Archive for September 2008
In a move which instantly multiplies the moral hazards and inefficiencies associated with our banking system, the Irish government has guaranteed the deposits and borrowings, estimated at around €500 billion, in Irish banks. The cover has an expiry date two years from now, but the probability of Ireland making a swift recovery from this crisis is now significantly lower.
The critical function of banks is to allocate capital according to where it can be used most productively, as expressed through the interest rates which people are willing to pay and the likelihood of these people to repay their loans. Banks should balance their desire to earn interest from making loans with the need to ensure that they have sufficient reserves to meet the current demands of their depositors and indeed pay interest to their depositors. These functions are hampered by interference with the interest rate and the enforcement of a government monopoly on the supply of money through the mechanisms of central banking. Yet so long as private, competitive banks exist within the structure imposed by the central bank, there can still be some degree of economic calculation performed by these banks.
Now that all private bank risk has been socialised by the explicit guarantee of bailouts, the need for banks and bank customers to calculate these risks accurately has just been thrown away. All mistakes will be paid for by the government. The implications for the efficient allocation of Ireland’s productive resources are simply awful.
If indeed we witness bank failures which require the Irish government to start coming up with some of this €500 billion, it could mean the bankruptcy of the State. We could be facing higher taxes for many years to come or, if the ECB is kind enough to print enough money to bail out the Eurozone financial sector, a hyperinflationary depression.
Truly, this cure is worse than the disease.
The Construction Industry Federation is looking for the government to “re-stimulate” the property sector. Less kindly, it seems like they want the corpse of Irish house prices to be propped back up.
The Government should help first-time buyers to purchase the estimated 40,000 houses lying unsold in the country, it was claimed today…
CIF urged the Government to take an equity share in first-time buyers’ homes to boost affordability.
The low level of deal activity at the moment is explained by the currently high spread between what developers are asking for and what potential buyers are willing to bid. Considering the extent to which house prices have already fallen (CIF estimates roughly 25-30%) and the rapidly deteriorating state of credit markets, it seems clear that bids aren’t going to be increased any time soon.
This means that without government aid, builders are going to be forced to offer lower and lower asking prices in order to move their stock. But if you agree that house prices were artificially inflated during the credit boom, this seems like an utterly appropriate development. Lower prices mean a return to normalcy and the chance for a more balanced and sustainable economy. Far from being a disaster, it is the real “correction” which puts the economy back on the right track.
Not that it won’t be painful for some – many people are going to have to adjust their lifestyles. What it does mean for homebuyers, though, it that houses are going to become affordable again. Without the money funnelled by the stimulants of artificially low interest rates and irresponsible banking practices into the housing markets, homebuyers won’t need to take on mountains of debt just to get a foot on the property ladder.
Just as the unusually large amounts of credit provided to homebuyers during the boom forced them to bid up house prices and stimulate too much construction, government “aid” to homebuyers now will simply permit builders to keep house prices at artificially elevated levels and delay the rebalancing of our economy. Far from helping homebuyers, it will slow down the onset of genuine affordability and at the expense of the ordinary taxpayer.
Price-fixing is the very last thing the government should be doing at a time like this. The sooner we recover from the boom, the better. This means that house prices should be allowed to fall by as much as is necessary.
…lawmakers on both sides pointed to an outpouring of opposition from deeply hostile constituents just five weeks before every seat in the House was up for election as a fundamental reason that the measure was defeated. House members in potentially tough races and those seeking Senate seats fled from the plan in droves.
So it appears that constituents have, at least temporarily, succeeded in protecting themselves from a comprehensive bailout of financial elites. With an election around the corner, any incumbent who gave a blank cheque to Hank Paulson for the nationalisation of Wall Street’s problems should have feared being unceremoniously dumped out of office.
And reluctant though I am to stray into party politics, it is noteworthy that only one-third of voting Republicans supported the plan. In contrast, over 60 percent of Democrats attempted to pass what would have been one of the greatest acts of corporate welfare in world history.
Where to from here? We can now be slightly more optimistic about the US economy recovering from its problems without imposing on itself something far worse than the business cycle. Only slightly though. This bailout was a particularly offensive intervention, but of course its failure does not mean that the general trend to interventionism will be reversed. The final phases of the business cycle will now be reached sooner, and it’s hard to predict what could happen in that revolutionary atmosphere.
While we’re on the subject of democracy, it’s clear that the two major parties require extraordinary encouragement from voters to resist intervening. As you could easily predict, both presidential nominees supported this massively unpopular plan.
Washington Mutual, with $307 billion in assets, is by far the biggest bank failure in history, eclipsing the 1984 failure of Continental Illinois National Bank and Trust in Chicago, an event that presaged the savings and loan crisis. IndyMac, which was seized by regulators in July, was one-tenth the size of WaMu.
The one bright spot for US taxpayers is the buyout by JPMorgan, which saves them from insuring WaMu’s accounts through the FDIC. Ironically, the FDIC, what was supposed to be the US deposit insurer of last resort, will probably itself need a bailout in the near future. According to a research firm quoted by Bloomberg, the $45 billion fund will need about $200 billion to cover the 100 banks which are estimated to fail from now through 2009. A WaMu bailout alone would have cost $30 billion.
Of course, the activities of the FDIC will seem positively quaint if the $700bn Paulson bailout is passed.
A major bank in Hong Kong has successfully managed to survive a run, but the article in today’s International Herald Tribune recalls how another bank was not so lucky, back in 1991:
A long line at a bus stop then in front of a branch of the troubled Bank of Credit & Commerce International was mistaken by passersby for a bank run. What followed was a frenzied effort by Hong Kong residents to pull their money out of the bank, which quickly collapsed and set off runs at other Hong Kong banks, which survived.
That’s correct: a queue at a bus stop was enough to topple the bank and threaten the entire Hong Kong banking sector. People correctly understood that the failing bank did not have enough reserves to pay each depositor; their only mistake was in believing that other depositors had already begun to exit.
It is indeed a problem of collective action. If we trust other depositors not to move, then we don’t need to move. If we don’t trust them not to move, then we may be tempted to move, thus forcing them to move also.
It’s a classic dilemma, but a perverse way to run a banking system. It means that nervous deposit holders must forever be on the lookout for unusually long queues at bus stops.
Dublin’s ISEQ index slumped 7.7% to stand at 3,6871 by 1pm – down 305 points. The banking shares were in freefall with their losses being blamed on the ban of ‘short selling’ of financial stocks, which was announced last week. Traders said the ban prevents speculators from balancing out investment risks and resulted in far fewer people willing to buy bank shares as a result.
Reported in the Gulf Times (via Max Keiser):
Socialist President Hugo Chavez has said the $900bn being spent by the US government to bail out failing financial companies dwarfed his bill for nationalising a big chunk of Venezuela’s economy…
“They have criticised me, especially in the US, for nationalising a great (telecom) company, CANTV, that didn’t even cost $1.5bn,” Chavez said at a ceremony that included representatives of US oil company Chevron.
“The US has spent $900bn, four times what the Venezuela produces in a year, to try to boost the troubled finance system and housing market.”