Why the push to failure?

Failure in war can be a bad thing. Failure in business can be a personal loss, and in some instances a detriment to the economy. With the recent calamity hitting the two largest mortgage lenders, not to mention other large American business concerns, it seems to a select few that failure is indeed a viable and good option.

A gamble with very high stakes is being openly promoted by adherents to a free-market orthodoxy. These individuals, gaming on anger and the perceived loss of utility of these given enterprises, are pushing the public onto this wager.

It is a game of economic Risk, where they believe the prize is their perceived fruits of their ideology. The economy, weighed down onto it the full weight of bad decisions, is in need of help. Intervention and regulation would make rational medication to this sickness. First and foremost with the ailing giants of the home loan industry. But these free-market libertarians believe such action would not pose as the cure. A clarion call has gone out by this group. In particular, the resistance to bailing out the two mortgage giants, Fannie Mae and Freddie Mac. Actually, bailing out any large American company, or in many cases consumers.

Let the homeowners eat cake!

Now I'm not saying that the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Mortgage Corporation ("Freddie Mac") aren't deserving of scorn. To be sure, not only should their books be audited and their activities curtailed, but the upper managers need to be removed. But these free-market fanatics simply want to throw out the baby with the bathwater (or at least attempt to sell it a parachute first!).

Why does it seem to me that all Washington ever seems to talk about these days is bailouts? Bailout Freddie Mac Bailout Fannie Mae
Bailout Wall Street. Bailout homeowners. Is it possible in America today that no one is allowed to fail?

You know, Phil Gramm was right. We are a nation of whiners. No one wants to believe that failure is an option anymore. Whatever happened to personal responsibility? Or learning from your mistakes? Or going through transformative difficulties that just might change your life and your behavior? But it seems like failure is off the board nowadays and that it’s government’s job to rescue everybody.

Whatever happened to the philosophy of Friedrich Hayek, the great free-market economist and Nobel Prize winner, who said the great thing about capitalism is the freedom to succeed beyond your wildest dreams, but that there is also the freedom to fail?

- short excerpt from "Is Failure No Longer An Option?", Larry Kudlow

What you have read above is just a small example of the tune being sung by those on the conservative and libertarian right. In the past, I have talked about Larry Kudlow, but I actually thought he could see the bigger picture. Now he has advocated that the two giants be broken up, which may not be a bad idea. Where I find fault with his ideas, is that he and his kind want to see them fail. How could they not see the damage that could happen on an aggregate scale?

Simply to break up Freddie and Fannie and the securitization of the remaining debt porfolio would not solve anything. It is sort of like the running argument about nuclear weapons and an incoming asteroid; if a nuke is launched instead of one giant problem would we be faced with a multitude of smaller catastrophic impacts? The same here, without real and proper regulation, what happens if we see a chain reaction of failures of the newer 12 "mini-fannies and baby freddies"? And making the remaining $5 trillion notional mortgage debt into packaged securities simply transfers the risk onto an already weakened financial system is asking for problems. We now know there is no uniform value for this debt, and pricing these new mortgage-backed securities would be difficult at best in the current housing environment.

Most economists are proclaiming that we are heading into a recession. Overall housing prices will depreciate in such an environment. Purchasers of this debt will want some sort of guarantee, and thus we could be back to having the government make some sort of promise. Assuming that these purchasers aren't foreigners banking on commodity-backed sources like petrodollars, then these buyers themselves will need access to credit. The Federal Reserve, assuming they drink this kool-aid of "risk transfer", will have to extend the borrowing window to companies like Goldman Sachs and others, this will batter the US dollar as an excess of liquidity is introduced.

Lastly, institutional investors themselves, assuming they hold onto their fiduciary responsibilities, will attempt to offset. If one believes that the credit derivatives market is large now, wait until this goes through! If the government attempts to clamp down on the over the counter market like swaps, then the action will simply be moved overseas. This is why you haven't seen much regulation introduced in petroleum trading, as it is very easy to transfer such activity beyond American jurisdictions.

It's more than just a simple bailout, it's about societal stability.

Perhaps my perspective is tainted from the fact that I believe in what I call "managed capitalism." I've never thought that laissez-fair capitalism to be appropriate in this day and age, what Milton Friedman preached as his idea of "freedom," simply cannot be applied to our society. This may sound like an anathema to many (and no doubt I'll get the hate mail), but we have many dependencies ranging from the disabled to infrastructure needs to veterans. The only way to utilize a system in which people like Larry Kudlow and Ron Paul advocate would be to cut loose these dependencies.

You see the current debate over Fannie Mae or Freddie Mac or even General Motors is a much larger philosophical one as it an economic one. Joseph Schumpeter (and others like Frederich Nietzsche) touted a concept known as "creative destruction." Basically, one form of goods or services is done away with one that is more improved. The horse and carriage industry was wiped out by the automobile one. This was sound and practical in the early era of industrial economics, though it did cost workers their jobs. But as we progressed into a more advanced stage the costs get higher and higher, in many cases beyond the money issue. Stability and order (note, I'm not talking in the same sense that one hears from fascist ramblings) for a middle class to sustain their families and in the end Democracy, must be made paramount.

GM and beyond

There are many, including myself, who are upset with General Motors and the possibility of a buy out. The company knew that the SUV party would not last forever. And not just General Motors, but Ford and Chrysler, both for decades have not had their act together. If, as management often claimed, they were doing the right thing, then why has companies like Toyota eaten their lunch? It's almost justifiable to oppose any assistance to these companies.

Saying this, one needs to a bigger picture. There is a smart progressive way and the stupid conservative way in doing this. The latter could be seen in Japan for over a decade in the form of "zombie companies." Legal entities that by all accounting standards should have declared bankruptcy and be liquidated but by some action by a banking group or government were kept alive. Mimicking this is not in our best interest.

So why save GM or Ford? Why not let "market forces" do their voodoo and allow these companies disappear? After all, as many in the bubble would say, a "better" one will arise from the ashes; probably by some young entrepreneur or a private equity group. To which I say fat chance! If starting up an auto group and successfully competing against any giant were easy, then Tucker in the late 40s would be around, and newer companies like Zenn and others would have mopped the floor with the Big Three.

The fact remains, given the inherent costs, starting up an auto companies is significantly cost prohibitive. And to build one in short order to replace the jobs and economic loss from the vaporization of the Big Three, is almost borderline fantasy. I say borderline, because there is only one sure way to make that a reality, and it is something conservatives and the current Republican Party would never do. That is subsidization of these start ups either monetarily or other means.

I highly recommend everyone pick up Prof. Ha-Joon Chang's "Bad Samaritans," it goes into detail how the Asian Tigers built up their industries. I'll give you a hint, it wasn't free and fair trade! These countries knew it was in their national best interest to have a strong manufacturing base, and the government did just about everything it could to promote domestic industries for home markets and export. The US government, despite claims to such, have abandoned such an agenda decades ago.

The loss of industry means the loss of knowledge. Engineering skills soon go untaught because students don't feel their is a future in such knowledge. And it isn't just the high end high tech stuff either, we are losing such time honored skilled craftsmen like glass blowers and such. Short of the development of a whole new industry, jobs in blue-collar (and increasingly white-collar) work is becoming a zero-sum game. Wage arbitrage is probably the best example of this.

A loss of an industrial pillar weakens the nation as a whole, making us more dependent on a foreign source for a good. It's really a national security issue, as we have established a fragile web, symbolized in Just-In-Time this or that. We have transferred onto ourselves risk in return for a supposed discount to the price future goods (and in the case of the investor class) and return on equity. Unfortunately, these folks haven't taken in all the variables!

Should every wager be backed by the taxpayer?

Ultimately, we all end up paying for any buyout the state initiates. The question becomes then, what are the limits of our generosity? The probability of a given sector of the financial industry imploding and granting assistance has risen tremendously. One need only look at specific cases like Long-Term Capital Management (LTCM) which saw itself self-destruct in 2000. The government feared that a run on equities as the hedge fund try to bail itself out. Soon intervention was had, and we warded off a potential stock market crash.

There have been several other similar cases since then. Each time, either the state or a group of institutional investors came in. But none of these incidents can mirror the possible calamity that would befell one of the large hedge funds or blue-chip company or government-backed entity. Be it the size of the enterprise or their portfolio, what we have now has grown so exponentially, that failure would be a fatal systematic shock. But we return to the question at hand, should we aid and bail a business concern in crisis, particularly one whose nature is that of speculation?

Until we set about reform in the market system, particularly in the spot and derivatives field, we are call to heed such a bail out. I should note that this is not entirely an American problem. There have been similar situations all over the world. It is within our grasp to set limits to speculation. Repealing many of the deregulation legislation here and abroad must be promoted. For example, raise the margin requirements and lower the position limits on many futures contracts. You don't need to outlaw speculation, it does serve its purposes. But it needs to be monitored and regulated. Not moving towards such an agenda is simply granting permission for the ramped abuse of these financial products.

Lastly, as a society who looks forward to retirement, we need to decouple the financial welfare of that outlook with that of speculation. Capital gains on 401Ks and other such investment retirement vehicles is also often met with capital losses. Retirees demand a safe and dependable income. Gaming the market as the sole means of achieving a semblance of comfortable living is an open invitation to disaster.

A religion by any other name

The free-marketeers have been playing semantics for a long time, tying the words "freedom" with "free market." Profit is deemed to be ecumenical whose only moral or legal objections should only be found by the taste of the market. Freedom's political connotations are merged with an economic perspective. Allow anyone to set up any enterprise. Should such activities born harm to a community, then said community will not assert monetary benefit to such an establishment. Eventually, it is believed by these folks, that the "bad company" will be replaced by a "good company." Thus salvation comes in the knowledge that the system will heal itself in time, like paper cut on a finger. Government is there only to set a basic set of rules and essentially become a night watchman state. Intervention, they believe, will only halt the repair or maintain the pain. They talk of civil liberties, but ultimately this is come to be an auxiliary for the liberty to pursue profit. And in this religion, salvation don't come cheap!

Uncertainty has often been placated by possibility with these folks, often the latter being a new privately-produced answer. Hence their bravado in speaking out in the allowance of failure in an entity. If A goes, need not worry because a person (or market) will come up with B. But it is this very prognostication that they fall back on, that is also in this author's opinion, one of their greatest weakness. For what happens if some private entity or person doesn't come up with B?



excellent post

Just a reminder to people, over in the user guide is the code to put up a link to EP on cross posts. We are starting to hop in terms of readers but people need to find us.

It is a joke, free trade and deregulation is more like a taxpayer subsidized pass for corporations and when it comes back and bites them, once again the taxpayer is stuck with the bill for the latest debacle.

What is the percentage of foreclosures which occurred simply because of deceptive or predatory mortgages and refinancing?


thanks for letting me post and your comment. Um...ok maybe I'm stupid, but where is that link thing for the cross post??

I am stupid

nevermind, found it!

you're not stupid & sourcing

There is a lot of stuff on this site. Of course since I'm admin, people can just use the email and ask, no biggie.

I started thinking about US auto manufacturers and I think it might be an exceptional case of how outsourcing is really bad and it's bad because it's death by spreadsheet. They look at their company by 3rd party sourcers, spread sheets and think, "oh, if something is profitable, we'll just acquire it" versus actually innovate, have R&D in house and set the market direction. I mean even now they could bring back those box cars that got 45, 50mpg with technology that is over 40 years old and instead we have ads now (all of the auto manufacturers) trying to present 23MPG and so forth as now "fuel efficient" (cough, cough). They are exceedingly mismanaged. Managed by spreadsheet instead of innovation, future strategy and product.

Perhaps GM was a soviet car company?

In a way, they had become inefficient and badly run like an old mill in the former USSR!

we should look into these corporations

on management. I do know GM does spend a lot on R&D but I also know they have been offshore outsourcing in droves. While GM is busy closing plants, Toyota is investing in R&D in the US and building a plant.

Great Article Johnny

Pretty well spot on.

Too much of US industry's management today only know how to chop, cut, close, downsize and outsource.

There is virtually no creating innovating, building going on.

Surely old technologies die or change, but without anything new on the horizon to take its place its a strategy that leads to long term decline and death of industry.

The growing economies of the world are doing it by building infrastrucure and manufacturing base, something we are rapidly forgetting how to do

US industry is setting itself up to failure - and the primary culprit is short term thinking and the need to please Wall Street rather than build up mainstreet

Start up subsidies

" say borderline, because there is only one sure way to make that a reality, and it is something conservatives and the current Republican Party would never do. That is subsidization of these start ups either monetarily or other means."

Isn't this pretty much what the Europeans did to create Airbus? propped up the troubled remains of the european aerospace industry and subsidize the heck out of it?

sure do

That would be another excellent blog post topic. How other nations create incentives or have programs to build up industries in comparison to the United States.


Well, it looks like Ford is going to retool some plants but focus on the Focus.

The problem is currently it gets about 24/35 mpg. Don't they get it? People want 50 mpg or better, why can't they get it together to make such a thing? The technology is often 40 years old! Where are the hybrid plug-ins?

Ford goes on and on about environment, yet beyond pumping hydrogen hype, where is the R&D into alternative vehicles, fuel efficient vehicles? They have a SUV which gets 34 MPH highway, which I believe is the best of any larger vehicles, why don't they expand on that?

It isn't just Detroit

I am going to try to track it down, but in one of the car magazines there was an article comparing the 70s Toyota Corolla with the current model

A bit surprising that the newer model is several inches longer, wider and taller than the original model and weighs almost 1000 lbs more

The old models were spartan and had few power accessories like steering brakes or air, and most had sticks, todays are loaded with power accesories and automatic

Little wonder that the fuel mileage isn't any better either


yet another great topic for a blog post. I comparison/contrast of MPG (you have to adjust for today's ratings) and cars from 40 years ago. I'm not sure but it seems Honda had a car too that got like 70 mpg or something outrageous. America! To the junk yard we go in search of fuel efficient vehicles!


engines from the 1970s got terrific gas mileage. And one of the said stories has been that VW has cornered much of the clean diesel market, and are able to produce cars that get tremendous mileage for the euro market.

VW Jetta TDI

They stopped selling them last design change or two - supposedly they didn't meet the US "Tier II" std for diesel emissions

Those routinely got 45 mpg or better And they weren't a typical diesel - they had plenty of pep and pickup - if you didn't know it was a diesel.....

Honda Civic

The original honda civics of the 1970s got into the mid 60's mpg - of course they were tiny little two seaters with a two cylinder motorcycle engine and a chain drive

but very economical none the less

Minor correction

The model I was thinking of was the N600 - the predecessor to the Civic and the first US imported Honda car

Mom's Geo

My Mom's old 94 Geo gets 45 MPG around town and 52 on the hiway - better than most hybrids!

I crack up too when they advertise 25 mpg as fantastic mileage - my old 60's and 70's (pre emission controlled) beaters got at least that

The problem is that they have loaded them up with safety features (a good thing on balance) that added weight as well as more and more power accessories (rob power and ad weight) as well as adding more emission controls (again on balance not a bad thing) without updating engine designs - although some contend that most of the efficiencies to be gained in internal combustion have already been made. Beautique gas blends that have removed additives like lead also have harmed fuel efficiency (however again getting rid of lead has not been a bad thing)

We do need the return of the true economy car - plain jane models with minimal features and fuel efficent engines

I have said this before but a big part of the shift to trucks in the 80s and 90s was that you could still get a basic utilitarian truck in a economical package as they loaded up the cars with more and more geegaws - however nowadays trucks are just as loaded and costly as cars - and as a result reliability, maintainability and economy has suffered