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Financial Logic and Morality

Posted by Larry Doyle on March 22, 2009 12:26 PM |

I am a proud graduate of the College of the Holy Cross, a Jesuit institution in Worcester, MA. The strength of a Jesuit education lies in the principles of Logic and Morality. While I fully appreciated my classes in Economics, German, Philosophy, and others, my classes in Logic and Morality made the greatest impact on me. Those classes forced me to think, not make rash judgments, take positions, and defend them.  

Fast forward to 2009 and a banking industry facing hundreds of billions, if not trillions, of unrealized losses. How do we most effectively, efficiently, and expeditiously address the health of this banking system so that our economy and population can regain its footing and prosper?  Let me revert back to the late ’70s and early ’80s and the principles instilled in me by those Jesuits.

 My Logic class utilized “decision trees.” My Morality class was based on the principle of “the greatest good for the greatest number.”

What have we learned over the last 6 months, as well as the last 16 years, to help us chart our way forward?

 Should we nationalize certain insolvent banking institutions, liquidate assets, obliterate shareholder equity, and force creditors to take a discount on their loans? This model was utilized in Sweden and other Scandinavian countries in the early ’90s. Their economies recovered over a 2-3 year time frame.

Is our banking system so large, so globally interconnected, and so levered as to make this approach feasible? What have foreign entities who have invested in our bonds and stocks done over the last 6 months to address and mitigate this risk? They have repatriated their holdings. In the process of doing that, we saw our government interest rates move up by approximately 1% in the intermediate to long maturities. We have seen our equity markets sell off by approximately 50%.  Have our markets sold off despite our government’s actions or partially because of them? I would maintain the latter.

Over and above these moves in the markets, we have seen our largest creditor, The People’s Republic of China, jawbone our government about our honor and integrity in standing behind our markets and a number of our larger financial firms (Fannie Mae, Freddie Mac, et al). Logic tells me, the Chinese were sending our government officials a clear signal that they would further repatriate their holdings if those holdings were not protected. How did our government respond to these moves in the market and messages from our foreign creditors? Uncle Sam blinked.

Every government decision – both under the Bush administration and now the Obama administration – is defined to buy time, defer losses, and protect the very institutions that took the imprudent risks. In utilizing this approach, our officials are violating basic free market principles and enacting massive moral hazards.       

Our government also blinked in the takeover of AIG. There is no doubt that the government funds injected into AIG flowed through to the creditors of that organization. Why didn’t our government forcefully negotiate with these creditors to take a discount on their payments?

Our government is blinking again as it rolls out three programs intended to restart the flow of credit in the consumer finance markets. Each of these programs is based on similar principles of cheap government loans to investors to incentivize them to purchase stale loans and securities on bank books. In addition to the cheap loans, the government will subsidize the purchases by underwriting a large percentage of future losses on these investments. These deals are potentially very sweet and attractive for investors.

While it may seem as if the government is “giving everything away” in the midst of these programs, what is the government getting in return?

1. Don’t think for a second that the proposed legislation to heavily tax compensation of those in the financial industry is not intended to be a redistribution of wealth.  I firmly believe the administration and Democrats believe this tax and other likely restrictions on compensation within the financial community is a fair price for the government to charge for not nationalizing certain institutions. 

2. For investors in the aformentioned programs, the price the government is considering charging over and above the price of the cheap loan is:
 – inability to hire foreign workers
 – government accessibility to the investors’ books
 – restrictions on compensation

I firmly believe the Obama administration and our Democratic Congress view the capital provided to our financial institutions is an outstanding cover to allow them to promote and enact their very liberal, social agenda. We have seen this extensively already and I believe we will see much more of it in the days and months ahead. In so doing, this administration and Congress are promoting a large measure of class warfare and populist outrage.

In regard to the moral hazards playing out throughout our housing and financial industries, make no mistake these moral hazards are nothing more than the extenion of the moral hazard that was perpetrated by Freddie Mac and Fannie Mae over the last 15 years. Who benefitted from that moral hazard? The very politicians from both sides of the aisle, but predominantly the Democratic side, who are enacting the legislations promoted now.

What are the real costs of this fiasco and who pays? Well, let’s look at the movement in the Treasury Inflation Protected Securities Market (TIPS), gold and oil, and banks in the last few days. The markets (TIPS, gold, oil) are screaming that we will experience significant levels of inflation. 

Who would want to work at a well run bank or other financial institution, not in need of government assistance, but subject to government restrictions on compensation? Nobody!! As a result, those stocks led the market lower on Friday.

I accept the fact that our government needs to aggressively fill the void in consumer demand at this juncture. However, the undisciplined spending and massive deficits projected by the Congressional Budget Office will drive our interest rates and taxes higher. Who pays? 

The American taxpayers both now and, to an even greater degree, in the future.            

We should have let the market work and utilized  selected firewalls and bankruptcy procedures to manage the unwind of institutions. 

Uncle Sam’s blinking has sold out our free market principles and those in America who treasure them. Uncle Sam’s blinking will clearly prolong our economic pain and the price of that pain. I do not view that as either logical or moral!!

LD

  • thinkaboutthis

    It is amazing to me. It is almost like what happened to healthcare when the HMOs and PPOs were introduced, except this is the financial industry.

  • Larry Doyle

    Think…For our entire audience,can you give us a Reader’s Digest version of what happened in healthcare with the introduction of HMOs and PPOs? Thanks..

  • thinkaboutthis

    This is Joe’s Liver (lol)… In my view, HMOs and PPOs, basically took the individual/companies capitalistic opportunities and placed them into caps, limitations, and forced grouping of practicing. As a result the consumer was diverted into this model and the ability for broad based healthcare became restricted within itself.

    Again, I am no financial wizard and learning as I go, but as an observer, I am noting some similarities with the direction the government is herding the banks.

    • Larry Doyle

      Thanks…socialized finance. Well, in so many words we had a socialized housing system under Freddie and Fannie (whether we knew it or not) and we can see where that got us.

  • fiscalliberal

    Larry – Would you agree that it was the private securitizaation of Sub Prime and Alt A loans in the private sector market was the real problem. As I recall, it was the Investment banks that went bad because of off book securitization.

    I agree that Raines should be in jail for other reasons, but Fannie and Freddie only got into sub prime and alt a late and when it all came down, they only had 14% of the market. They mostly had the 30 year standard mortgages with 20% down or 10% diwb with private mortgage. So to claim fannie and freddie only obfuscates the analysis

    The socialized finance is only in the losses in addition to the losses of pensions etc. The rich executives are the one’s that got the private profits.

    Oh by the way, a lot of the underlings in the Investment banks took it in the shorts also. Just like the good people of Enron. At least the Enron executives got caught. Bernie Madow is the only one going to jail so far.

    I think that is what is fueling the outrage and the bonuses are easy to understand. All this money is going into the problem and there is no reason to believer that the money changers are removed from the temple.

    When you are facing layoff’s etc, things get clear in a short while

    • Larry Doyle

      Fiscal…you raise some good points. Allow me to comment.

      The explosion of the sub-prime and Alt-A businesses were not due to Freddie and Fannie but to legislative influence both during the Clinton and Bush administrations to increase homeownership. Instead of responsible lenders filling this void, a number of boil room operations (Aames, Delta Funding, Alliance Funding, Long Beach, Ameriquest, et al) sprouted up and started writing loans and selling them to Wall Street who securitized them. These outfits should have been regulated heavily right from the get go.

      Freddie and Fannie entered the equation when they saw the amount of product being originated and wanted to capture part of the market.

      That said, from the early 90s Freddie and Fannie massively grew their internal portfolios given the availability of very cheap financing. This period was the start of the “private profit/social loss” which I truly equate as significant moral hazard. Pols, Wall Street, and F/F execs all fed from this trough. The foundation of the F/F problems actually pre-dated the sub-prime problems by a long shot.

      I have neither seen nor heard any inkling of expected indictments. Where are the leaders and federal attorneys pushing for these?

      Why have a lot of these situations occurred and why are we faced with the travesty of the current situation? In my opinion, our leaders in Washington are MASSIVELY conflicted. In an attempt to serve two masters, (those who fund them) and those whom they are supposed to serve, they are unable to perform. We are seeing this scenario on an ongoing basis and now to a much greater extent.

      As a result….NO CONFIDENCE!!

  • Pingback: Topics about Banking » Financial Logic and Morality | Sense on Cents

  • TeakWoodKite

    Gal from Cal posted this Bailout tracker at NQ.

    The weight of your burden will soon be lifted. This the message of hope and change.

    As to who pays for the message, it will be the tax paying public.

  • Larry Doyle

    thanks for that link…

  • bonddadddy

    Your forget Larry …… America is now hooked into CHANGE!!!!! folks like you are getting blamed for what caused all these problems . Your values are precisely what Obama ran on and trounced .

    You are the stooge they plan to come make pay for this madness ( as well as every other American that thought study hard , play sports by the rules , save , prosper were the rules to play by to be a real winner )

    The angry mobs now riding tour buses to see the AIG homes will soon be cruising Greenwich Ave with tour guides pointing to the nice homes as where all the criminals live who should be raided / robbed .

    This is how Chavez rose to power , by the way . Blame the ‘rich’ and claim you will crush them in the name of giving their wealth to the poor but at end of day , crush everybody in the top 49% and offer free lunches to everybody in the bottom 51% .

    Rules of decency that made America great ? all gone .

  • Larry Doyle

    …and that will only occur if those good,decent, hard working people allow it to happen. I am not going to sell America out quite so quickly.

    I would encourage you to stay the course and fight the fight.

    Welcome to the site. Visit and comment often!!






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