With hindsight, should Lehman have been bailed out?

[Puppycow]

Did everything go to pot because Lehman Brothers didn't get a bailout, and it was the first dominoe at the head of a long chain?

[brumsen]

Well, put it this way... if you have a big hall full of dominoes. Apart from aesthetic considerations, does it really matter which one is going to fall first?
We ain't seen nothing yet. I'm very curious about the discussions on support for the Big Three today.

[Puppycow]

No, it doesn't really matter if it's a big domino like Lehman or any other investment bank of comparable size.

(Of course the domino analagy is imperfect)

[brumsen]

The way I see it: letting Lehman fail was a bit of an experiment, which did have fairly disastrous consequences. As a reaction to that, it seems that anything and everything is now eligible for a bail-out.
But I do not think that can last. At some point the bail-outs will have to stop. There seems a bit of an ideological crisis raging in liberalist free-market capitalism, but at some point it has to dawn on everyone that continuing with bail-outs is impossible. It is anybody's guess whether that will be before or after the dollar has crumbled. Possibly before - but then again I think the events that are going to cause a collapse of the dollar have already been set in motion, and are pretty unstoppable now.
So the question is really: do we keep throwing money at businesses in order to prop them up? Since that money is likely to become near worthless in the foreseeable future, there seems to be little reason not to increase the debt a bit further.
Given all this, did Lehman really matter? Not that much, I think, except that it seems to have given rise to the impulse to bail out everything.

[Tippit]

But I do not think that can last. At some point the bail-outs will have to stop. There seems a bit of an ideological crisis raging in liberalist free-market capitalism, but at some point it has to dawn on everyone that continuing with bail-outs is impossible.



Since the Fed can create as much money out of thin-air as it wants, the bailouts don't have to stop for a very long time. They can continue transferring purchasing power from dollar holders to the bailout beneficiaries until there is no purchasing power left.

There is no crisis in "free-market capitalism" because there hasn't been anything resembling a free market since the creation of the Federal Reserve System in 1913. Why you and others confuse the monopoly of the most important thing in any economy - the money supply - with free markets is unclear.



So the question is really: do we keep throwing money at businesses in order to prop them up? Since that money is likely to become near worthless in the foreseeable future, there seems to be little reason not to increase the debt a bit further.
Given all this, did Lehman really matter? Not that much, I think, except that it seems to have given rise to the impulse to bail out everything.

Since that would only serve to rip off the public by debasing the dollar even more, and further distorting asset prices, it would only serve to make the situation worse.

[brumsen]

Since the Fed can create as much money out of thin-air as it wants, the bailouts don't have to stop for a very long time. They can continue transferring purchasing power from dollar holders to the bailout beneficiaries until there is no purchasing power left.
You're right - in principle. But what's the point of bailed-out companies if nobody can afford their wares? Surely that insight is not far off?

There is no crisis in "free-market capitalism" because there hasn't been anything resembling a free market since the creation of the Federal Reserve System in 1913. Why you and others confuse the monopoly of the most important thing in any economy - the money supply - with free markets is unclear.
Call it what you want. It may not have been a free market since 1913, but nonetheless I think we can safely say that all the bail-outs are not exactly in line with the ideology that has prevailed during that time.

Since that would only serve to rip off the public by debasing the dollar even more, and further distorting asset prices, it would only serve to make the situation worse.
For most, yes. But surely you're not suggesting that there are no people for whom this would work to their benefit?

[Francesca R]

Did everything go to pot because Lehman Brothers didn't get a bailout, and it was the first dominoe at the head of a long chain?I don't know. The decision to let Lehman fail was taken in a necessary hurry lacking the information about how widespread its effects could be that is now available. The case for lender/buyer of last resort is to prevent the damage that would result from even a temporary period of "excessive" pessimism/fear in the belief that the some of the excessive consequences can be completely avoided. However it is scarcely possible to remove from this the concomitant moral hazard that may prevent the "correct" pricing of risks. And "excessive" and "correct" are judgement calls. And logically, prevention of excess should be symmetrical, yet no government in the world really sets out to lean against bull markets in risk-taking. Now they are talking about that more, but it is not the first time, and the discussion is slightly surreal because nobody expects such a cycle imminently.

The Lehman bankruptcy did produce a worse outcome. And it is possible that its rescue could have reduced the bill for subsequent rescues. Or it could have postponed financial trouble for later and made it still worse eventually. I think we learn as we go along. Somewhat dispassionately, it is valuable to this learning process to have such a data point.

[brumsen]

The Lehman bankruptcy did produce a worse outcome. And it is possible that its rescue could have reduced the bill for subsequent rescues. Or it could have postponed financial trouble for later and made it still worse eventually. I think we learn as we go along. Somewhat dispassionately, it is valuable to this learning process to have such a data point.
I don't get it. It produced a worse outcome than what? Basically what you say directly after is that we can't (yet?) really know whether letting it fail produced a worse outcome than rescuing it.
I think there is a basic philosophical problem with the knowability of the truth value of such a counterfactual, since you can't repeat the experiment in exactly the same conditions.
Which would also mean that the value of the data point is likely to be rather limited.

[Francesca R]

We won't know the comparison of letting it go versus rescuing it. When I say "produces a worse outcome" I mean it caused unforseen additional difficulty/panic in the prime brokerage area (Lehmans was one of the biggest PBs) and an unanticipated upward spike in perceptions of counterparty risk. When I say "learn as we go along" I mean that we are learning what it means when an investment bank disappears and that was not known in advance, no matter who claims to have known.

However nasty it is, there is value in this.

[Tippit]

You're right - in principle. But what's the point of bailed-out companies if nobody can afford their wares? Surely that insight is not far off?



Monetary debasement (inflation) for the last two decades has gotten us into this mess, and has served to disrupt the price system while simultaneously enriching an elite banker class. More of the same won't solve the problem, and will in fact make it worse.



Call it what you want. It may not have been a free market since 1913, but nonetheless I think we can safely say that all the bail-outs are not exactly in line with the ideology that has prevailed during that time.



I would say the un-free market has definitely prevailed. The Federal Reserve has supervised bailouts not limited to the LTCM Hedge Fund, Orange County California, the City of New York, Continental Bank of Illinois, Amtrak, and many more, not to mention its recent looting of the American public. The "freedom" to buy a few products from massive corporations, be taxed into oblivion, have your currency debased, and watch the largest, most corrupt, and most inefficient institutions not be "allowed to fail" aren't close to representing true free-market ideology. Criticism of something that doesn't exist is meaningless criticism.



For most, yes. But surely you're not suggesting that there are no people for whom this would work to their benefit?

Yes, big bankers, hedge fund managers, and fat cat automotive executives, to mention a few. Of course this will happen under the premise (and the implicit threat) that it's necessary to save the broader economy.

[Francesca R]

There is no crisis in "free-market capitalism" because there hasn't been anything resembling a free market since the creation of the Federal Reserve System in 1913. Why you and others confuse the monopoly of the most important thing in any economy - the money supply - with free markets is unclear.I can't speak for other posters, but I would not wish to confuse centralised monopoly of money supply with a free market in money at all. After all, a free market in money (with the word "legal" essentially removed from "legal tender", and rates of interest and exchange backed by nothing other than competing and coalitional individual will and intent), are a reliable route by which that money is debased and usurped by private force, which does rather more than rip off the public.

[Puppycow]

It is anybody's guess whether that will be before or after the dollar has crumbled. Possibly before - but then again I think the events that are going to cause a collapse of the dollar have already been set in motion, and are pretty unstoppable now.

I don't see that at all. I agree that it's counterintuitive, but I think there's actually more danger of deflation now than of a collapse of the dollar. One dollar can buy more of most stuff today than it could this summer. The situation is much like that of Japan in the 1990's and early 2000's. And the yen is stronger than ever.

[brumsen]

I don't see that at all. I agree that it's counterintuitive, but I think there's actually more danger of deflation now than of a collapse of the dollar. One dollar can buy more of most stuff today than it could this summer. The situation is much like that of Japan in the 1990's and early 2000's. And the yen is stronger than ever.
Nonsense. Look at the history of the trade balance of Japan, and then of the US - and you will see where the difference is. Temporary strength of the dollar means nothing.

[Francesca R]

Nonsense. Look at the history of the trade balance of Japan, and then of the US - and you will see where the difference is. Temporary strength of the dollar means nothing.OK. The US has had a trade deficit, and Japan has had a surplus, since the 1970s. So a "collapse" of the dollar against the yen due to this is . . . imminent any time now?

[brumsen]

OK. The US has had a trade deficit, and Japan has had a surplus, since the 1970s. So a "collapse" of the dollar against the yen due to this is . . . imminent any time now?
I'd me more inclined to say, against the yuan. Or gold.
Yes, I think so, and I am not the only one either.

[Francesca R]

What does Japan's net exports have to do with those? (And what does the US trade balance have to do with the gold price?)

[brumsen]

What does Japan's net exports have to do with those?
Nothing much. It was puppycow who compared the yen and the dollar in order to argue against imminent collapse of the dollar, and I simply pointed out an important difference between the two countries.

And what does the US trade balance have to do with the gold price?
I'm sure you know, but I'll say it anyway:
the US trade balance has only been able to get so much out of hand because the dollar has been the currency of reference, which everybody was willing to trade in. However at some point nobody will want to buy dollar bonds anymore. This will lead to a collapse of the value of the dollar against other currencies, and one likely scenario will be a flight to gold. Hence demand will explode, and so will the price, especially since mining operations have been more or less choked by the relatively low gold prices recently - which were the result of hedge funds dumping their gold assets.

[Francesca R]

Nothing much. It was puppycow who compared the yen and the dollar in order to argue against imminent collapse of the dollar, and I simply pointed out an important difference between the two countries.Yes there are differences, but falling prices and zero nominal interest rates were accompanied by a soaring yen.
I'm sure you know, but I'll say it anyway:
the US trade balance has only been able to get so much out of hand because the dollar has been the currency of reference, which everybody was willing to trade in. However at some point nobody will want to buy dollar bonds anymore. This will lead to a collapse of the value of the dollar against other currencies, and one likely scenario will be a flight to gold. Hence demand will explode, and so will the price, especially since mining operations have been more or less choked by the relatively low gold prices recently - which were the result of hedge funds dumping their gold assets.Well I certainly read that type of analysis a lot but it has been doing the rounds for almost a decade. There has been no significant move away from US dollars in the reserve portfolios of central banks (beyond that which can be accounted for by exchange rate movements themselves). There is no indication whatsoever of any shortage in demand for US treasuries, which can be demonstrated by their extremely low yield to maturity, which has plummeted in the last month from what were already multi-decade low yields. And this is in an environment where ballooning issuance (in order to pay for government ownership of bailed-out institutions and for Obama's expected-to-be-forthcoming trillion dollars or so of fiscal stimulus) is public knowledge. And the trade-weighted dollar has been the second strongest majoy currency since mid year (after the yen, actually).

It seems to me that if the dollar was going to "collapse" then the time to do that would have been rather recently. If the current mess didn't trigger it, what will?

[Mister Agenda]

Yes there are differences, but falling prices and zero nominal interest rates were accompanied by a soaring yen.
Well I certainly read that type of analysis a lot but it has been doing the rounds for almost a decade. There has been no significant move away from US dollars in the reserve portfolios of central banks (beyond that which can be accounted for by exchange rate movements themselves). There is no indication whatsoever of any shortage in demand for US treasuries, which can be demonstrated by their extremely low yield to maturity, which has plummeted in the last month from what were already multi-decade low yields. And this is in an environment where ballooning issuance (in order to pay for government ownership of bailed-out institutions and for Obama's expected-to-be-forthcoming trillion dollars or so of fiscal stimulus) is public knowledge. And the trade-weighted dollar has been the second strongest majoy currency since mid year (after the yen, actually).

It seems to me that if the dollar was going to "collapse" then the time to do that would have been rather recently. If the current mess didn't trigger it, what will?

Isn't there a principle that bad money drives out good? The problem with gold is people hoard it instead of spend it, which limits its usefulness as money. If you had some gold in an inflationary period I imagine you would sell it off a little bit at a time for cash and spend that. It would never actually take the place of fiat money unless the supply of cash dried up. Wouldn't people be more likely to start using less-inflated currencies in the case of Zimbabwe-style inflation than turn to commodity currency? Due credit to Dr. Kitten who brought the point up in another thread, but I don't recall the name of the person who formulated the idea.

[Francesca R]

I don't think anyone was talking (in this thread) about gold being used as legal tender (Gresham's Law (http://Gresham's Law) BTW), but about the USD collapsing against other currencies and gold because of the US trade deficit [net exports], or the current account deficit [net exports + net investment income + net transfers].

I can't link these due to copyright, but I searched through some archives and found some papers written by Jim O'Neill (chief economist at Goldman Sachs) that go way back:

5 Jan 1999: "US Balance of Payments--Unsustainable!" (It was -2.5% of GDP)
11 March 2002: "US Balance of Payments--Still Unsustainable" (-4% of GDP)
10 March 2004: "US Balance of Payments. Unsustainable, But . . . " (-5% of GDP)
17 Jan 2007: "US Balance of Payments: Is It Turning and What Is Sustainable?" (-6.5% of GDP)

All of these called for long term dollar depreciation. The dollar is lower compared to 10 years ago against the euro and the yen, but not drastically, and most of this can be explained by relative inflation (so its purchasing power is not much different)

[Toke]

Hyperinflation would solve the problem of bad debt in housing and credit cards, right?
What are the downsides, and are there a choise?

[geni]

Hyperinflation would solve the problem of bad debt in housing and credit cards, right?
What are the downsides, and are there a choise?

Dirrectly an inability to import anything.

[geni]

We needed someone like Lehman's to fall over to deal with the moral hazard issues. Against that it was a really bad time to have someone like Lehman's fall over so rock meet hard place.

[Francesca R]

A one-off (large) rise in general prices, or even a credible announcement that there will be such, would depreciate the purchasing power of all nominal assets and cash, and that of nominal income streams. In theory real assets (equities, real estate and index linked bonds) and inflation-linked income streams (most wages) should retain their purchasing power, and therefore nominal debt should shrink in value relative to these. The exchange rate should fall by an offsetting amount to the rise in domestic prices, so foreign currency debts would rise (although in theory not relative to the value of domestic real assets)

In practice I don't think this kind of trick has ever been achieved without a great deal of losers (wage earners, savers, investors, pensioners) because there are extreme economic costs involved in bringing the inflation rate back down again. In short, nobody would believe that a one-off dose of "hyperinflation" would be just that (particularly international investors).

[brumsen]

Well I certainly read that type of analysis a lot but it has been doing the rounds for almost a decade. There has been no significant move away from US dollars in the reserve portfolios of central banks (beyond that which can be accounted for by exchange rate movements themselves). There is no indication whatsoever of any shortage in demand for US treasuries, which can be demonstrated by their extremely low yield to maturity, which has plummeted in the last month from what were already multi-decade low yields. And this is in an environment where ballooning issuance (in order to pay for government ownership of bailed-out institutions and for Obama's expected-to-be-forthcoming trillion dollars or so of fiscal stimulus) is public knowledge. And the trade-weighted dollar has been the second strongest majoy currency since mid year (after the yen, actually).

It seems to me that if the dollar was going to "collapse" then the time to do that would have been rather recently. If the current mess didn't trigger it, what will?
You seem to think that the worst is over. I don't.
Moreover, I fail to see how the fact that until now a ballooning trade deficit has not caused a drastic depreciation of the dollar until now, enables us to conclude that there will not at some point be a stampede out of the dollar.
Let us hope that you are right.

[The Central Scrutinizer]

There is no crisis in "free-market capitalism" because there hasn't been anything resembling a free market since the creation of the Federal Reserve System in 1913. Why you and others confuse the monopoly of the most important thing in any economy - the money supply - with free markets is unclear.

:dl:

It's dah joohs!

Folks, what he's calling for here is a free market for the money supply. Which means anyone can print any money they want. Your employer pays you in Hefedrees, but every store in your town only accepts Kollopseez? Well, too bad for you! I guess you'll have to move. That's the free market in action! But at least we got rid of those jooh conspirators at the Fed!

[Francesca R]

Moreover, I fail to see how the fact that until now a ballooning trade deficit has not caused a drastic depreciation of the dollar until now, enables us to conclude that there will not at some point be a stampede out of the dollar.It doesn't, but you were rather more direct than saying "we cannot rule out a dollar devaluation sometime". You said it was inevitable, now.
It is anybody's guess whether that will be before or after the dollar has crumbled. Possibly before - but then again I think the events that are going to cause a collapse of the dollar have already been set in motion, and are pretty unstoppable now.

[Toke]

Dirrectly an inability to import anything.

I see some humorus aspext to soviet style euro/yen/ruble shops in the US.

Particulary when economists try to defend unleashed capitalism.

[brumsen]

It doesn't, but you were rather more direct than saying "we cannot rule out a dollar devaluation sometime". You said it was inevitable, now.
I said: the collapse of the dollar seems to me inevitable now.

YOU said: at various states of the trade deficit there have been doomsayers, until now they've always been wrong.

I said: That they've been wrong in the past does not mean that they'll always be wrong.

YOU say: but your original point was stronger than that.

I say now: indeed it was. I have merely shown that your reply can hardly be thought to have proved me wrong. So what I said could still be right. If you want to prove me wrong you'll need another argument than the one you gave.

[Francesca R]

I have merely shown that your reply can hardly be thought to have proved me wrong. So what I said could still be right. If you want to prove me wrong you'll need another argument than the one you gave.No it doesn't "prove you wrong" (IE prove an exchange rate forecast wrong). But you are basing the forecast on the US trade and current account deficit, which has been around for decades. So it's more that that argument for a $ collapse is weak.

(In fact, FX forecasts are very much a lottery.)

[brumsen]

No it doesn't "prove you wrong" (IE prove an exchange rate forecast wrong). But you are basing the forecast on the US trade and current account deficit, which has been around for decades. So it's more that that argument for a $ collapse is weak.

(In fact, FX forecasts are very much a lottery.)

OK. Agreed. Both of our arguments are weak, because you can't predict exchange rates any more than lottery outcomes.

Well, I still wonder if that statement is literally true. Can't you at least point at certain tendencies in exchange rates, and make predictions about the general direction? (Which is more than what you can say about lotteries.) Surely you would agree that things don't look all that rosy for the dollar, even if you don't believe in an imminent collapse?

[Francesca R]

Well, I still wonder if that statement is literally true. Can't you at least point at certain tendencies in exchange rates, and make predictions about the general direction? (Which is more than what you can say about lotteries.) Surely you would agree that things don't look all that rosy for the dollar, even if you don't believe in an imminent collapse?The most reliable (IMO) tendency is that real exchange rates of developed countries (FX rate deflated by the differential time series of traded goods prices) show stationarity, or mean reversion over periods of several years. So for example, the yen, dollar and euro (Deutschemark or ECU before 1999) are more or less at the same level against each other today (give or take 10%) as they were in the 1970s when the post WW2 "Bretton Woods" arrangement was abandoned, but they have fluctuated a lot and for sustained periods in the interim.

As to whether things "look rosy", FX rates are relative prices. Things don't look peachy for the euro either, nor the yen*. They can't all go down against each other.

*or the pound or the yuan or the rupee or the (Latvian) lat or (Swedish) krona or . . .

Or course, this type of thinking cues up commodity bugs.

[skepticalbeliever]

I think Lehman brothers should have been allowed to fail. The people there took big stupid risks that were unmanageable. These types need to be allowed to fail or we'll have to give everybody a bailout.

[Toke]

Looks like everybody IS getting a bailout.
Exept the taxpayers.