, six months after Lehman, it seems like people are already forgetting about it and trying to push Citi over... which would make the Bank Of United States collapse in 1930 seem like child's play.

What's your take on the "Sweden" solution, where banks were forced to take the writedowns before the government stepped in?

I'm not opposed to the Swedish solution, but I do think people are putting too much faith into it that it's the One True Magic Solution That Will Fix Everything. The contagion is just too widespread to think that fixing just banks will solve everything. After all, Citi is only half banking (commercial and retail) but the losses are in all parts of Citi.

And the Swedish model wiped out all the shareholders. In Sweden's case, that was a significant but relatively small percentage of Swedes. A vast majority of Americans have money in financial stocks and bonds, even now in a time where Amazon's market cap is higher than all but something like seven banks or financial companies in the world.

My best friend's father is a broker; he's been fielding calls for months from these retired folk who bought bonds in Citi and BoA and Fannie and Freddie worried that their retirement money was going down the tubes. I'm surprised he still has hair.

And in a sense, we have a Swedish solution already -- the FDIC. The problem, again, is that the FDIC can only fix banks. They can't untangle AIG's CDS mess, they can't buy MBSes and clean them, they can't regulate derivatives or hedge funds. All they can do is show up on Friday evening and take over your local bank.

But we're rapidly running out of solutions, and the Dems in Congress seem to be about punshing everyone for the sins of a few, while the GOP seems to be about letting everyone fail despite history clearly showing that it's what exacerbated the 1929 crash and sent us into the Great Depression.

It's like the neighbor's house is burning down and the embers are falling on your roof, and the firefighters are arguing whether they should put out the blaze at all and shoot the kid playing with matches instead.
posted by dw at 10:57 AM on March 9, 2009

Not quite true. You're correct that this wouldn't be ideal, in macroeconomic terms, but what most people will actually do is pay off debt. This is even worse than savings -- savings is money that can be spent in the future, debt retirement is paying for spending that's already happened.
posted by eriko at 8:44 AM on March 9

I've not had time to really ponder this yet, but to me this seems like precisely what needs to happen.

Would each consumer not be better off, and more likely to consume, if they had lower debt? Would the banks not be better off, and less likely to have to foreclose or persue debts in bankruptcy if people are paying off what they owe?

I'm curious what I'll think about this after lunch... but at first blush this seems like a fine solution.

This is something I also thought about this morning in the shower... I'm not sure why the gov't doesn't just become "the bank"... for certain circumstances. My house may have declined in value, but it is not worth $0. If the gov't were to take over my bank loan, I would be paying interest to the gov't, and if I tried to default, they could enforce payment through my taxes. They could also "tolerate" readjusting my mortgage, going interest only during unemployment, or even 0% interest for a time being.

All of these would be superior to what is happening now. And underneath it all is still an asset that is worth "something", not $0.

One day the market will recover. One day real estate values will rise again. Someone stands to make a frightening amount of money on this.

Who is getting all these houses that were worth $300,000 and now are being foreclosed because they are only "worth" $80,000? 5 years from now, certainly 10 years from now, those houses will easily be $300,000 again, and QUITE LIKELY much more.

This entire economic downturn, ESPECIALLY being driven by real estate values, seems profoundly myopic to me. These aren't tulip bulbs. These are tangible goods and often land.

Do bankers really expect everyone to abandon Southern California?
posted by Ynoxas at 11:01 AM on March 9, 2009

Warren Buffett to Timothy Geithner: Your 'muddled' message hurting recovery.

New US House Report Critical Of Banks' Use of TARP Funds

Four largest TARP recipients spent billions on 'questionable transactions': memo

House panel criticizes bank bailout oversight

Cuomo Demands Merrill, Bank of America Bonus Data

(Flashback: precisely one year ago this month the cause of the crisis on Wall Street was identified as the shadow banking system, and almost four years ago AIG was called the next Enron)...

Why TALF is bad for America

TALF: To Serve Man
posted by ornate insect at 11:21 AM on March 9, 2009

"IANAE either, but I cannot see how simply giving money to the banks, AIG, the big automakers works better than putting it in at the bottom. On both psychological and fiscal levels, money to the consumer would give a better bang for each buck."

Meanwhile, if all these entities collapsed, we could see effects throughout the whole economy which would be much more devastating. You could still have your stimulus check, but it wouldn't do much good if we don't have a functioning economy.

The government is the spender of last resort, which is the reason it's being done this way. Giving money to people individually would likely not result in much increase in spending.
posted by krinklyfig at 11:27 AM on March 9, 2009

"Who is getting all these houses that were worth $300,000 and now are being foreclosed because they are only 'worth' $80,000? 5 years from now, certainly 10 years from now, those houses will easily be $300,000 again, and QUITE LIKELY much more."

Well, these loans have been securitized. If the value drops, it affects the securities to which the loan is attached. The banks don't want to value all their holdings like this, and it is partly due to mark-to-market, so the securities are only worth what the house is currently worth. This means not only the homeowner but the investors get wiped out if the house is devalued, and it's not just individual investors who hold these securities, but mutual funds (meaning a lot of 401k accounts), institutional investments, muni investments, etc. If banks are holding these securities, it opens up bigger holes on their books, and indeed it may reveal that many banks are not at all solvent. There is a lot of delaying going on for various reasons.
posted by krinklyfig at 11:32 AM on March 9, 2009

stop the AIG loans

You know, throwing AIG overboard sounds good and it makes us all happy because They Wasted Our Money, but given what a complete and total mess they are and how deeply entangled they are with the bond market through credit default swaps... well, we don't know what would happen if they just up and failed. But "cataclysmic" would be a good starting point.

The scary part, of course, is that AIG failing is probably only the third or fourth worst thing that could potentially happen to the financial system this year. And I'm not including black swans.
posted by dw at 11:42 AM on March 9, 2009

Bernanke Says Insurer AIG Operated Like a Hedge Fund (a hedge fund we are now keeping afloat)

Credit-default swaps harm businesses:
...Six Flags Inc. and...Ford Motor Co. may be pushed toward bankruptcy by bondholders trying to profit from credit-default swaps that protect against losses on their high-yield debt.[...] "Before, you really had to worry mostly about where you were in the" company's capital structure, [Eagan, an investment manager] said. "Now, you have to consider the possibility that you might have this large holder of CDS incentivized to see it go into bankruptcy. It's something that's going to come up more and more."

GE Capital Hires Banks to Sell Government-Backed Debt

The Woman Greenspan, Rubin & Summers Silenced (October 2008):
In 1997, Brooksley Born warned in congressional testimony that unregulated trading in derivatives could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it." Born called for greater transparency--disclosure of trades and reserves as a buffer against losses.
posted by ornate insect at 11:45 AM on March 9, 2009

dw--if you read some of the links in my first post, you'll see that the AIG money is going through AIG and to the banks. Why not just cut out the middle man, and give that money directly to the banks but with some actual oversight and strings attached?
posted by ornate insect at 11:47 AM on March 9, 2009

k-fig > ...Meanwhile, if [banks, automakers, AIG] collapsed, we could see effects throughout the whole economy which would be much more devastating. You could still have your stimulus check, but it wouldn't do much good if we don't have a functioning economy.

Well, first we all know that they wouldn't all just fail, as in cease to exist, right? A few would be shuttered, some would get merged or taken over, and some would be nationalized. This is still going to happen for some anyway, despite all the money we just flung at them.

Secondly, unless it went under a mattress, stimulus directly to consumers would either pay debt (possibly avoiding some bankruptcies and foreclosures), go into savings or investments (... the BANKS), or get spent. As Mutant pointed out, a direct consumer stimulus could have restrictions on it that force the consumer to spend it in specified ways or lose it.

The government is the spender of last resort, which is the reason it's being done this way. Giving money to people individually would likely not result in much increase in spending.

The government can also be the lender of last resort, if necessary.

You also discuss how house values affect the securities that are based on them. I get that, which is why I believe that if the number of foreclosures can be reduced, less of those securities go south, and the realestate won't be awash with power-of-sale properties.

In the same para you mention that [events] may reveal that many banks are not at all solvent. There is a lot of delaying going on for various reasons.

No shit! This stage of denial, of willful ignorance and groundless faint hope helps no-one except the banks and only for the short-term. We need to know NOW what the real story is, rotten or not, and deal with it.
posted by Artful Codger at 1:52 PM on March 9, 2009

The government can also be the lender of last resort, if necessary.

You know, not so long ago, the government was the lender of last resort, and it was even printed on the money itself. Now, I'm not suggesting we turn our greenbacks into silver certificates like we used to have. But how about "pay to the bearer 3 acres and 1 mule?" I mean, we've got plenty of open land left, right? Or "pay to the bearer, 100 bushels of corn." Let the politicians pick their pork.

Better still… when the notes are printed we could have the treasury randomly choose from thousands of "things" we agree are worth certain amounts of money. So, your $5 bill might be redeemable one medium-sized stuffed panda, but your friend's five could be a family-sized bottle of aspirin (generic brand).

I am a genius.
posted by Civil_Disobedient at 4:37 PM on March 9, 2009

Gargantuan derivatives market weighs on all other issues
posted by ornate insect at 5:26 PM on March 9, 2009

Its probably best if we don't make decisions based upon the superficial knowledge of people whose primary job is to be a columnist.
posted by sfts2 at 7:30 PM on March 9, 2009

the superficial knowledge of people whose primary job is to be a columnist

No argument with that philosophy, but in this particular case, I don't think it applies. He has a background very suitable for writing just this kind of article.
posted by woodblock100 at 8:44 PM on March 9, 2009