“The only reality-based solution to dealing with bankrupt, insolvent institutions is to let them fail and let them file for bankruptcy protection. Once this has happened their debt is largely discharged. To not do so, or as Ben Bernanke’s plan would have it, to give all of these insolvent institutions billions of dollars to keep them afloat, means that (1) a multi-trillion dollar deficit becomes the tax burden of future generations of Americans, (2) those who became rich on their own excesses are not held to account and retain their individual wealth while the majority of Americans struggle to get by, and (3) the speculators and gamblers who went into debt are released from any responsibility—they are free to find new ways to exploit the system, and they know that if, in the near future, they run up bad debts again, relief awaits in the form of help from the government. Hence there is no deterrent to this type of behavior. And so Ben Bernanke’s plan, at best, creates an enormous tax burden for future generations of Americans while simultaneously doing nothing to deter would-be speculators and Ponzi-schemers from plying their trade time and time again. In other words, the Bernanke and Obama plans are not solutions, they are obfuscations. They do nothing to change the system that has brought us to this point.”

(One of my favourite sites.)

On President Obama (4)

One of the earliest things that I disliked about Obama’s political stance was his support for subsidies to ethanol producers.

This wasn’t just because I tend to disagree with subsidies generally but because of the havoc that such subsidies cause on the food market, as can be seen from the rise in the price of wheat recently. The policy which Obama supports is directly responsible for the immiseration of millions. (For more detail on just how scary the situation is, see Stuart Staniford’s article here.)

I tend to see this as a perfect example of government intervention – a well intentioned act that goes wrong. Where we have room to become even more concerned is with regards to protectionism, in particular, whether Obama, perceived to support protectionist policies, is likely to sign into law another Smoot-Hawley tariff act.

So my issue with Obama is whether he will try to use the powers of government to escape from the crisis in such a way that the problems become worse. That is, will he understand the problems clearly enough to recognise that central control is not a viable solution?

The energy crisis is the most severe problem faced and, as exemplified by his policy on ethanol, there is little sign that Obama understands the extent of this. (This may, however, be due to electoral calculation – we shall see what he really believes when it comes to making decisions, eg on the future of GM/Ford etc – see below.) His language about “a rescue plan for the middle class” is, however, ominous for its inappropriateness. There is no way in which the middle class of the United States can be rescued, and to make that a principal soundbite from his earliest press conference is deeply disturbing.

The model or prior example that is generally being referenced in present day discussions, especially about economics, is the experience of the 1930s. In particular I have a strong suspicion that Obama sees himself as following in the footsteps of FDR, who actively used government intervention to ‘prime the pump’ to get the economic system running again.

This ignores several things, things which are rather important.

The first is that FDR faced no shortage of resources. There was abundant energy available, along with raw materials and, in particular, the government was solvent. Given the effective bankruptcy of the US it seems unrealistic to expect Obama to have enough finance to achieve his aims, not least if the US dollar collapses in value.

The second is that, by the time that FDR was elected, the shape of the crisis was clear. I am not persuaded that Obama has a decent understanding of the predicament that he is inheriting, and nor do the American people (or most other populations come to that) – that is, I think he needs to ponder Dmitri Orlov’s work. We will see very early on whether Obama ‘gets it’ when we see how he treats the car industry. Either he will actively try and reshape it towards extremely efficient cars and (more importantly) a retooling towards massive investment in public transport, especially rail – or he will try and keep the system going for a little longer. If he chooses the latter then he will fail, miserably.

Consequently, thirdly, I expect the Obama campaign to try and act dynamically and aggressively, using the levers of government, to try and change things around. In this endeavour they will fail, because the wires connecting the levers to the parts of the engine have been severed. One of the principal impacts of Peak Oil will be the hollowing out of government. In such a situation the political future belongs to someone who can bring Clint Eastwood’s desires to fruition: “I wish there was a Libertarian candidate who would put forward a more Libertarian point of view – leave people alone, don’t put so much regulation on them and live within our means. Everybody’s going to have to go back to that.”

It is possible that Obama will realise that this is the situation early on in his first term of office and that he will then use his considerable rhetorical gifts to persuade the US people both of the magnitude of the tasks that face them, and their ability to meet those tasks. I suspect that he won’t be able to do such a thing however, which is the burden of my next and final post in this sequence.

How Canada solved their part of the financial crisis

“In August 2007, it was discovered that Canada, just as the U.S., had a subprime mortgage-backed securities problem. Since the Canadian economy is more than ten times smaller than the American economy, the magnitude of the problem was also smaller, but it was nevertheless acute.

Indeed, Canada’s subprime mortgage market was a smaller proportion of the total mortgage market than in the U.S. and mortgage defaults have not been as prevalent in Canada as in the United States. For instance, there has not been a housing bubble burst in Canada. Overall, risky mortgage-backed paper constituted, about 5 per cent of the total mortgage market, while in the U.S., subprime mortgage paper constitutes about 20 per cent of the total mortgage market, and mortgage defaults have been rising dramatically.

Nevertheless, there was some $32 billion (CAN) of non-bank asset-backed commercial paper in Canada. When this market became illiquid after August 2007, as a consequence of the global credit crisis that originated in the U.S., a restructuring committee was assembled in Canada by large pension plans, Crown corporations, banks and other businesses holding the bulk of $32 billion in non-bank asset-backed commercial paper (ABCP) in order to find a solution to the liquidity problem. (Large Canadian banks covered the asset-backed commercial paper that were on their books or in their money market funds). This was the Pan-Canadian Investors Committee for Third-Party Structured ABCP, chaired by a Toronto lawyer, Mr. Purdy Crawford, and created after a proposal that originated from the large Quebec pension fund, the Caisse de dépôt. This was the Montreal proposal.

The committee ended up proposing to restructure the frozen and illiquid securities into longer-term securities. It proposed that ABCP notes, initially intended as low-risk and short-term debt, be exchanged for new replacement notes or debentures that would not mature for years (seven or nine years) while earning interest originating from the underlying primary mortgages. The plan was approved by a Canadian court last June and is scheduled to close by September 30, after Canada’s Supreme Court refused to hear an appeal against the plan.

The plan was designed to prevent a forced a fire sale of the asset-backed paper and to restore confidence in the Canadian financial system, especially in the money market funds. And it did all that without the government risking a penny of taxpayers’ money.

Of course, those entities that had invested in what they believed to be liquid and relatively high-yield 30- to 90-day debt instruments had to accept new notes maturing within nine years, but most of them thought that this was better than the alternative of outright liquidation. Those investors can hold the newly-issued notes to maturity or they can try to trade them in the secondary market. A market for asset-backed securities was thus indirectly created where none existed before.”

Now why couldn’t the UK be that sensible? (Via ClubOrlov)

Two good articles on the financial bust

I read various economic blogs regularly (another aspect of my general geekiness) and thought you might be interested in these two articles, as they are comparatively clear about our current mess.

Number one: “The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process. And, to be sure, fraud is everywhere…”

Number two: “When big operators take on a lot more risk than they otherwise might — they drive faster, perhaps, because they know their car has anti-lock brakes — it tends to raise the danger stakes for the system as a whole. Millions of dollars of losses can break the bank at a few unlucky firms. Billion — or even trillion — dollar failures can bring down the whole house of cards, especially given the dense network of dependent relationships that exists in the global financial arena.”

I do think the sub-prime fiasco is the trigger for the fourth turning.