2002: Bailout & "too big to fail" theme predicted

Well, Bookworm may have found <something huge.

Researching for another post she came across this prophetic bit of writing by economist Utpal Bhattacharya, of the Kelley School of Business at Indiana U:

As no rational agent would be willing to take part in the last round in a finite economy, it is difficult to design Ponzi schemes that are certain to explode. This paper argues that if agents correctly believe in the possibility of a partial bailout when a gigantic Ponzi scheme collapses, and they recognize that a bailout is tantamount to a redistribution of wealth from non-participants to participants, it may be rational for agents to participate, even if they know that it is the last round. We model a political economy where an unscrupulous profit-maximizing promoter can design gigantic Ponzi schemes to cynically exploit this “too big to fail” doctrine. We point to the fact that some of the spectacular Ponzi schemes in history occurred at times where and when such political economies existed—France (1719), Britain (1720), Russia (1994), and Albania (1997

Bookie questions the…well, not the timing…she just wonders if we’re living through a coincidence or some applied theory.

Let me add to Bookworm’s find, this from the NY Times, in 1999. Yeah. 1999:

”Fannie Mae has expanded home ownership for millions of families in the 1990′s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. ”Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980′s.

”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

Why didn’t anyone try to stop this from happening?

Oh…wait…people did.

I don’t remember much about that in the press. But there’s lots of stuff I don’t ever remember seeing reported.

Well, then again, the press can’t be expected to report on everything. After all, someone has to gurgle about how the Obama’s have reinvented sex…or something

Reader C writes in:

many…actions of the new administration, have that “contrived” feeling. For example, the current dust-up about the AIG bonuses. If my memory recalls correctly, I read that when the initial bridge loans and the 40% equity share in AIG were made by the Bush administration, AIG was required to provide full disclosure on everything as a condition of the loans, including bonus payouts. I find the “outrage” quite manufactured. (How can the current administration not know the terms?)

[...that's a very good question, indeed, considering Geithner wrote the guide lines for the AIG bailout money -admin]

Similarly, two weeks ago, Citi was said to be “in very bad shape.” This bad shape was the reason for another infusion of bailout money in February. Their stock price below $1.25 per share. And, now suddenly, Citi reports a $6.8B profit for January and February. Both Bank of America and Wells Fargo are hinting at similar good news on their balance sheets. (A pal at WF has said they’re still working lots of overtime like it was last October.) Something is not right. Also, the Bush DOJ had begun a criminal inquiry in December/January to determine who began the electronic run of $550B last September. Since the change in administration, the investigation seems to have fallen out of sight.

Plenty of “hmmm …” at play.

Yeah…too bad our press is so incurious.

Incurious. That’s a word you never hear anymore. Remember when everyone was saying “Bush is incurious…”

Funny…now the press, which was never very good at asking Democrats anything “uncomfortable” seems to have lost any pretense of curiosity.

Curiouser and curiouser.

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  • http://hootsbuddy.blogspot.com Hootsbuddy

    To paraphrase another line “I come to bury Fannie and Freddie, not to praise them…”

    Puh-leese, can we let go of the blame-the-CRA meme and get on with some solutions. There is enough blame to go around.

    The Community Reinvestment Act and its various tweaks may have been the beginning.

    A symbiotic, incestuous relationship between Fannie, Feddie and members of Congress from both parties is definitely one of the roots.

    So, too, was a misguided effort in the seventies to get more people involved with home ownership in an effort to prevent their burning down rental property for which they were paying more than it would cost than if they were buying the property.

    Enough has been said about sub-prime lending and predatory practices. Maybe we should have left red-lining alone. When Congress tried to fix it they created more problems than solutions.

    It may have been a mistake for banks (and others) to sell debt contracts in a secondary market. (My favorite story is about a bank in Pennsylvania that is not affected by the mess because they have millions tied up in mortgages that cannot be sold. They deal with the Amish and houses sold on the aftermarket must have electricity.)

    But the wholesale mess that we see now is way out past those little seeds. No one in government invented multiple tranches of bundled “securitized” debts (an oxymoron if ever there was one) or “credit default swaps.”

    “Credit reporting agencies” now have as much credibility as hookers.

    The same unwatched pool in which today’s too-big-to-fail outfits were swimming was the same one in which Bernard Madoff was able to pull off the financial crime of the century.

    We know now that the problem is global. It seems the Chinese were just as gullible buying up what turns out to be fools gold as were Madoff’s victims. But guess what? Their economy is not in as bad a shape as ours for two reasons. They (first) don’t believe in deficit spending, because (second) they still think in cash terms. Ninety percent of cars sold in China are sold for cash. And what few “mortgages” are held are sold to borrowers who put down fifty percent or more. How very quaint!

    India seems to have escaped the mess (except for losing customers who can’t afford to buy as many exports) because the banks are all nationalized and they never got involved with these new-fangled financial cocktails. Silly Gandhi and his spinning wheels… what did he know?

    Eastern Europe is on the brink of insolvency, developing economies are apt to return to food and medicine crises if their fragile structures start to collapse and I’ve probably been reading too much Nouriel Roubini.

    Perhaps there won’t be civil unrest abroad or here, but these are more than cocktail party chatter topics. Tent cities are mushrooming up in more than one place, and a second wave of foreclosures is now underway, not as the result of adjustable rate mortgages but job losses.

    Time has come to hang together or get ready to hang separately. Thanks for letting me vent.

  • Texas Oak

    Occurred to anyone the whole thing may have been faked.

  • Texas Oak

    Was the %550B last September a real run, or was it merely a paper exercise designed to create a degree of panic.

  • btsea

    Who knows? We may find the parable of the loaves and fishes is a better model of life than the micro and macroeconomincs textbooks everyone reads in college. In the end, the “economy” may have more to do with saying “please” and “thank you” to one another and God, than with an MBA pyrotechnic show.

    I remember the place I was working at in the early 90′s. It was a very solid company. It’s stock was nothing spectacular. The employees bought the stock on the company plan and would joke about how it never made huge gains. Then we got a new CEO. At one of the meetings he told us he had got back from a meeting with the investors and an investor asked him why the stock wasn’t performing well. As an attendant at the employee meeting, I am listening to this story and thinking, “Ok, here comes justification for an unfolding sequence of events where the employee gets treated poorly to improve the companies yield.” And sure enough, things went downhill from that point the rest of the decade. Quarterly stock performance was the measure. Then it was said that we needed to double in size–to become a billion dollar company? On what basis?

    So now we are at the point where one wonders, how much more money can be wrung out of our companies (the companies, that is, that haven’t already been shipped overseas)? Have we fallen for a high profit myth that has enslaved us in the process? How much profit is reasonable, and on what basis? How high of interest rate is reasonable and on what basis? Remember the days of 5-1/4%? I don’t see these questions being discussed, yet they seem to be pretty fundamental. What is a reasonable level of human economic growth?

    Remember the story in the Bible about the Israelites and the pharaoh? Interestingly, the more the Israelites were oppressed, the more they increased and multiplied. Can the same be said for our country? It seems the harder we have worked, the fewer children we have had.

    I can’t wait for the Pope’s encyclical on the topic. I am very anxious to see his analysis.

  • btsea

    Oops, I just realized (after I walked away from the computer) that I said in my above post “parable of the loaves and fishes” when as we all know, this was a MIRACLE that Jesus worked!

    A little additional commentary regarding the economy. I suspect many of us have seen what it took to achieve the level of corporate performance of the past couple decades. Fellow employees that couldn’t hit home runs every day got the emotionless ax. Those at the top got bonuses, often for moving parts or all of the company overseas. We numbly nodded our heads that it was all good because the hierarchy said it was good and afterall it was necessary to realize the profit goals. And of course anyone who dared disagree…did not last long. I wonder if it is possible to develop a corporate structure where the employee can voice moral concerns without worrying about losing their job? After 10 or 20 years at a company shouldn’t one have a higher status than that of a flunky?