Economics

Putting the "Loss" Back in "Profit and Loss"

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George Mason University professor and economics romantic Russell Roberts is not so happy about the Fed bailing out Bear Stearns:

Yes, letting Bear Stearns go under would have been dangerous. But helping JP Morgan devour Bear Stearns is dangerous, too. Where does the government stop in protecting people from irresponsibility? Home owners and lenders are next. The political pressure is inexorable for some sort of bail out. And then comes more regulation of investment banks.

In a world where people who make bad decisions are spared the full consequences, only one thing is certain. We've encouraged more people to make more bad decisions in the future. The real price to be paid isn't the dollar costs of any bail out but the encouragement of recklessness and irresponsibility. That will make all of us poorer down the road.

Logical to the point of obviousness, sure, but it's the kind of the thing that bears repeating in the coming months. Whole thing here.

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  1. BSC was trading at $160/share less than a year ago. To claim that the Fed has eliminated consequences from the Bear collapse is absurd. Sure, the Fed propped up the bottom of the collapse, but Billions have been lost nonetheless.

    This is not a defense of the Fed’s actions, but the argument made by Roberts stinks. There has been plenty of useful market information transmitted by the Bear collapse. The Fed has essentially put a mattress under someone who jumped from a ten story window. The mattress may have saved their life, but they’re still severely messed up from the fall.

  2. In a world where people who make bad decisions are spared the full consequences, only one thing is certain. We’ve encouraged more people to make more bad decisions in the future.

    Why does Russell Roberts hate hard working Americans?

    Sorry, I was channelling John Edwards for a sec there.

  3. “Yes, letting Bear Stearns go under would have been dangerous”

    Can somebody more economically literate than I explain just how much danger we’re talking here?

    Doesn’t the downfall of a big beast provide opportunities for enrichment for others picking over the corpse (sorry about the metaphor)?

    Are these opportunities, plus the usefulness of the lesson that failure is painful and responsibility must be taken, clearly overwhelmed by the aforementioned dangers of allowing the beast to collapse?

  4. I’ve got to agree with MP on this one. As much as I hate government bailouts, it seems to me like the owners of BSC paid a hefty price for the company’s actions.
    I certainly learned a lesson when American Home Mortgage went bankrupt and stock I’d payed $15 for suddenly became worth 47 cents.

  5. Sometimes your purpose in life is to serve as a warning to others. Bear Sterns needed to fail as a warning to the rest of the industry. At this point, is there any conduct short of outright criminality that a big firm could engage in that would actually result in you know failure?

  6. Cerro, here’s the best synopsis of what I’ve read:

    Basically Bear Stearns failed because of a “run on the bank”. They were running completely on credit – every day they had to pay back billions in loans, which they paid for by getting billions in new, short term loans (in the middle of that they used the money to make investments that paid back enough to pay off the loans). All the bank’s creditors decided simultaneously to stop loaning them new money, and demanded what they were owed on the existing loans. The problem is that most of the wall street companies are running on credit just like Bear Stearns was, at least partially in their investment wings. The thinking was that if Bear totally collapsed without some kind of bailout, then everyone would panic, stop lending to ANYONE, and demand their money causing a run on ALL the banks at once, which would pretty well shut everything down.

  7. But the people who took out the mortgages were tricked! TRICKED! All for Profit!

    I heard this brilliant segment on network news the other day. Apparently people are being lured into con-jobs by companies promising to help them out of their mortgage troubles. I don’t know the details because I was too busy smacking my head against the wall that the same people entered yet another bad agreement.

  8. Allowing people who make bad decisions to suffer the full consequences of those decisions, will result in a quicker and more prosperous recovery. The more the government “props up” the economy, the less incentive there is to make the painful adjustments needed. Federal bail outs only serve to extend and deepen periods of economic decline. In other words, the unintended consequence is the opposite of the intended consequence. Unless your cynical enough to think the intended consequence is to pay off favored constituents at the expense of everybody else.

  9. Reinmoose-

    Some of those “rescue” deals were pretty weird. It appears there are ample grounds for criminal prosecution in a lot of cases. And I heartily approve of pursuing them.

    But (for the ten thousandth time) it’s just not that hard to look at how much money you earn, and compare it to the payments on your loan, and see which is bigger.

  10. Sometimes your purpose in life is to serve as a warning to others. Bear Sterns needed to fail as a warning to the rest of the industry. At this point, is there any conduct short of outright criminality that a big firm could engage in that would actually result in you know failure?

    There are different degrees of failure. From a Street perspective, Bear Stearns did fail. It may not have absolutely failed (i.e. closed its doors and fired all of its workers and caused chaos as their customers scrambled to relocate their salvaged assets), but when your stock price plummets 95%, that’s certainly failure from a Street perspective.

    And remember…Refco failed 100%…for entirely different reasons…but still, it’s not like big brokers are always propped up by the Government.

  11. cynical enough to think the intended consequence is to pay off favored constituents at the expense of everybody else.

    What? Quit looking at me.

  12. Logical to the point of obviousness, sure, but it’s the kind of the thing that bears repeating in the coming months.

    Yes, but does it bear stern repeating?

  13. “The thinking was that if Bear totally collapsed without some kind of bailout, then everyone would panic, stop lending to ANYONE, and demand their money causing a run on ALL the banks at once, which would pretty well shut everything down”

    Thanks, Mith. Next questions:

    1. Aren’t there *any* other lenders that would-be debtors could look to? Anywhere?

    2. If not, and financial meltdown ensues, what is going to happen that is so ghastly that it’s worth simply deferring Armageddon, as these bailouts would appear to be doing? Why can’t it happen now, if it’s inevitably going to happen one day?

  14. what is going to happen that is so ghastly that it’s worth simply deferring Armageddon

    Some people call it “price discovery.”

  15. “But (for the ten thousandth time) it’s just not that hard to look at how much money you earn, and compare it to the payments on your loan, and see which is bigger.” (P Brooks)

    Exactly. I’m just having trouble mustering up sympathy for people who feel ENTITLED to make a killing on the value of their home, and consider it a huge tragedy if they don’t.

    And even less sympathy for banks and financial institutions who lend the money to those who buy into that fantasy. What, they should take NO RISK?

  16. All the bank’s creditors decided simultaneously to stop loaning them new money, and demanded what they were owed on the existing loans. The problem is that most of the wall street companies are running on credit just like Bear Stearns was, at least partially in their investment wings.

    Mith,

    I believe that this situation was also exasperated by the fact that Bear could not borrow from the Fed under their latest cash infusion lending plan the way banks and some other financial institutions were able to. Bear was locked out of the federal capital that many other institutions were able to dip into because of the Fed’s rules on who can borrow from them.

    Please correct me if I am wrong.

  17. Mith gets it exactly right, IMO. The perverse thing in our system is that the bailout was actually the exactly right action to take, because anything else could realistically bring massive bank runs and total collapse. It’s simply a kind of a cascading cell failure that necessarily follows when you have a dense graph of fickle, near-overloaded players:
    In inflationary boom times, the “best” investment bankers are those that go for maximum short-term profit if things go well, either because they don’t care or don’t understand it, explaining the extreme profits in booms and the bizarrely crazy stuff that comes out in busts.

    This nice mix of fractional (or no) reserve banking and fiat money that brings network engineering nightmares like that to the money system is of course completely workable and common sense, unlike ridiculous dreams like abolishing fractional reserve systems and reintroducing a commodity standard, which is totally unworkable in our complex, modern world. Because then we wouldn’t have enough money to buy what we can’t afford.

    Or whatever pundits for the status quo wouldn’t believe for money.

  18. GWB McChimpler’s economic 8 year plan.

    1. Privatize profits (as long it’s for the right people)

    2. Socialize losses (so everyone else helps to make sure #1 happens)

    3. Get re elected.

    4. Leave office with economy in the shitter, with a sweet retirement and that stupid smirk.

    /So tired of hearing that the economy is OK from him and Faux News.

  19. just how much danger we’re talking here?

    Grave danger?

  20. I have to agree with MP and others here. The shareholders of Bear Sterns were punished in full (They received almost nothing for their shares — in a limited liability society that is all we can ask) and all the employees, with a few key exceptions, are losing their jobs. The Fed stepped in because to have Bear Sterns go bankrupt — thereby punishing all those who trusted the firm with their assets — would create the right atmosphere for a bank run, which could quite literally send us into a second depression. Roberts is letting ideology interfere with good economic and financial policy, in my opinion.

  21. But if other banks are participating in the same shenanigans as Bear Stearns, and I’ve read they mostly are, why *shouldn’t* they fail too? It’s gonna happen–might as well be now.

  22. They always say they make money off interest for assuming the risk of loaning out the money. OK well they assumed the risk and so long as everything is flowing back in profit no problem. All of a sudden the risk they accepted comes home to roost and the tax payers have to cover their RISK. I am not seeing where the risk comes into play under this scenario.

    So now the Feds are backing buy outs and loaning money to loaners to cover their risks. Why doesn’t the government just loan the tax payers their own money to finance their homes at the low rate they are giving the lenders to borrow money to cover their asses? Seems to me this is now nothing more than a scheme where the government loans someone else’s money to it’s friends and their friends then make the 2-8% inbetween without any assumed risk. What a lovely plan, so long as your a lender.

  23. The Fed stepped in because to have Bear Sterns go bankrupt — thereby punishing all those who trusted the firm with their assets — would create the right atmosphere for a bank run, which could quite literally send us into a second depression. Roberts is letting ideology interfere with good economic and financial policy, in my opinion.

    welcome to the world of stagflation, we’ll never get to a depression, but it’ll last longer.

  24. B-S had a run they couldn’t cover, the Fed helped out the last customers who couldn’t (or wouldn’t) get out in time.

    But it should have been a fine time for some very rich cocksuckers to re-learn a lesson children hear all the time – don’t put all your eggs in one basket.

  25. “””Exactly. I’m just having trouble mustering up sympathy for people who feel ENTITLED to make a killing on the value of their home, and consider it a huge tragedy if they don’t.””””

    Same here. I saw something on the news a little while ago and they were making it sound like being upside-down on your morgage was the end of the world. It made me wonder if anyone of them taken a loan for a new car, which is upside-down as soon as you drive it off the lot.

  26. I saw something on the news a little while ago and they were making it sound like being upside-down on your morgage was the end of the world.

    The problem with being upside down is when you are in a bad load and the payments are more than you can afford (esp if they have just adjusted up).

    You can’t really refi since you owe more than the house is worth. What you need to do is talk to your lender and hope that they will reduce the principal or restructure the loan under better terms.

    Lots of lenders aren’t interested, or in many cases, the servicer of the loan doesn’t hold the note and doesn’t have authority to renegotiate terms. The holder of the note is now some hedge fund that really doesn’t know a lot of specifics about the assets.

    For many of these upside down lenders who can’t renegotiate, their best options has become to simply mail their keys in to their servicer and move out. Which is happening more and more.

    Is this the end of the world? No, not really. But isn’t a healthy market place either. These types of situations hurt everyone in the market place.

  27. For many of these upside down lenders who can’t renegotiate,

    upside down lendees

  28. “The ultimate result of shielding men from the effects of folly is to fill the world with fools.”

    –Herbert Spencer

    Note to Herbert: Too late.

  29. Being “upside down” would mean having taken a loss on buying your home, rather than making a profit.

    This loss can be temporary, just like a profit can also be temporary, if one continues to make payments on the mortgage. The lendee also continues to be able to live in his home. Just like the guy who is upside down on his car loan continues to drive the car.

    What I think clouds the issue is using terms like “punishment” and “reward”, rather than “loss” and “profit”. Just who is it who is “punishing” someone who fails to make a profit? Or rewards someone for “being responsible”?

  30. When people who make bad decisions are bailed out, then perhaps it wasn’t such a bad decision.

  31. “””The problem with being upside down is when you are in a bad load and the payments are more than you can afford (esp if they have just adjusted up). “””

    That’s not a problem with being upside down, that a problem with people spending more than they can afford. Pretty much everyone that buys a new car is upside down as soon as they drive it off the lot. As long as they can afford the payment, its not a big deal. Except you just paid more for something than it’s worth.

    “””These types of situations hurt everyone in the market place.”””

    Not really, there are bottom feeders that will score some good deals on houses.

    “”””The ultimate result of shielding men from the effects of folly is to fill the world with fools.””””

    The taxpayer is the biggest fool. As atrevete points out, it’s not foolish to the person being bailed out.

  32. I said:

    The problem with being upside down is when you are in a bad load and the payments are more than you can afford (esp if they have just adjusted up).

    You said:
    That’s not a problem with being upside down, that a problem with people spending more than they can afford….As long as they can afford the payment, its not a big deal. Except you just paid more for something than it’s worth.

    I don’t think we are disagreeing.

    Not really, there are bottom feeders that will score some good deals on houses.

    They may, but as has already started happening, now people with good credit histories are having a harder time getting loans to buy even these good deals. Regardless though, it is not a healthy marketplace.

    If too many people are upside down, all prices will be suspect and confidence in the housing market will continue to fall.

  33. I also believe another grave concern was that if BS declared bankruptcy, many financial derivatives the company was holding which had only been marked-to-model, would have been marked-to-market to pay off creditors. This would have allowed pricing of other similar derivatives which have not yet been written down because they still use the mark-to-model price for valuation. They (the institutional holders) could no longer claim they don’t know what the market price of these holdings would be. The losses on these holdings (many of which were in mortgage and corporate paper) would have been massive and would have covered the spectrum of financial institutions from banks to mutual funds in a cascading manner on a global scale. Imagine the effects.

  34. The last time the government stepped in to declare ‘bank holidays’ and stop runs on banks, we had a depression that lasted twelve years.

    So much for the notion that if you allow runs to happen, it’ll shut the economy down.

  35. The losses on these holdings (many of which were in mortgage and corporate paper) would have been massive

    And these holdings suddenly have buyers who believe they still contain all their value?

  36. “They may, but as has already started happening, now people with good credit histories are having a harder time getting loans to buy even these good deals.”

    Good.

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