Wednesday, November 26, 2008

Jonathan Krause Really Needs to do Better than This

After a winding and fairly foolish examination of the current financial crisis Jonathan Krause thinks he can solve the nation's economic woes:

So for the umpteenth time, I'll say that until we address the root problem of our economic mess--too many people too far in debt--we can just look forward to crazy bailout plan after pointless bailout plan coming from Washington.

That's right folks, Krause's solution to the problem is stopping buying shit.

Krause is taking a pocketbook approach to an enormous problem -- I've never had to factor a derivative into balancing my checkbook at the end of the month. It's one thing to drone on and on and on about one of Krause favorite themes -- personal responsibility -- but the problem here isn't just that people are buying iPod's when they should be buying groceries or paying off they're mortgage, the problem is that they have been told by the financial professionals whom they have paid good money for guidance that they can do both.

We're not just talking about credit cards and payday loans here, as Krause seeems to think, we're talking about commercial paper markets and credit default swaps and transfers of money that make the $15,000 limit on your MasterCard look like pocket lint.

We're not where we are now beacuse people couldn't save money, we got here because ordinary people with bad finances were encouraged to take out crappy loans because loan officers were encouraged to offer said loans so that the bank could bundle them up and sell them as securities to other financial institutions.

Long story short, it was in the incentive structure of the loaners to provides folks with bad credit with loans because the banks they worked for would never have to pay the consequences of a loan (or all of them) defaulting (... or so they thought). In fact, loan officers were rewarded for the number of loans they were able to process and not necessarily for their quality. That creates a pretty blatant conflict of interest that inevitably led to a culture of giving "free money' to people that shouldn't have received it.

Krause irresponsibly plays small ball with this post. This claim is utter bullshit and ifentifies its author as being someone without a fucking clue what's going on in the financial sector these days:

"Those who have been responsible the past few years have plenty of credit options available to us."
Not so. In fact, many of the responsible players are getting screwed harder than anyone right now.

When banks started to realize that they were going to eat shit with all of these subprime loans the first thing they did was check and see how much money they owed to other financial institutions. Turns out that most banks owed a lot -- they were leveraged up the yin yang and needed to get cash quickly. Normally they would just go out and get a loan from another bank, but every other instituition was experience the same thing...

So what did they do?

Step 1.) Stop the bleeding.

No more loans. Period. After that, they looked around to how liquid they were. Not so much, was the answer. When banks stop offering loans, it's like the financial system stops breathing. When people stop breathing they start to panic and banks tend to opporate in the same manner -- that when they went to

Step 2.) Call in loans.

Get liquid in a hurry. Now who do you think they're going to go to for cash in this situation? The folks with the shitty loans who can basically walk away from their homes without any worries. Of course not! They're going to the folks with the money, the folks that, paradoxically, can actually grow the investment of the initial loan. When this happens the financial system basically starts working in retrograde: instead of money circulating throughout the economy it starts to flow back to a few central nodes (banks) in the system where it's horded to keep those banks above water at the expense of pretty much everyone else.

This is awfully close to a post-modern bank run, only instead of customers running to withdraw their savings, it's other financial institutions.

The thing that pisses me off about Krause's post is that it is completely devoid of even the slightest rudamentary knowledge of the subject he is discussing. Though he's talking about an economic issue, Krause ignores any actual discussion of, you know, economics in favor of grafting a populist-libertarian interpreatation of "economic fairness" on to the problem.

"Too many people too far in debt" is only a small part of the equation -- it's not a "root problem," in fact, it's actually a symptom of far larger institutionalized problems discussed above. Krause doesn't understand that because (apparently) it doesn't comport with his ideology. Well, there's a reason why economics is called "the dismal science" -- it's because pretty much nothing is fair.

The alternative to the "crazy bailouts" Krause so loaths is a catastrophic and instantaneous collapse of the American economy. The reverberations of such a disaster will ripple through even the most responsible of spenders. The social consequencies of such an economic armaggedon would be devestating and would take decades to recover from.

Krause's post reminded me of this post, the first thing I read off my RSS feed thins morning: Why CNN Struggles to Cover the Economic Panic. Krause is having the same problem, only where CNN has been clueless, Krause is being reckless.

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