Thursday, May 07, 2009

Calvinball in the Financial Markets

One of the funniest themes in the old Calvin & Hobbes cartoon was the game "Calvinball," a totally improvised game that had really no rules. It's a funny idea for a cartoon that centers on the adventures of a 6-year old boy, but it's no way for a president to conduct economic policy:

Many investors are sitting on the sidelines, as is much money. Why? Because it is impossible to know what the rules of the game are. And that's because the administration and the Congress keep changing the rules in capricious ways in pursuit of larger political objectives.

Government interference in the normal conduct of business has had a chilling effect on financial markets and threatens the progress of the recovery. The Treasury and the Fed have created many new programs to provide liquidity to the financial system, to help banks restructure their balance sheets and to re-invigorate securitization markets.

So far, the interest in these has been distinctly muted because potential participants fear the longer term consequences of getting involved with any of these programs.

The Term Asset-Backed Lending Facility (TALF) is a good example. It was designed to stimulate an important part of the credit market--based on securitized loans--by providing a facility to lend up to $1 trillion in loans to buyers of top-rated securities that are collateralized by credit-card debt, auto loans, student loans, small business loans and commercial real estate loans. Because they are non-recourse loans, the investors have little downside exposure. But so far, they have stayed away. They are afraid of the strings that may be attached, since the loans are ultimately secured by TARP funds.

Above all, business people are rational actors, especially those with a fiduciary duty. If you can't be sure of the rules, it would be foolhardy to invest money, or pursue financing of any sort. That's why the Chrysler deal is such a problem. Why put money into an enterprise if the government is able to rewrite the rules to your detriment and vilify you for making legitimate claims as a creditor?

This isn't a game. I wonder if some of the people in Washington really understand the implications of what they are doing.

5 comments:

W.B. Picklesworth said...

I wonder if some of the people in Washington really understand the implications of what they are doing.

Is it oversimplifying to say there are two options?
If yes, then they are criminals.
If no, then they are incompetent.

I'm leaning towards the former. But I'll add a caveat to it because I think I really am oversimplifying it. They think that the ends justify the means (as sometimes they do.) For them, it is worth cracking some eggs to make our society more "fair" and more "just."

It is worth noting that, under this scenario, our political leaders must have some strongly negative feelings toward America as it has existed up to this point. It seems a line has been crossed from feeling remorse for things done wrong to believing that the American past is stained and must be left behind as we move into a new, and quite different, future.

Anonymous said...

Mark,
I fail to see how laws have been broken. Saying mean things about hedge funds hardly impairs the rule of law. What law makes it illegal for the President, or anyone else, to criticize someone? What about the Chrysler situation is illegal? Cite me the portion of the U.S. Code that the Presidents Chrysler situation has violated.
You’ve got 60,000 folks working for Chrysler, and don’t forget the multiplier effect; for every Chrysler job lost many others go down the tubes as well. Delivery people, suppliers, small businesses around these plants, etc. And the very real possibility of a spiral that takes GM down too. I understand your Libertarian leanings, but I am not ready to take the risks involved of a Chrysler/GM collapse when we are on the brink of God knows what economic calamity. The entire Midwest, but especially Michigan and Ohio, hangs in the balance. I know you know what a tipping point is, but do you think you know where it is? Are we past it? Neither of us knows the answer to that. The facts are simple: the administration worked to negotiate with Chrysler's creditors to avoid a bankruptcy because that would allow for more chance of success and would not harm the brand of the company as a bankruptcy would; they got that with 95% of it's creditors but hedge funds and investment banks wanted to liquidate figuring they could get more.
Guess what? They miscalculated. That is what hedge funds frequently do, and folks that invest in them should know that. A court has upheld the plan that the majority of stakeholders want to push through, so where has the law been eroded?

Regards,
Rich

Mark Heuring said...

WBP,

I don't think there's anything criminal per se. I think it's simply hubris. And those who are ruled by their own hubris tend to view their own will as more important than whatever rules might be in play. That's how a secured creditor can become unsecured.

I suspect you're right about the line being crossed, though, and you are spot on about the reasons.

Rich,

Your argument starts with a strawman and goes downhill from there. Look back through the post - did I say laws were broken? No need to go through the U.S. Code.

You are a sophisticated enough person to know the difference between statutory law and generally accepted practices (e.g., rules). In a typical bankruptcy, secured creditors are at the front of the line. Precisely because this deal was not typical, Obama and his team was able to rewrite the rules to benefit constituencies that ordinarily would have been at the back of the line. Can he do that? Apparently, since he did and is likely going to get by with it. Should he? That's a different question.

The article from Forbes that I cited talks about the basic principles at stake and the implications -- business people are rational risk takers. If there's even a hint that the government can swoop in deus ex machina and change the rules of engagement, no rational business person will want to take any risks. And that way lies Argentina.

My "libertarian leanings" don't have much to do with my argument, by the way, except that I figure that simple, easily understandable rules are the best in most cases. But that's more my belief in Occam's Razor than my reading of Milton Friedman. If we are to avoid the economic calamity you posit, we need to get back to a normal, systemic business environment where capital flows, instead of being parked on the sidelines. That was the point the Forbes article was making and I am amplifying.

I don't have any illusions that I'll change your mind, let alone Obama's, about this. You'll just have to learn what the implications are for yourself. As will we all.

Mark Heuring said...

One other point, Rich -- the reason the Chrysler deal had to be outside of the normal bankruptcy courts is so Obama could get the result he wants. If the statutes governing bankruptcy get in the way, simply move the transaction out into a netherworld. Like Calvinball, right?

Night Writer said...

Put another way, do you want the umpire calling balls, strikes, outs and runs, or do you want the fans in the stands doing it from their perspective?

Which way has the best interests of the game in mind, and which is based on the passions and needs (and biases) of the moment?