Bailout Bill To Make Money Market Liquidity Crunch Worse?

Boy, I wish I had thought of this, and why no one else save some smart readers have focused on the mechanics of the Paulson plan operations is beyond me. This bill is moving ahead like the Titanic…..with high odds of similar outcomes.

Hoisted from comments, we turn the mike over to reader Don:

The bailout, I mean rescue plan, can be seen as nothing less than a new Ponzi scheme. It works like this:

Fed as only lender, in an attempt to keep the financial system from imploding;

TARP needed to keep Fed balance sheet intact so that it can continue as only lender;

Treasury will need to significantly increase the amount of Ts (public money) auctioned to fund TARP;

Panic serves to encourage T. buyers, especially for bills;

This represents a liquidity trap: TARP recipients of Ts will hoard cash to buy Ts: rinse and repeat.

This results in drying up of lending to corporations/crowding out private capital – no new credit lines;

The Fed becomes a holder of private capital, the later of which is now frozen to protect that capital from deteriorating, The rollover scheme will restrict even more lending in the private sphere for purposes of keeping the financial sphere on life support, but with the consequence of furthering the deterioration of the ‘real’ economy.

The counterargument is that the TARP will end the fear, breaking the Treasury-hoarding. But with banks (presumably) able to use the new phony prices paid by the TARP as marks for asset valuation purposes (whether they sold to the TARP or not), you get less transparency and hence less faith in bank balance sheets.

Further remarks from reader FairEconomist:

My thoughts exactly, Don. Plus the durations target the drawdown precisely on the capital we need most. We’re desperately short of 3 month working capital, and here comes Paulson to take $700 BB of what we’ve got left away and dump it in the mortgage industry. I don’t think you could devise a worse plan. We might be better of if he *did* steal it.

Informed reader comment very much appreciated.

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61 comments

  1. Matthew Dubuque

    Matt Dubuque

    Gerald Corrigan, former NY Fed chief and current managing director of Goldman Sachs, today proposed, in my view, a way to address these concerns.

    Corrigan outlined a 3-point plan to accelerate reform of the CDS market that should accompany passage of the TARP legislation.

    He argues that one of the reasons the interbank (and by extension the commercial paper and other secondary transmission mechanisms) markets have frozen up is because of the tremendous uncertainty injected into valuation models by shortcomings in the current CDS framework.

    In short, he is arguing that by simultaneously reforming the CDS market, we can reduce the risk premia that is intensifying the spike in interest rates and this will help restore trust (and therefore assumption of counterparty risk) within the system.

    I can provide a link to these ideas he voiced today if others are interested.

    I have found his work to be deeply insightful in the past.

    Matt Dubuque
    mdubuque@yahoo.com

  2. Pascal

    “Where the Secretary receives a meaningful equity or debt position in the financial institution as a result of the transaction…” … “the Secretary shall require that the financial institution meet appropriate standards for executive pay…” The rest is just as unconvincing.

    OK. Let’s get this straight. It started with an easy-to-read (except for Mr. McCain) 3 page plan that was completely outrageous and summed up to the taxpayer taking the toxic assets and Wall Street taking good money with the hope of re-selling these assets later. It then went to a 100 odd page plan that added a lot of fuzziness while keeping the same basic principle. Just when you thought it could not get any worse, they came up with essentially the SAME plan, but with roughly 500 pages of incoherent and out-of-context bells and whistles – a 15 000% inflation rate in 14 days. Now THAT is what I call inflation! Maybe they are trying to reach an inflation rate in the number of pages equivalent to the bailout cash required? Wow.

    This bailout plan is like the Bush Administration and financial markets – it is in a highly refined state of broken! It was obvious from the beginning that purchasing at best a third of toxic assets at market prices will not decrease the excessive leverage of firms, which is the core issue they could have partially addressed through recapitalization with shared equity. All this is taking place while putting taxpayer money and the fiscal position at risk in the medium term, thus depleting the firefighting toolkit for the next Administration – the Bush rampage continues unabated…

    They are preparing themselves for a huge financial tsunami with improvised ad-hoc walls of sand bags, the mega wall of sand bags (bailout) still being dwarfed by the proportions of what is coming. I repeat myself: this is a glass of (expensive) water thrown at a burning house.

    I think we need to accept reality: this financial tsunami will simply happen no matter what and we should not waste resources in fruitless, risky, and potentially costly endeavours. Granted, Paulson and co. can’t say that and they MUST do “something.” But I can say that: generalized global deleveraging must simply happen, and it hurts. We should try to contain the damage while preparing for the storm when it hits the streets… and pray for a functional and coherent Administration!

  3. Anonymous

    “… and pray for a functional and coherent Administration!”

    There’s an old saying, “pray to God, but row towards shore!”

    We all now that this was a deal Bush made long ago – lend us your global money to let us pay for the War, and I’ll pay you back…

    Hence, end of term, end of deal.

  4. Anonymous

    I get the basic principle here, that the government might be eating up the little private capital that is available through the issuance of T-bills, but the explanation really needs some beefing up before any but the very financially astute will understand this.

    “Panic serves to encourage T. buyers, especially for bills;

    This represents a liquidity trap: TARP recipients of Ts will hoard cash to buy Ts: rinse and repeat.”

    These two points have to be established rather than assumed, as well as elucidated with better language.

    I very much applaud the insight, however.

  5. lewy14

    I second what Anonymous 7:43PM said.

    In particular I don’t get how auctioning more Treasuries induces panic, especially since much of the discussion has been around potential for depressing prices at mid-duration (bonds, not bills).

    And I don’t get how providing prices (phony or not) lessens transparency and confidence (which is near non-existent at present).

    I’m not saying I agree or disagree, I just don’t have enough here to go on.

  6. Anonymous

    This really may be an all hands on deck moment for our nation, Yves.

    The bailout is not going to work, and people will pretty quickly understand this.

    I think connected folks need to begin to look at unthinkable alternatives: One I would suggest is a quick reduction of the work week to 32 hours.

    I know this is totally off the radar scope, but I am pretty sure it needs investigation.

    There are frar too many proposals looking at obscure details of the financial system, when the real danger is a swiftly unfolding impact on ordinary American families. Our families cannot be bailed out, so unorthodox methods should be investigated. It would cost no money to implement.

    Remember, this was the alternative path we could have followed out of the Great Depression, but we chose instead to use inflation.

  7. Anonymous

    Au contraire, confidence is high, apart from a few hedge withdrawl notices. Mom and Pop aren’t queued up around the block at Wells Fargo and Chase, demanding cash. GM and Chrysler are still in business. Buffett is buying, Obama is smiling, oil is cheap, and Ireland just indemnified every Irishman in perpetuity. Yay!

  8. Anonymous

    TARP = Troubled Asset Relief Program, the official name for the “bailout bill’.

    Some rare truth in advertising, since they are trying to cover up some steaming doo-doo.

  9. joe

    Sometimes I can’t believe how dumb I am.
    There is a money drought in the neighborhoods.
    Scarcity of capital.

    We the people, acting through our government, need to inject liquidity into what is being called the Main Street economy – because that is where the rest of us live.

    For some reason, we need to go through the private banking system to get there.

    Pity.

    Too bad we the people couldn’t bypass that private banking mechanism, and provide some common sense trickle-up economics for a change.

    This article postulates very well the precise mechanism which may be exploited – nothing wrong with that – by those wealthy few who have already mismanaged the US econmy, in order to enrich themselves further at the expense of the American taxpayer.

    I am pleased that Matt has provided a focus on the most seriously understated part of the day’s discussion, which is the basic problem underlying our state of illiquidity.

    Matt explains that Gerry Corrigan (bowing) argues that “”one of the reasons the interbank (and by extension the commercial paper and other secondary transmission mechanisms) markets have frozen up is because of the tremendous uncertainty injected into valuation models by shortcomings in the current CDS framework.””

    So, to be sure, one serious cause of the problem is the fact that we don’t know the value of our holdings.

    Pity.

    Here’s a former FED banker who wants the taxpayers to bail out his private company because when he was a FED banker he failed to ensure the necessary transparency, oversight and information that was needed to provide for a secure and stable banking system.

    I feel for you, Gerry.

    But, there’s the rest of us.
    The Main Streeters and the dirt roaders.

    If our government had the right to create the nation’s money via Treasury-issue, debt-free credits to the American people, well, then WE would get first use of that money coming through the taxpayer’s pocketbook.

    That REALLY seems like the right thing to do right now.

    Keep America going.

    Have trust and confidence in ourselves.
    And in the full faith and credit that the American people will, after all, pay it back.

    I don’t know what I was thinking here.

    The end of modern capitalism, maybe?

  10. Anonymous

    watching cnbc now… guy from cato institute against the bill ….. this freaking idiot, larry cudlow, doesn’t even let the guy finish ….. you stupid stupid larry …. just shut up and listen to the guy … i have never seen a half bald baby in my entire life….

  11. Anonymous

    Seems likely that the offering will be massively oversubscribed. After the 700 billion is gone, then those institutions that got rid of their troubled assets will be in better shape. Those that failed to get rid of those assets will be in far worse shape. Is it unreasonable to suggest that we’ll know in a week? By the way, isn’t this really a backdoor re-capitalization of the FED?

  12. Anonymous

    Help! I am confused. I don’t understand, can someone please explain:

    “This represents a liquidity trap: TARP recipients of Ts will hoard cash to buy Ts: rinse and repeat.”

    I want to understand so badly but I just don’t. Sorry to be slow on, this. If anyone could elaborate I would really appreciate it. Who are the TARP recipients? Do people who ‘sell’ assets to the gov’t, are they going to be paid in T-Bills? If not, how/why are they getting T-Bills? Or, are the banks just getting USD which they will then invest in T-Bills and not lend out to real businesses like they normally would?

  13. Douglas

    Yves you are completely IRRESPONSIBLE.

    The only objective you have is trying to foment as much PANIC and irrational thought as possible.

    First, we get posts about “pork” in the Bailout Bill without ever bothering to establish whether the “pork” was ADDED or were ALREADY THERE.

    THERE IS A DIFFERENCE.

    However, rather than bothering to establish that, we get a cherry picked list of “earmarks”.

    Hey Yves. I have a question. When were they added?? Is that a basic question? F YEAH BUT YOU HAVE NO CLUE.

    Ever since that dumbass comment about guns, this blog has been one crap post after another. No due diligence done by the author at all.

    Now, this is a great post, the foundation of which is posts from comments members in the bogus “pork” post.

    Now, the comments read “Is this the end of Capitalism?”.

    Starting to think there is enough stupidity in the last three posts on this blog to suggest some kind of bottom might be in. Are these posts the modern day equivalent of “blood in the streets”?

    Doug

  14. Don

    I have been asked the following, from a commenter:

    “I get the basic principle here, that the government might be eating up the little private capital that is available through the issuance of T-bills, but the explanation really needs some beefing up before any but the very financially astute will understand this.

    “Panic serves to encourage T. buyers, especially for bills;

    This represents a liquidity trap: TARP recipients of Ts will hoard cash to buy Ts: rinse and repeat.”

    These two points have to be established rather than assumed, as well as elucidated with better language.”

    I am basically working from a number of assumption, that I will attempt to make clear here:

    One, while the intent of the bailout bill might be to re-capitalize big finance and re-start lending, the flip side of this is that lending requires a borrower. My question is this: who will be that borrower?

    Here are my assumptions: Borrowing isn’t about to expand since a large segment of the population is in no position to take on more debt – too many of us are already burdened with debt – and I doubt the need for more debt exists among a large swath of corporations/business when we are slipping into an every deepening consumer driven recession. Businesses aren’t going to expand and grow when consumption is on the decline and will be for some time . . . since households are by necessity needing to reduce debt, not take on more, a situation made especially true while (another assumption), we continue to experience increasing job layoffs.

    I am assuming, then, that demand for more debt (or credit, if you prefer), just doesn’t exist. Consequently, this stated need on the part of the bail out plan is largely bogus. It’s real design is to unclog the movement of capital among the big boys – and the notion that by doing so it will then drip down to Main Street by increasing borrowing among households and business just doesn’t stand up.

    As for the panic rush into short term Ts: the panic has served Treasury well so far by keeping down yields (making it less costly for the Treasury in paying off that debt), at a time when the T. bill market is being flooded with ever new and expanding supplies, which need to be bought to keep the Fed balance sheet greased . . . thus the upside of panic, and thus the need to frame the “debate” as one of either you for us or your against us, no, I mean, either you are voting against a depression, or you are voting for one.

    More importantly, however, is the underlying point of my first assumption (that debt is not about to expand – and in fact will by necessity continue to shrink). If the injections by the Fed continue, which I (and others before me), argue that the bailout plan is really designed to support, then what happens if those injections do not lead to more lending/borrowing? My point here is that hoarding will continue. Consequently, the recipients of the injections will use the money to buy Ts, which serves to keep the operation going – with the recycling of injections – keeping the Fed balance sheet intact and the big banks from imploding. Thus the Ponzi scheme.

    So . . . in the end this has everything to do with keeping the big boys on life support, having little or nothing to do with “Main Street,” which of course explains why all the attention is being given to saving the little people. Doing so, we’re told, requires that we first save the big boys, if we want to save our own hide.

  15. Anonymous

    Doug, be careful, if Yves doesn’t like your tone, you will be banned.

    To the person who suggested a 32 hr workweek, do explain how forcing everyone to work less is going to be beneficial as we head into a recession. that is about as stupid a suggestion as any that have been made since the bailout discussion began.

  16. Sick of Politicians

    hey Dougie,
    CHILL OUT…
    nobody’s holding a gun to your head to read this blog…
    if you don’t like it don’t read/participate in it.
    Pretty Simple!

    Now for my real comment:
    Senate just passed the TARP (Taxpayer A%# Rape Program).

    On to the house where they will finish throwing the taxpayer under the bus….

    Bounce and crash…

  17. Anonymous

    This Blog used to be very interesting until a few weeks ago.

    Is has now transformed itself in a cove of maniac drepressive lunatics.

    Please go out of your house, have a look at the sun, the sky, smiling children anf flirty people ….

    The world is not finished, as usual we will manage to get out.

    Please do not try to look for the disaster angle of any action, you will always find one.

    Be propositive, let’s help each other out.

    A simplistic banker.

  18. Anonymous

    As I understand this ruse, the buyers of the treasuries used to finance this expenditure will most likely be foreign institutions and central banks. If in fact this is the case one could argue this proposal fills a short term need to the detriment of the longer term global economy. What a shock! This is off the subject but can anyone confirm that this bill gives Treasury more sweeping powers over the US economy. I have heard this is true but I have not read the bill.

  19. John Harris

    What does it matter when the pork was added? Nothing required the Senate to combine the bailout bill to a pork bill. God did not command it. It didn’t happen by accident. If Senate leadership decided to use the bailout to get the pork or else to use the pork to get the bailout, the result is the same.

  20. Anonymous

    “This Blog used to be very interesting until a few weeks ago.

    Is has now transformed itself in a cove of maniac drepressive lunatics.

    Please go out of your house, have a look at the sun, the sky, smiling children anf flirty people ….

    The world is not finished, as usual we will manage to get out. Please do not try to look for the disaster angle of any action, you will always find one. Be propositive, let’s help each other out. A simplistic banker.”

    Well, when things suck, it’s hard to be optimistic.

    I’m personally resigned to this situation. If the majority of the population and Congress want to f*ck this country up, I’m just going to shrug my shoulders and let them. I’ll take care of myself, my family, and friends, and that’s about it.

  21. Anonymous

    It would seem that central banks vulnerable to a dollar crash would be willing buyers/recyclers too.

  22. Anonymous

    Senate approves Financial Markets Bill 74-25. Here is who voted against the bill. If not listed, they voted yes.

    Democrats (39 yea, 9 nay, 1 no vote): Cantwell of Washington, Dorgan of North Dakota, Feingold of Wisconsin, Johnson of South Dakota, Landrieu of Louisiana, Nelson of Florida, Stabenow of Michigan, Tester of Montana, Wyden of Oregon

    Kennedy of Massachusetts did not vote due to sickness.

    Republicans (34 yea, 15 nay): Allard of Colorado, Barrasso of Wyoming, Brownback of Kansas, Bunning of Kentucky, Cochran of Mississippi, Crapo of Idaho, DeMint of South Carolina, Dole of North Carolina, Enzi of Wyoming, Inhofe of Oklahoma, Roberts of Kansas, Sessions of Alabama, Shelby of Alabama, Vitter of Louisiana, Wicker of Mississippi

    Independents (1 yea, 1 nay): Sanders of Vermont

  23. Anonymous

    Simplistic banker,

    This talk you find depressive happens to have been accurate. Roubini has been a very depressing read for a long time, and he has been spot on. We are in the middle of a financial crisis, the government is pushing through a crappy, hugely costly bill, and you want happy talk? Don’t shoot the messenger, the reality out there is not pretty.

    So you can be happy and hope the storm misses you. CNBC and Ben Stein are good for that sort of thing. Or you can try to be better prepared, which takes a stronger stomach.

  24. EvilHenryPaulson

    I thought I had posted something similar,
    October 1, 2008 7:05 AM

    Net capital inflow to the US = flat? With private investors and foreign SWFs replacing Central Bank and institutional withdrawals of foreign entities that need the cash for their own bailouts.

    Will the US government bailouts crowd out reinvestment into the US financial and manufacturing sectors also dependent on credit?

    I had the same notion coming from a foreign capital flows (see B Setser’s blog) perspective, and I agree – The Federal Reserve is becoming a Central Bank in the worst sense of the word.

    I will make caveat; lending will return to corporations for longer terms under some conditions. The Treasury is issuing paper heavily at 4, 13, and increasingly 26 weeks (Auction schedule), even if the existing paper rolls over into the same terms they are distorting the yield curve for the whole market.

    Banks will lend on longer terms, but credit markets face a net decrease in use of money market funds which could squeeze the heavy users (credit cards, auto loans) out into longer dated paper.

    The resumption in lending will be of little consolation to many small and medium businesses. Banks will be extremely averse to using depreciating assets as collateral like real-estate and some types of heavy equipment — even if there is a big enough margin of equity to protect themselves. Cash flow is also untrusted going forward into a sharp, deep, and potentially long recession L-shaped. Perhaps introduction of mark-to-opinion will encourage lenders to use something other than solid & liquid collateral (inventory).

    Other concerns include the scheduling of US debt has/will become unbalanced making the sovereign debt, and its credit rating, vulnerable to interest rate changes

    Others commenting on the blog: This blog did not cause the credit crunch, this blog will not cause a measurable impact in the macro-economy. Yes, this is not CNBC, and yes you are more than welcome to take Cramer + Fast Money's advice that the bottom is in. If you are interested in the equity markets, my opinion is we will head sideways until December and then there will be a resumption in falling stock market-price levels.

  25. albrt

    I definitely think this will backfire, but I’m more worried about the effect on the remaining private capital than I am about the effect on the Wall Street fee siphoners.

    Introducing a bigger supply of T-bills will coax the rates up from near zero. Three percent should be plenty high enough to give the folks with cash an incentive to stop looking for direct investments.

    And who would participate in money markets knowing how few productive investment opportunities are out there? The prospective borrowers are all insolvent developers, failing car dealers and underwater homeowners. Nope. T-bills for me as long as Paulson keeps ’em coming.

  26. Glory's List

    Dear Ms. Smith,
    I just listened to you on bloggingheads.tv, and I think you're correct: Paulson and the Admin are way WAY out to sea on this problem. The bailout, at best, will do nothing, and in 6 weeks, 2-3 months, things will start to really REALLY start to fall apart.

    What's your best case and worse case senario, and what should an "average" person like me do how has some savings, I'm freelancer, so I don't really have a "job," and I have savings and some stocks.

    Should I sell everything, buy meal-ready-to-eats and guns and oil and blankets and run away to the nearest cave?

    What can the average person do to best secure themselves over what's likely to be a very VERY bumpy ride?

    Thanks & Cheers,
    The Charters Of Dreams
    http://libertydesirebelief.thechartersofdreams.com

  27. Anonymous

    “We are in the middle of a financial crisis, the government is pushing through a crappy, hugely costly bill, and you want happy talk? Don’t shoot the messenger, the reality out there is not pretty.”

    Ok, what is the alternative, please you all, spell out a clear alternative.

    I understand the system is very flawed, that some actors need be punished, but probably is not the moment.

    Let’s save ALL those bank NOW, then, in a while, when trust in the system will be restored, we’ll go back hunting for all those responsible for the mess, we will rise government insurance cost for the banks, rise bank taxes to get back the money, whatever it takes.

    But now the system is at risk, for faults that are serious but are absoolutely not devastating.

    It is untoughtful to think that all wealth that was created in the last 12 years was fictius and only linked to leverage.

    Just close you eyes and remember 12 years ago, just think the access you have to informations, everything has changed … a lot for better.

  28. Glory's List

    Dear Ms. Smith,
    I just listened to you on bloggingheads.tv, and I think you're correct: Paulson and the Admin are way WAY out to sea on this problem. The bailout, at best, will do nothing, and in 6 weeks, 2-3 months, things will start to really REALLY start to fall apart.

    What's your best case and worse case senario, and what should an "average" person like me do how has some savings, I'm freelancer, so I don't really have a "job," and I have savings and some stocks.

    Should I sell everything, buy meal-ready-to-eats and guns and oil and blankets and run away to the nearest cave?

    What can the average person do to best secure themselves over what's likely to be a very VERY bumpy ride?

    Thanks & Cheers,
    The Charters Of Dreams
    http://libertydesirebelief.thechartersofdreams.com

  29. Pascal

    GREAT anaylsis evilhenrypaulson – thanks. Really. Great stuff. That was my take as well. To make a (long) story short…

    The mega bailout will have a very short lived (2 months) positive effect but most probably a longer effect on the fiscal position, which will significantly decrease the arsenal the next Administration will have to deal with the real storm in 2009.

    Country risk (USA) premium will increase, upward interest rate pressures will squeeze money markets and distort the yield curve even more, along with completely skrewed up risk assessment due to the lemons problem which will NOT go away and may even increase due to the freshly opened can of worms. Hedge funds exposed to CDSs will start having trouble, and THAT is way bigger in orders of magnitude. The rollover of debt will simply become harder and harder and we will be back to square one, with 700 B$ less… The New Year will start directly in Hell.

    Now can you give me your informed opinion on what you think this bailout will accomplish? Another question: what are your guesstimates as to where unemployment will go and where it would go without the bailout? If we expect 7-8% UR for 2-3 years, OK it is high, but is that worth all this panic and expenditures? In other words, is there real potential for this to turn into a true mega recession of several years with double-digit URs?

  30. Anonymous

    “To the person who suggested a 32 hr workweek, do explain how forcing everyone to work less is going to be beneficial as we head into a recession. that is about as stupid a suggestion as any that have been made since the bailout discussion began.”

    Actually it is not a stupid suggestion, simply one that has no currency. It actually was the central proposal of George McGovern’s book: Nonfinancial Economics, The Case for the Shorter Work Week.

    As you may know, several states have begun to implement the idea of fewer work day as means of controlling the budget expenditures with rising energy costs. In fact, according to one estimate, reducing the work week by one day might save as much as 8 million barrels of imported oil.

    What you may not know, is that it was actually the first response to the Great Depression, passing the Senate as the Connery-Black wages and hours bill. Which though passing, was never endorsed by Pres. Roosevelt. It was however, mentioned as a voluntary solution by Pres. Hoover.

    You should also know, that this “stupid idea” was expressly identified by Keynes in 1930 as the ultimate solution to the problem of unemployment posed by the Great Depression. And, was endorsed by Beretand Rusell in 1932 in his writing, “In praise of Idleness.”

    So, to aid in fiscal discipline, reduce imports and the current acount deficit, and address unemployment caused by an economic downturn – it may just bear looking into.

    Of course, I am not an expert on this issue.

  31. Pascal

    for The Charters Of Dreams… try to expand your web of contacts, don’t accumulate any debt, and stay positive and happy :) There is not much we can do (I am an economist who worked in a Central Bank)… the forces unleashed are incredibly strong and we can just hope that the financial crisis will not become an economic crisis… at least not too much. The real storm will hit in 2009. Just be psychologically ready to see a slow degradation of general economic prospects and you will also observe generally more negative social vibes due to cynicism…

  32. Anonymous

    11:02. There have been plenty of suggestions on this blog, other blogs, and op-eds, if you had checked. Yves was talking about the Swedish model way before it was popular to do so, and has served up other ideas too.

    In fact, that’s one of the very biggest lies about the pressure to get this bill passed, that it was the only alternative.

    The financial system is too large to be saved in its current form. There is too much debt out there relative to the size of the underlying economies. The financial system needs to be rationalized, not just propped up. That’s the fundamental flaw of your logic.

    No one ever said that nothing of value had been created in the last 12 years.

  33. Anonymous

    “To the person who suggested a 32 hr workweek, do explain how forcing everyone to work less is going to be beneficial as we head into a recession. that is about as stupid a suggestion as any that have been made since the bailout discussion began.”

    My factory is going to a 32-hour workweek for last week, this week, and all of October so far, but that’s because of reduced orders from customers.

  34. Pascal

    A shorter work week changes absolutely NOTHING to unemployment, other than perhaps increasing it a little due to decreased purchasing power! The aggregate unemployment rate is determined by frictional unemployment which is relatively low in the US, cyclical unemployment which is going to increase in the coming year, and structural unemployment which is market flaws such as overly stringent labour regulations (France) or wage rigidities. In the end, unemployment is determined by how far off the aggregate wage is from the labour market equilibrium and net purchasing power comes from the stuff you produce per hour – hence productivity. Period. Hours per week have NO theoretical framework and have not been an efficient policy when applied…

  35. Anonymous

    The 32 hour workweek made a ton of sense for factory workers and other people engaged in shift-work: at a given place of employment there really was some N hours of work worth doing in a week, and so forcibly restricting a given employee’s hours to 4/5 the previous range would’ve, ceteris paribus, lead to that place of employment needing to employ 25% more employees.

    When floating the proposal it’s usually assumed the hourly rate would’ve remained the same, and that the employees would’ve taken a 20% paycut; that might be harder to swallow, now, given how close-to-the-bone workers tend to play it.

    Net effect: increasing the # of bodies employed by decreasing the amount of labor demanded from each, thereby alleviating mass unemployment.

    NB: this isn’t an example of the so-called “lump of labor” fallacy; the fallacy is assuming as intrinsic fact about the world that there’s a fixed amount of labor to be done, so the only issue is how to divide it. The 32-hour workweek proposal was explicitly proposed in a context where many particular places of employment did have a fixed need for man-hours.

    In the upcoming new new deal it might not be a bad idea for the neo-wpa to do the 32 hour work week strategy: you pay individuals less and therefore can afford to employ more of them for the same budget, and the general disdain towards “slackers” (along with the low, low earnings) will have most neo-wpa employees scrambling for the private sector on an asap basis.

    The utah proposal was more about cutting down on transportation costs (4 days a week instead of 5 = 20% less spent on transportation to and from work).

  36. Pascal

    Yes. The Scandinavian approach is to outright nationalize… but a Republican White House will never do that! That is why we are here now…

  37. Anonymous

    From: http://economistsview.typepad.com/economistsview/

    Financial markets and financial intermediaries bring together people who have an excess supply of loanable funds with those who have an excess demand. But why do those with excess demand want the money? They want it because they believe they can use it to make profits through some business venture. They wouldn’t borrow the money if the expected payoff didn’t exceed the cost of the loan.

    So financial markets channel money to the real economy, and that is the source of the profits you see on Wall Street (beyond the zero sum game among some traders). Loans are paid back – with interest – from the profits the borrower made with the money. Money doesn’t breed, simply taking out a loan from a bank won’t make you wealthy, you have to do something productive with that money, that is where you get the profits to cover the loan and interest.

    So the ultimate source of profits on Wall Street is the real economy (though occasionally, i.e. when there is a bubble, the profits are based upon false valuations in the real sector). Profits come from people doing productive things with the loans they take out, and those productive things employ people and make the economy grow faster. Wall Street is a conduit to the real economy, it is not an end in and of itself, and when that conduit is not functioning properly – when money stops flowing through financial markets and intermediaries – productive activity is diminished and growth and employment pay the cost.
    ———
    During periods of recession, the demand for ‘productive’ credit decreases.

  38. Anonymous

    Don,
    I wonder if you overlooked something in your second assumption that even though there is a dire need to reduce debt as a whole, it’s going to be very hard for people to change their habits overnight. In other words, if the banks are willing to lend, there will be takers, however, the level of debt (vis-a-vis assets) may not be the same as before.

  39. Anonymous

    This is the guy with the stupid idea again:

    It just occurred to me that much of the anecdotal evidence so far offered on behalf of this bailout focuses on whether employers will be able to fund thier payroll and orders. There is the possibility that lower payroll and operating costs might alleviate some of the pressure on the credit markets as well.

    And, the 700Bn to be spent on this bailout might be better served to reduce taxes. Considering their are about 153 million labor force participants, 700Bn dollars would amount to about 4000 dollars per employee, or about 80 dollars a week in real income to offset the shorter hours of work.

  40. Anonymous

    Video from CNBC while the Senate voted. Discussing the historical context. Has Haines (Haines says “bitching” on live TV), Leisman, and Kudlow.

  41. battle for middle earth

    I doubt the next administration will foreclose on families that cannot pay their mortgage. When it becomes clear that the government will not foreclose, how much will those troubled assets be worth? How quickly will everyone figure out that their are few if any consequences for not paying.

  42. Anonymous

    Social Security and Medicare are the government’s biggest domestic programs; their outlays next year will run $656 billion for social security alone–almost as much as the proposed Wall Street bailout, and $412 billion, for Medicare. But this one-year cost of more than a trillion dollars is but a foretaste of future fiscal disaster. The total unfunded liability for these two programs–that is, the amount of promised benefits in excess of expected revenue–is $100 trillion. That is trillion with a ‘T,’ or about 140 Wall Street bailouts.

    http://www.huffingtonpost.com/bob-barr/bob-barr-warns-congress-m_b_130994.html

  43. Pascal

    Anonymous 11:39: good point, but your theoretical additional purchasing power to counter decreased hours following a fall in Govt, hence in taxes is still beside the point: the aggregate purchasing power is entirely determined by the average productivity of labour and nothing else. That is for the theoretical side… the pragmatic side is much simpler: G NEVER goes down significantly and never will, especially not once this mega bailout is passed… upward pressure on taxes will be impossible to get around…

  44. Don

    “Don
    I wonder if you overlooked something in your second assumption that even though there is a dire need to reduce debt as a whole, it’s going to be very hard for people to change their habits overnight. In other words, if the banks are willing to lend, there will be takers, however, the level of debt (vis-a-vis assets) may not be the same as before.”

    Lending standards are tightening at a swift speed. New credit lines for corporations is restricted in part by non-availability of credit or too high price to pay. Unpaid debt on the books is too high to re-start new debt expansion without the economy, number of jobs and income all increasing.

    The bottom line with the (admittedly purely speculative) notion that I presented as contained in Yves introductory commentary, is that the Fed is now in the same boat as the big banks, where the fate of each are joined at the hip. The key, and this is part of Paulson’s plan, is to administer which banks fail and which succeed.

    With their fates tightly woven, the ability for capital to expand by way of economic expansion is restricted, since the lending AND borrowing system are no longer adequately functional.

  45. Anonymous

    “11:02. There have been plenty of suggestions on this blog, other blogs, and op-eds, if you had checked. Yves was talking about the Swedish model way before it was popular to do so, and has served up other ideas too.”

    I’ve not seen a single clear suggestion. Any of the suggestions that were given would have been subject to the same carnage as the bailout.

    So, you say, Yves proposal is the Swedish model.

    Please raise your hands who in this forum is in favour of a straight nationalisation of all US Banks.

    I’m not.

  46. Anonymous

    11:02. Frankly, it isn’t worth arguing with you because you reduce everything to a soundbite and dismiss it.

    The Swedish model is not a straight nationalization. First, and this is still a very high level summary, the government did extensive study as to who could be saved, a triage of sorts.The banking system was reduced in size by banks too far gone being liquidated or folded into sounder banks. Shareholders wiped out, new top management installed, bad assets spun out to a liquidation vehicle, banks later brought public.

    The government did not have any reason to nationalize sound institutions, which is what I think you are implying was part of the program, and I would be astounded if they did.

    And when banks fail and the FDIC cannot find a buyer, what do you think has happened? The government owns it. It strikes me you are hung up on language and ideology and have not at all though through alternatives.

    They made money on it, BTW. It is UNIVERSALLY considered to be the most successful model of handling a financial crises. Fed, IMF, other papers agree on this point.

    So if you’d rather reject the best approach (or an American twist to make it optically more palatable), and advocate something that doesn’t, so be it. That why we are in the mess we are in. People having not factually grounded views of what works and does not work and insisting they are well informed.

  47. FairEconomist

    @Matt Dubuque – So Corrigan is saying if we combine the TARP with another program that actually helps, we’ll see some benefit. Possibly true but not much of an argument for the TARP.

    @evilhenrypaulson – lots of good points about the details of which kinds of loans are being affected and in what way. I think part of the problem is that the Fed folks, and Paulson, are thinking of the economy in Macroecon 101 terms in which there’s just one form of capital. But actually there are many and helping one market doesn’t necessary help or even not harm another market.

    @albrt – good point on the rates, which I incorporate into my analysis below. It helps me define the precise mechanism by which Paulson’s T-bills will crowd out working capital loans, which had been sketchy before.

  48. FairEconomist

    I’ve been thinking mostly about the durations issue, mostly because it’s really obvious something is going badly wrong in the commercial paper market. If you look at the volume report http://www.federalreserve.gov/releases/CP/volumestats.htm overall paper is actually *up* but the longer durations (20+ days) are way down. For example: the overall market average for the week of Oct 3 is 183,610, up from 2008 average of 148,710. But 20-40 day paper is only 6,778, *way* down from the yearly average of 15,864.

    So the market has lost about 2/3s of its ability to convert liquidity to 30-day loans. 90-day is probably similar although there are technical issues with analyzing the chart because 90-day would expire during the end of year crunch so there probably isn’t much demand. Next week we’ll be able to look at 90-days again.

    One of the most critical functions of the banking system is converting short-term deposits into longer-term loans for businesses. Much of the working capital market, for decades has come via money market funds (MM). Joe public or Joe CFO deposits money into a MM. That MM loans it to a bank (usually by buying paper, and usually at a medium duration) and then that bank loans it out to business for inventory, payroll or whatever. The MM has converted Joe’s demand deposit into a fixed-duration loan.

    The problem we’re having is that people are fleeing commercial MM for treasury MM. Those are buying treasuries and thus converting the money to the desirable medium duration BUT that money is loaned to the Fed, and the Fed doesn’t make working capital loans. So the deposited money that had been made into working capital has been diverted into the Fed and lost to working capital.

    The Fed is kind of trying to address this by loaning out money via various auction/discount windows. BUT, those loans have been overwhelmingly overnight – a particularly nasty demand deposit because it goes back so fast. For a bank to convert that to a 90-day loan it’s got to win 90 auctions in a row – a very risky deal with a crunch on. So the Fed undoes the duration conversion, and then some, converting the liquidity into a form that the banks can’t make into useful-duration loans.

    Right now we have both commercial and treasury MMs. Deposits have shifted from commercial MMs to treasury MMs, and consequently we have less working capital (a commercial MM product) and better credit for the Fed (a treasury MM product). But, treasury MM rates are now very low and the gap between treasury and commercial fairly high, which creates an incentive for depositors to put money into commercial funds, producing some working capital.

    When Paulson dumps out his 700 billion in treasuries it’s going to be at the short end. That will drive up rates for short-term treasuries. This will obviously draw even *more* deposits into the treasury MMs. That means even less in the commercial MMs and thus less working credit, the eventual commercial MM product. Hence Paulson’s billions remove working capital by competing for the deposits that could get used to make working capital loans. That 700 billion is going to go to fairly long-term mortgage securities. So Paulson’s billions divert credit from working capital to long-term mortgages – from where it’s most needed to where it’s most wasted.

    Even if the giveaway adequately props up the banks, which I doubt, they still can’t make working capital loans, because the raw material they used (commercial MM deposits) will be desperately short.

    I think it’s very telling that in two days of hearings and two weeks of discussion we have yet to see *any* detailed mechanism for how Paulson’s plan will increase the supply of, say, inventory loans. It’s not that every economist in the world is an idiot, it’s just not going to help. I think people have fallen into the fallacy that if it costs a lot it must be valuable. Paulson’s plan falls into the category of very expensive way to hurt ourselves.

  49. ciccocicco

    “11:02. Frankly, it isn’t worth arguing with you because you reduce everything to a soundbite and dismiss it.”

    Sorry, if I sounded like that. I’m actually quite satisfied that at least you have a proposal and are not just showing all the fallacy of the bailout.

    I don’t agree with the Swedish model because it requires high ethic standards on the part of politicians that could be found in Sweden and not in the US.

    Even if I don’t agree I would anyhow accept it as a solution, any solution is better than doing nothing.

    With regard to the Swedish model, it REALLY was semplicistic. Basically they passed a law that seaid that all banks whose ratios where below 2% coulb be seized by the government.

    But are you sure that a large part of the people around this blog would be in favour?

  50. Anonymous

    I’ll call you 11:02 since that’s easier to write…

    If a bank here got to 2%, I think the regulators would have a heart attack. That’s way below the levels they look to have.

    In a video at Barry Ritholtz’s blog, Chris Whalen, who is a banking industry expert (well regarded private research service, big bucks clientele, you have to be a lot better than a Wall Street analyst to have your own boutique), had nothing but good to say about the FDIC’s competence. Conversely, he wouldn’t trust anyone else in DC to handle banks. So the skills are there, but Paulson wants to build his own bureaucracy.

    I’m not a regulatory expert, but my understanding is that bank regulators have very broad authority regarding their charges, If they declare you insolvent, there is no way to appeal. I assume some legal provision has been made in return for getting a bank charter.

    So in the US, we wouldn’t need a law like Sweden’s. The regulators could take banks with a low level of capital out and shoot them (I’d suspect at least a big bank, since they have a lot of assets with squishy values. Believe me, if a bank’s books said its equity was 2%, I’d bet a team of inspectors could find a basis for questioning enough valuations to have it declared insolvent).

    We just tend to bend over backwards not to put banks under. But look at Freddie and Fannie. They were asked to agree to the conservatorship, but told it could be done on an involuntary basis if they tried fighting. And both, well certainly Fannie, as far as their public financials were concerned were in compliance with statutory capital requirements (Freddie was out of compliance on one metric).

  51. Juan

    anon 10:59 PM,

    Please recall that paper representations of and to wealth are not directly productive of wealth but are fictitious capital standing next to, and against, that surplus value created and expected to be created within the real economy. Such claims to anticipated value can, have, come to contradict what they claim.
    Evidently there are limits which credit creation and modern intermediation assist in surpassing but only at the cost of creating still greater tensions until these become unresolvable. The financial mode of appropriation fails even as/because crisis management seeks its perptuation.

  52. Hughson

    I dont know much about the economics but i have taken a short cut a researched and read extensively on the history of money to conclude that if the US does not Move quick to sure up the system, we will all be lauched back into stone age. The chances that this will succeed are low given historic similar instances but it is worth a try. The whole world is dependent on the dollar and it will support the deficit of the US at greater cost.

  53. Anonymous

    So far, Bernake’s and Paulson’s “track record” has been to create a bigger bailout, to fix the previous, failed bailout. Obviously, we’re at the end of the road with that tactic. So if this mother-of-all bailouts doesn’t work, I sincerely hope the Thomas Friedman’s of the world stop looking to these “leaders” for solutions. If only a couple of Roubini-types had been advising them all along, we’d be in better shape.

    Ben and Hank supporters are unable to explain why these two, who have consistently misread the severity of the problems, and who are the root cause of the problem (Ben’s predecessor, Greenspan, and Hank at GS), should have the solution. Their real-time track record is near zero.

  54. River

    Why don’t we call a spade a spade? Imo, the bailout bill is nothing more than an attempt to prop up a failed economic model, a recapitalization of the banks with taxpayer money, and most of all a life line to the financial elite who are ‘friends of the administration’.

    TARP will do little to stop the tidal wave that will destroy Main St and small businesses. Once small business, which provide about 40% of US employment and is the only REAL economic engine propping up the US economy, is unable to raise capital to continue business, the game is over. No amount of government spending of taxpayer money can replace small business revenue and job creation.

    The butt heads are sacraficing the last remnant of capitalisim, small business, in an attempt to save their pals on Wall St.

  55. Anonymous

    River said: “Why don’t we call a spade a spade? Imo, the bailout bill is nothing more than an attempt to prop up a failed economic model”

    This is the guy with the stupid idea again:

    I really have concerns about this, and that something like the great depression would not be a survivable event today. Conditions are very different than they were in 1930. Only a fraction of one percent of the population live on farms today and could provide for their immediate needs.

    Leveraging in the financial sector is matched by economies of scale in the manufacturing sector – which implies a horrendous and rapid downside if things begin to unravel.

    For instance, agriculture rests on a very narrow base – .67 agricultural workers for every 100 non-agricultural workers. This would seem to leave that sector very sensitive to a sudden rise in unemployment.

    85 percent of workers do not produce a single real good, so all material production rests on the output a very small segment of the population which is itself very vulnerable to a downturn. We could, for instance, lose all the US automakers in a matter of months if things continue as they have been reported in September sales.

    All the economists I follow are focusing on the niggling details of a financial bailout, no one is looking at a potentially disastrous macro event.

    A shorter work week, with aggressive tax reduction for working people, might allow for an orderly unwinding of the debt bloated domestic market, but no one is looking at it. In fact, the merest suggestion leads to cries that it is insane.

  56. DailyVus

    what to do to prepare for the worst? There’s protecting assets that has been well covered here. I like the medicine, food, cigarettes and bullets barter information. Thank you.

    Start thiking about relocating to a place know for its kindness. You can pitch in with whatever your resources are and survive happily at the same time.

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