More on the Financial Crack Up

The Left Business Observer always provide intelligent insight without cant or rant. (And the founder of the LBO, Doug Henwood has a nearly perfect name.) Anyway, here is a link to his take on the 'current' financial crisis - except he is writing about the bailout of Bear Stearns back in March 2008 for the now quaint cost of a mere $30 billion federal guarantee.

Reflections on the current turmoil 2

An excerpt:

Saving Bear

The most astonishing announcement of all doesn’t appear on the graph: the Bear Stearns rescue, if you can call the essential liquidation of an 85-year-old firm a rescue....

Was it necessary? And what does it mean?

To answer the first question with a question of sorts: depends on what you mean by necessary. If you’re a free marketeer, your answer is no—let failure take its course, and everything will work out in the long run. (It was in a very similar context that Keynes made his famous remark about our being dead in the long run.)....

But if you think the risks of throwing millions out of work to make a political point aren’t worth it, then some sort of bailout of Bear was necessary. The firm wasn’t all that big (and the past tense is warranted, because it’s going to be absorbed by JP Morgan Chase), but it was connected to scores of other institutions, like banks and hedge funds. If Bear had gone under, it would have left those so-called counterparties holding an empty bag, and many would have probably followed Bear down the drain. And they could have dragged still others down.

Aside from that direct effect, the blow to confidence would have been enormous, and without confidence, the financial markets just can’t operate. If Bank A doesn’t trust that Bank B is good for the money, it’s not going to trade with it. That would mean a freeze-up of normal business and consumer lending that would quickly throw the real economy into the tank.

Real money needed

JP Morgan Chase is paying a notional $2 a share for Bear Stearns, a thirtieth of what it was worth less than a week before the takeover. But JP Morgan is also assuming the risk for some of Bear’s crappier assets, which could turn out to be worthless, or close to it. The Fed is offering JP Morgan $30 billion in guarantees against the worst, which may or may not ever be needed. In any case, so far the Fed has made mostly promises that have not yet been called on. So there hasn’t been any significant expenditure of public funds on this bailout....

But it’s also extremely unlikely that this crisis will be resolved without the expenditure of real taxpayer money, and probably large gobs of it. Resolving the savings and loan crisis of the 1980s took about $200 billion of federal money—amazingly, no one knows exactly how much; the equivalent today would be $400–500 billion.....

Since the expenditure of public funds is probably inevitable, it would be very nice, if the public actually got something in return—though the precedents for this are not encouraging. At the very least, the financial system badly needs to be re-regulated to prevent the sort of wild speculative adventures that have become routine in recent decades.....This whole boom–bust–bailout cycle has gotten very wasteful and very dangerous.....This time around, the hangover is even worse than the last go-round. What might the next one look like without some sort of re-regulation?....

The underlying problem

That brings us to the next issue at hand: the housing problem itself. All the financial melodrama discussed above is a reflection of the fundamental underlying problem that people took on mortgages that they couldn’t afford to buy houses that are now declining in value. All the Fed’s gyrations cannot really resolve that fundamental problem. And it’s very unlikely that there’s much of anything that the government could do to change that either.

As LBO has pointed out before, the housing boom that took off in the mid-1990s was totally unprecedented in U.S. economic history.