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.”
Fears of a banking meltdown have paved the way for the Irish government to increase bank deposit guarantees to a massive €100,000. But as Patricia A. McKoy (2006) wrote for the IMF, socialising deposit risk fosters even more irresponsible activity.
In the deposit insurance context, moral hazard manifests itself in two ways. First, explicit deposit insurance gives insured banks incentives to pursue added risks because they can capture any profits but shift any losses to the government. Second, explicit deposit insurance reduces incentives by depositors and shareholders to monitor their banks. As Professor William Lovett put it, “If governments and modern nations do not allow most banks to [fail], how can the leaders and managements of banking institutions be disciplined and avoid unduly risky, negligent, or adventurous lending policies (or simply poor asset-liability management)?”
What exactly is the problem?
In a world with no deposit insurance, a bank that is considering making a risky loan knows that it will have to pay depositors more for taking on the added risk. Either the bank will pay the risk premium or it will not make the loan. In a world with deposit insurance, however, insured depositors will not demand a risk premium because they know that the government will insure their deposits up to the legal limit, regardless whether the bank makes the loan. Thus, deposit insurance gives banks incentives to take added risks – either by increasing their leverage or investing in riskier assets — thereby increasing the government’s exposure to losses. These incentives are especially strong for undercapitalized banks. Moral hazard will exist so long as the total expected profits from a bank’s asset portfolio exceed the explicit costs of deposit insurance (premiums) plus its implicit costs (the costs of regulation).
McKoy goes on to explain some techniques by which the moral hazards associated with bank deposit guarantees can be limited. She notes that in certain circumstances these measures have probably played a strong role in preventing bank runs.
I wouldn’t disagree with those points, but it’s still the case that bank failures and similar disaster scenarios, far from being the cause of economic crisis, are usually best thought of as symptoms, effects, and parts of the cure; in other words, that bank catastrophes teach important lessons which should, in the long run, help prevent the type of destructive bubble behaviour which brings them about in the first place.
Bank shares in Dublin have shot up today after the Financial Regulator introduced a ban on shorting them. The obvious interpretation is that short-sellers are now unwinding their positions and that traditional investors believe it is safer to return to the market.
While this price action is easily explicable, in the medium and long term the ban is unlikely to help the banks. Why? Because short-selling actually reduces market volatility. Let me explain how.
Suppose shares in Bank A are trading at €10 each. Suppose I take a look at their loan book and figure that the share price would be much closer to zero if it was being valued properly. So, for a small fee, I borrow some Bank A shares and sell them. This puts marginal downward pressure on the stock. If enough people do it with me and we run down the price, it might even upset some of the bank’s executives, long-term shareholders, employees and customers.
What happens next? I wait to see if my view of the correct share price (<€10) becomes more widespread. If this happens then I get to buy back shares at some reduced price, say €1 each, and then return them to the lender. I gain €9 per share minus the cost of borrowing the shares and transaction costs.
If the share price rises, however, then I get drowned and face an unlimited loss.
The key fact here is that when I eventually buy back the shares I put upward pressure on the stock price. Just as my original selling of the shares dragged it downwards, my later action pushed it upwards. My profit is proportional to the intertemporal mispricing which I help to correct, and the social function I provide is to supply shares when demand for them is high, and a buyer when demand for them is low.
It might help to consider what would have happened if I had not acted. There would have been fewer sellers when Bank A was at €10 so the price would stay higher for longer. Assuming that sentiment eventually does turn against the bank, then when it reaches €1 there is one fewer buyer to lift it back up, so it falls even harder. Without me, the swing is from €10 to €1 is actually more wild.
This explains how short-sellers contribute to market efficiency by smoothing out stock price movements and thus removing volatility from the system.
There is an argument sometimes made that short-sellers can act in packs to collectively drive down stock prices. It is alleged that false rumours are spread which also help to intimidate normal shareholders. A downward trend is manipulated into existence, after which the short-sellers then cover their positions and take their unfair profits.
While this practice is theoretically possible, it would be extremely difficult for short-sellers to coordinate such activity. Also, the profits could not very be great unless a significant number of ordinary shareholders were scared away from their holdings. But in any case it is true that investors surrender to short-term trends and the rumour mill both when stocks rise and fall, so these issues, to the extent that they exist, are not unique to the shorts.
In terms of what is happening right now, it seems most likely that the bans on short selling the Irish, UK and US financials have been precipitated by a combination of political factors. These include the need for some to assign blame for recent disastrous share price declines, and the general trend for increased regulations and restrictions on trading activities.
The bans are understood to be temporary so it is to be hoped that they can be reversed as quickly as possible to restore one of the increasingly few forces for order in the financial markets.
Year-on-year the leaving cert results come out and one finds the same newspaper headlines:
Standards falling across-the-board, exams being ‘dumbed-down’, curricula being shortened, increasing numbers failing mathematics and unable to continue in education, fewer and fewer students capable of entering into third level science courses, lack of engineering graduates etc. etc.
In a time called the Information Age where information is more freely available than ever before in human history how is this possible? The internet exists in a staggering number of households today, yet students today cannot solve simple geometry problems and are becoming more and more ignorant and indifferent.
Many criticise the government for lack of investment. However, the government spends €10 billion of tax payers money on education every year in the Republic of Ireland in supplement to the enormous amounts already paid by parents for private schools and extra lessons for their children. That’s a ‘1’ with ten ‘0’s after it! Is more money really the answer? What is the government doing now that is so detrimental to education that it wasn’t doing in the past?
Well, why were there higher standards in the past one might ask? What did the government do in the past that worked?
Funnily enough the State originally had nothing to do with education. It was through the work of the private and independent sector that Irish people became known internationally as having a high standard of education.
So in that case who exactly built our schools and universities then?
Take, for example, St. Ignatius Rice who was the founder of the Christian Brothers. In his early life he was a merchant-banker in Cork who amassed a fortune and then, upon the death of his wife, decided to spend his fortune establishing schools to educate the poor. He then became a priest, founded a religious order with his wealth and became the ‘educator of Ireland’, all entirely independent of any State interference.
Most Irish Universities were funded by charitable initiatives of philanthropic individuals like Cardinal John Henry Newman establishing UCD (obviously independently of the British Crown) or the Catholic Church founding a university at its seminary in Maynooth.
All of these institutions provided a service that was to a large degree free for the poor with high educational standards that led Irish people to rise rapidly in other industrial countries, especially the United States. Under these Irish educational institutions, STANDARDS ACTUALLY ROSE!
So what happened?
Why is the State involved in schooling now and why are standards now falling?
Why on earth is education free and compulsory today if it was of higher standard and more effective at schooling the poor in the past when it was neither free nor compulsory?
In the book ‘Education: Free and Compulsory’, Murray Rothbard explains,
‘A tax supported, compulsory educational system is the complete model of the totalitarian state’. Obviously the state and the political class want obedient and docile citizens that will believe whatever they are told and not question their masters. But there is an even deeper and more sinister agenda at play as well. Why was it that free and compulsory education was one of the essential ten tenets in Karl Marx’s ‘Communist Manifesto’?
One of the most important facts about human nature is the great diversity among individuals. The development of individual variety tends to be both the cause and the effect of the progress of civilisation. As civilisation progresses, there is more opportunity for the development of an individuals reasoning and tastes in a growing variety of fields.
The record of the development of compulsory education is a record of State usurpation of parental control over children on behalf of its own; an imposition of uniformity and equality to repress individual growth; and the development of techniques to hinder the growth of reasoning power and independent thought among the children. To understand this one must first recognise the underlying intentions of free and compulsory schooling at the hands of the State is a ‘drive towards savage uniformity’ and egalitarianism for as Rothbard says ‘the creed of equality and uniformity is a creed of death and destruction’.
The modern school is not far different from Sparta where the children were seized by State and educated in barracks to the ideal of State obedience. When one thinks about it, school is essentially as much a prison today as it was back then, a place where you are no longer in the protection of your family, but, in many cases at the mercy of those who now control and order you around. Interestingly, lying was considered a proper instrument of the State to use in its indoctrination of the people in Sparta.
Fascism, Nazism and Communism: it is a grave and unanswerable indictment of compulsory State education that these modern totalitarianisms were eager to institute public State schooling in their regimes. There is no need to discuss the mind-numbing State propaganda that melted the minds of these countries’ inhabitants and reduced them to helpless dependency upon the State. In time, they all became savages as civilisation was erased in the classroom and in the minds of the citizens and replaced with State idolatry.
At the basis of totalitarianism and compulsory education is the idea that children belong to the State rather than their parents. One of the leading promoters of that idea in Europe was the infamous Marquis de Sade, who insisted that children are the property of the State. For it is essential for the growth of State power that habits and minds and feelings of all the children be molded into absolute equality, and then the nation will be ripe for the final of equalisation of property and incomes by means of State coercion. Throughout the plans of these State ‘educators’ run hatred of human diversity, particularly of the higher standard of living of the rich as compared to the poor. Their agenda is not only one of promoting State Absolutism and ‘Absolute Equality’- to which the system is admirably suited- but to educate the ‘whole child’ and create the ‘New Socialist Man’. A man of no thoughts of his own but who simply acts in obedience to his masters.
Now in Ireland, the fact of the matter is that with the exiting of the Catholic Church and other religious groups from the management of schools we have seen the final total nationalisation of the educational system.
Now the system was always somewhat nationalised since the founding of the State. The State and the Church were always in battle over the control of the minds of the people but in many cases they came to mutually beneficial arrangements. By paying the wages of the teachers whilst allowing the schools themselves to be ‘nominally private’ under the Church, the state found a way to induce the private schools to teach state supremacy without outlawing private schools, as was done in some other countries.
Thus, Plato’s ideal of full State communistic control over the children has now finally been realised.
The idea that there is any need for a Department of Education is absurd. These meddlers have ruined the entire educational experience for generations of Irish people. By enforcing certification for minimum standards, the State effectively, though subtly dominates the private schools, and makes them, in effect, extensions of the public school system. Aside from all these underlying intentions, the State still wants scientists to develop the technologies necessary to fully control the human mind and engineers to man the nuclear power stations that will power the bureaus of statistics where the mathematicians develop their projected growth models of future food rations.
However, further education in civilisation cannot be obtained at all under full political control of the schools. It is possible only to a certain frame of mind in which knowledge is pursued voluntarily. Furthermore, in a State system there are no competing curricula. There is no way of know how best to teach subjects because the State does not have other curricula to compare against. The Irish Curricula is essentially an enclosed system. The requirements to be learned shall always fall. In the UK now universities are no longer accepting the A levels but are introducing their own standardised examination for applicant students. In this case, the British government have managed to devalue the once impressive and comprehensive A levels such that not even their own public universities will accept the results anymore but demand the private sector to supply them with an adequate testing system!!!!
To the Statist who is convinced that unless there is compulsory education parents will neglect their children and not send them to school ‘Do you think nobody would entrust his children to you to pay you for teaching them? Why do you have to collect your pupils by compulsion?’ The spirit of schools has changed from philanthropy to the poor to something which all children are induced to attend.
One of the most damning indictments of the schooling system is that teachers are under the Civil Service. As a result, once a formal examination is passed, which has little relation to actual teaching competence, and a little time elapses the teacher is on the public payroll, and foisted on the children for the rest of his working life.
Tyranny by majority vote may be unpleasant enough, but at least if the rulers are subject to democratic checks, they have to please the majority of the voters. But government officials who cannot be voted out at the next election are not subject to any democratic check whatsoever. They are permanent tyrants. “Taking something out of politics” by putting it into the Civil Service certainly does increase the ‘morale’ of the bureaucracy. It elevates it into near perpetual absolute rulers in their sphere of activity. The fact that teachers are under the Civil Service is one of the most damning indictments against the Irish compulsory system of today.
The effect of progressive education is to destroy independent thought in the child, indeed to repress any thought whatsoever. Instead the children learn to revere certain heroic emblems and to follow the domination of the “group”. Thus, subjects are taught as little as possible and the child has little chance to develop any systematic reasoning powers in the study of definite courses. This is evident where school is seen by many to be a chore when in fact learning is the most exciting and natural pleasure for humans! We are beings who learn constantly from the moment we come into existence so when learning becomes a horrible chore it is because the system has squeezed all creativity, inspiration and humanity out of the learning process.
Equality and uniformity are pursued more than ever, even under the guise of letting individuals do whatever they like. The plan is to abolish grades, by which better and worse children know the extent of their progress, and instead to grade “subjectively” or not at all. This is clear in the Irish educational system where they are gradually replacing the Leaving Cert exam with continual assessments. Even in the UK they are now considering abolishing the GCSE exams and replacing them with a new syllabus revolving around ‘team work’.
The idea that the school should not simply teach subjects, but should educate the “whole child” in all phases of life, is obviously an attempt to arrogate to the State all the functions of the home. The idea that the State can re-engineer man is a hang-up from Marxism that has become blurred into the supposed ‘essential’ functions of the State. In the end, this egalitarianism is as Rothbard put it ‘A Revolt Against Nature Itself’.