Thursday, May 7, 2009

Oh, details, always with the details

Robert Reich today on the outcome of the Treasury Department "stress tests":
The outcome of the "stress tests" will be that the banks needing extra capital will get it from the Treasury. But where will the money come from, now that the TARP fund is almost exhausted and Congress is dead set against providing more bank bailout money? The Treasury will simply swap debt for equity – turning what the banks owe the government into shares of stock in the banks. Presto. Ailing banks will get more capital, and Tim Geithner won’t have to go back to Congress to ask for it.

But by this sleight-of-hand, the public takes on more risk. Much of the money we originally gave Wall Street took the form of senior debt. We were preferred creditors, meaning that in the event of bankruptcy (or some form of it) we’d get repaid first. But as shareholders, we’d get nothing. As we’ve seen time and again during this economic crisis, shareholders lose big.
Wait a second. Let's go back:
But by this sleight-of-hand, the public takes on more risk.
Professor Reich goes on to discuss the likelihood that, should we become the major bank shareholders, we might well not make the money back (though that doesn't seem to be the common assumption of the administration and most economists), and it's not clear at all how governance is done in a publicly-owned bank (my guess: business as usual, see AIG for details).

It seems to me that pretty much everything that's being done right now pushes risk onto the most vulnerable, and anything that might reduce risk (national health care, for example) is deferred or delayed or otherwise left for later.

Perhaps this is inevitable. After all, the nation as a whole has spent itself and leveraged itself into a remarkably risky position, and none of this can be unwound without involving the "regular people." Clearly, a good portion of what we're experiencing now is actually the realization of the risk we deferred year after year.

But risk rarely spontaneously decreases, it takes positive innovation to do that. Otherwise, most actions just move risk around. For example, the invention of circuit breakers made the use of electricity far less risky than it had been. Traffic lights, the use of automobiles - we could come up with any number of examples.

The financial world, however, has spent its time on innovations that do not in fact reduce risk, but move it around. Sometimes that's been desirable, as it is for commodity futures, in which the risk is removed from the farmer who just wants to focus on growing a healthy crop, and given to a trader who's comfortable with the downside potential (but believes his or her innate smarts will offer upside).

What we've seen over the past few years is the negative side of innovation, a host of complicated-sounding products that have simply moved risk around, and not always to those who are willing to embrace it. We've also had a lot of puffery, much of it expounded by seemingly trustworthy types, to the effect that, for example, the stock market always offers positive returns over the long haul. And we've bought into that puffery, believing that risk has somehow been removed from the system when nothing of the sort has happened.

That hits home only when a family wakes up and realizes that putting Junior's college fund into a can't-drop-in-price house, or worse yet, into a big screen TV, actually pushes their risk (and Junior's) into unacceptable territory.

We can explain a few other things through this spreading of risk (if you want to read some real-life examples of risk-shifting, I direct you once again to Peter Gosselin's excellent book High Wire). Income inequality is a direct consequence of spreading inappropriate risk around the economy.

It's also the case that there is a global risk, and, as we take steps to reduce the risk in other countries, we assume that much more ourselves (creating more certain income streams for Indian computer programmers makes returns for American programmers that much more uncertain - I'll leave it as an exercise as to whether there are other compensations that make up for that).

There is clearly a political opportunity for someone to pick up on and speak to the increasingly risky lives of Americans. It could be done by intelligent re-examination of our national priorities, adjusting spending even as we provide appropriate stimulus; this is unlikely, as chronicled today by EconomistMom. Or we can slip into foolish demagoguery, which appears to be the approach of the Republican Party.

What we could do is reprioritize, accept that our chickens have come home to roost, and intelligently reorder things so as to deal with the reality of a poorer nation than we would like to believe we have. I am not hopeful.

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