Bailouts Don't Address the Real Problem

Submitted by Rich Toscano on October 1, 2008 - 12:20pm

Every pundit on Earth is playing the game of picking the various bailouts apart and proposing their own improved bailout schemes. But I think that most of the conversations going on out there miss a critical point: that this bailout and the ones that will in all likelihood follow it fail to address the root cause of the problems.

That root cause, in my opinion, is that the vast majority of political leaders, regulators, and pundits zealously cling to a deeply flawed analytical framework.

To put it more simply: the people and principles that blithely led us into this mess are absolutely the wrong people and principles to lead us out of it.

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Submitted by peterb on October 1, 2008 - 12:32pm.

Elegant statement! Reminds me of what many people said about Bush when he was running for re-election.

Submitted by cr on October 1, 2008 - 12:53pm.

...long-term economic strength is based on what a society produces, not what it consumes

We produce a lot a debt, that's gotta count for something, right? Oh, wait.

Well written. Unfortunately these days common sense is neither.

Submitted by underdose on October 1, 2008 - 2:18pm.

Definitely one of your best articles, Rich.

The only part I raise an eyebrow at is your reasoning that Messrs. Bernanke and Paulson are unlikely to be lying. Sadly, in this society, liars are rarely caught. People just believe anything, and forget that they once believed it. You are in a very small minority who keep old quotes and use them to prove people wrong. But the mainstream news media does no such thing. It is entirely possible, even likely, that Paulson and Bernanke took a page from the boss's (remember who hired them!) playbook and boldly, brazenly lied knowing full well that almost nobody would call them on it. It seems odd, if they were completely incompetent, that Goldman Sachs would have largely made out well in the process, and their friend at JP Morgan would be cleaning up. It's a little too convenient. And notice, no one at CNBC or CNN or anywhere are doing what you've just done, point out how grossly wrong Bernanke and Paulson were. So in the mainstream perception, Paulson is still regarded as a "genius". No one else is suggesting incompetence or dishonesty, so if these guys were lying, no one is any the wiser and why shouldn't they have been so bold about it.

Submitted by temeculaguy on October 1, 2008 - 2:31pm.

Easily your best work and something worth syndicating. I'm forwarding a link to that article to my friends who ask me to explain the bailout to them, this will save me hours of explaining.

Submitted by FoamFinger1 on October 1, 2008 - 3:01pm.

Rich, Another great piece, well done.

I have been following your work here on Piggington's and other sites such as AnotherFB for the past couple of years. all the while pointing out what was about to unfold, Thanks for all of your hard work.

I personally find it difficult to watch the MSM anymore because of their inaccurate and topical approach to any issue. Reading here and doing my own research, then listening to the MSM just makes me want to scream.

Keep up the great work.

(Go Chargers)

Submitted by 34f3f3f on October 1, 2008 - 3:28pm.

I'm not so sure that an economic framework is being used, flawed or otherwise. I also think that governments are reactive as opposed to proactive by nature, which may explain why nobody has done anything until now. With the US manufacturing base in decline, and financial service industry in the driver seat, consumerism and debt are the economic fuel. How do you reverse this with China's cost advantage producing so much of what we consume? In the absence of a fundamental shift in the way America does business, which is unlikely without superhuman will, the reality is you have to build on what you have, and accept it as part of the evolution of market economics, which is now global. Painful as that may be, and I would never wish to dampen the enthusiasm for change, if we are to believe our leaders, we have a serious problem on our hands, and the consensus is, it will become worse unless we act. It may only be a short term solution, but we have to accept that sometimes our rights often have to defer to hindsight judgments we pass on those we elect into power.

What is wrong with the debate over the bail-out is a lack of clarification of the quantitative effects of 'doing nothing'. We hear the same reasons given over and over again, about the economy freezing as a result of loans disappearing from student loans, to car loans, to mortgages, to businesses borrowing to paying wages. This lack of clarity may be because we are in virgin territory, and simply don't know the answers, and are simply clinging to what is likely. But the crux of the matter, is if many more mortgages are to reset next year, then it follows more damage will be likely. Moreover, if the subprime crisis has caused this much damage (and I'm not confident many predicted exactly what has gone so far), then what is to come doesn't bear thinking about.

There is a crisis of Government versus the People on this issue, and if the powers that be prevail, it will (may be) a sad day for democracy, but I am for getting over this crisis, and then going back and fixing the underlying problem.

Submitted by JRB on October 1, 2008 - 7:03pm.


Once again, you’ve written an excellent analysis. Why do our elected representatives insist on maintaining their ignorance?

Is the political agenda and the resulting “conventional wisdom” spouted by the MSM just a function of who is making the largest campaign contributions?

How do you think this bailout will affect the inflation/deflation prospects for the country? I’ve seen good arguments made for either outcome: The Fed will flood the market with dollars and inflate away the country’s debt, or the coming demand destruction from a severe recession will result in 1990’s Japan style deflation.

Submitted by zk on October 1, 2008 - 10:28pm.

I've always considered your writing excellent, Rich, but this piece stands out. Brilliant!

It's a shame that, to our government, common-sense thinking is outside-the-box thinking.

Submitted by Rich Toscano on October 2, 2008 - 12:21am.

Thanks everyone for the kind words; they are much appreciated (especially since I banged this article out really fast and I was afraid it might be too rambly).

I just saw a great example of the lack of accountability I was railing on in the article. In today's WSJ there is an article pitching a scheme to stabilize housing prices:

One of the authors is one Chris Mayer. Does that name sound familiar? He is a Columbia econ faculty member who co-wrote a paper and WSJ editorial ( ) in September 2005 arguing that there was no housing bubble and calling housing skeptics "chicken littles."

The logic offered in the paper/article was ridiculous and I lambasted it at the time here:

So after writing a paper denying the world's biggest housing bubble (and by coincidence publishing it at the very peak of that bubble) this same guy writes an article saying that we should listen to his ideas for how to fix the problem. And he gets published in the WSJ. And, probably, people listen to him.

The complete lack of accountability, skepticsm, and (apparently) memory is really quite incredible.

Anyway, thanks again.


Submitted by Rich Toscano on October 2, 2008 - 12:23am.

On the inflation question posed by JRB, I am firmly in the inflation camp (notwithstanding an initial burst of disinflation just as we saw after the tech wreck). I've been meaning to write an article on this forever but in the meantime, see Bernanke's "It Won't Happen Here" speech to see why I believe there is almost no chance of a protracted deflation with this guy at the helm.


Submitted by Dougie944 on October 2, 2008 - 4:03am.

Thanks Rich. That was a most excellent article. Too bad you are preaching to the choir.

I feel like I have taken crazy pills and nobody with pull will listen to reason.

Submitted by Liz357 on October 2, 2008 - 9:40am.

Go vote!!!

Your piece was very long, so I skimmed most of it.

I may have missed how you propose that we get out of this mess.

I saw a lot of blame. We can blame Bernanke and Paulson but we can blame ourselves too. I appreciate your blog but wish it had let to some kind of fundamental change. I wish I had done more.

Now we've got Novemeber around the corner. Go vote people out of office. I don't care if they voted for the package or not. Let's shake it up and say we won't put up with all of the backoffice deals that are made in the name of making more money this year than last year, so that we can all consume more this year than last year.

Submitted by cr on October 2, 2008 - 10:14am.

I keep hearing more and more say consumers need to get out there and spend money. Of course they mean tomorrow's money i.e. debt.

Yet at the same time people want to artificially prop up housing prices.

We all know if housing prices were lower people would have far more to spend on everything else, yet the figureheads simply miss that.

Before the bubble popped we knew this time was different and would cause the rise in unemployment we are seeing and drive prices down even further. This is reality now, and I think prices will over shoot their mid 90's low's adjusted for inflation.

I just wonder how many more kitchen sinks our leaders will borrow before Hanky, Bernanke, and Franky are tried for treason and replaced with people who will do the only thing that will (albeit painfully) get us out of this mess - raise rates, and stop spending.

Submitted by MadeInTaiwan on October 2, 2008 - 2:27pm.

I have a slightly different take on this. Some counter points to a excellently reasoned article by Rich in no particular order

1. Market is always right, in the long run. Otherwise you would not have corrections. The problem is that people using a snapshot or a short time frame to justify whatever it is that they justify.

2. I suspect that Bernanke and Paulson are not completely clueless nor completely lying. They probably suspected something not quite right in housing market, but did buy into "flawed analytical framework" as you put it. It is not the problems, but it's magnitude and how it affects upon first glance unrelated parts of the economy that spooked them. Besides, they are supposed to calm the markets even as it declines. Do you really expect a Fed Chairman and the Treasury Secretary to openly say "We are living in a ponzi scheme"?

3. My crude understanding is that the bailout is not designed to prop up home prices in the long term, nor save the Wall Street investment banks or the hedge funds. It is designed to allow an orderly retreat instead a mass stamped to the exit. This hopefully allows banks for example facing a squeeze to be able to unload assets for more reasonable prices and face their obligations. as the upside mortgages are not worth close to 0, which seems to be what the market is pricing them for. This will allow good business to expand, or keep operating. After all, I don't want to be trampled by the crowd even though I had been responsible.

4. Precisely because the problem has gone global, cooperation with other central banks may be needed.

5. Rich thinks that the overall trend is inflationary even with the bailout, I don't know enough to dispute, except that a lot of smart people (seems like half half?) are worried about the opposite.

Of course, if Rich's point is that credit bubble is so huge that there is nothing the central banks can do in conjunction, then again I am not knowledgeable enough to debate that point. However, I think it is reasonable for the govt to attempt to stem it.

I absolutely agree that we need to fix the underlying problem, but maybe that is easier done if we can get a bit of a breather. Again, the orderly retreat thing.

If posters know the housing market will return to normal, probably overshoot on the way down, then why is everyone so angry (inpatient I understand) if the government tries to minimize the damage on the way down. A few less (name your profession here) thrown into the street is a price I am willing to take for a slower deflating housing market. Full disclosure, it is easier for me to say as I've bought in 95, but I would not mind moving up.

Let's face it, we were probably staring at hyper inflation even before the bailout. People like us who save and did not over extend are going to be screwed anyways, so what is another trillion if we can avert a depression?


Submitted by CA renter on October 2, 2008 - 3:54pm.


Excellent article, and right on the money!!!

Everyone on CNBC is whining about illiquid assets and "frozen" credit. The problem, just like housing, is in the prices. Interest rates are higher because they've finally broken out of the artificially suppressed rates of years past. Less "fake" money means the real money is going to be more expensive to borrow. Welcome to reality.

Thank you, Rich, for being a voice of reason in a sea of fools. :)

Submitted by ltokuda on October 3, 2008 - 6:10pm.

Market is always right, in the long run. Otherwise you would not have corrections. The problem is that people using a snapshot or a short time frame to justify whatever it is that they justify.

That's like saying "A broken clock is always right ... 2 times a day. Maybe its not right in the short term. That's why it corrects itself. The problem is people are using a snapshot or a short time frame to justify whatever it is that they justify."

A better way to say what you are arguing is that "The market is almost always wrong."

Submitted by underdose on October 3, 2008 - 8:06pm.

MadeInTaiwan, I'd like to counterpoint your counterpoints.

Jane, you ignorant slut! (I hope I'm not the only person on here old enough to remember that joke...)

1. Much as I share what sounds like your faith in the free markets (sure beats a corrupt and inept central planner), sadly I think the flaw with both the markets and planners is that they involve humans. Most humans are almost always wrong. The majority of participants in the markets are almost always operating under incomplete knowledge, have gross misconceptions and are hijacked by their emotions. So, no, I don't agree with you that the markets are right. Reality asserts itself despite how wrong the markets are, and that is why corrections happen. But since the humans in the market are still wrong, even during corrections, it never quite corrects correctly. Often it overshoots, or one imbalance will morph into another (see Tech Bubble v. Housing Bubble). And the market is still wrong today, even as housing prices are moving back towards something fundamentals might support, because most participants still don't know why this is happening.

2. Do I expect a Fed chairman to admit there is a Ponzi scheme? YES! It would have been really damn refreshing if Greenspan had called it a Ponzi scheme back in 2002 and pulled the rug out instead of saying "this is great" and throwing more gasoline on the bonfire. If they are denying the fact that it is a Ponzi scheme just to try to keep the markets calm, they are completely lying. And covering up the risks until the risks reach catastrophic proportions and the markets panic is a completely incompetent tactic for keeping the markets calm.

3. Rich's criticism of the bailout (and mine) is that it is irrelevent what the intention is. These people are batting a thousand at achieving absolutely nothing that they intended and abusing the economy with unintended consequences instead. I don't care what the bailout is designed to do; I strongly suspect it will exarcerbate the rush to the exits. I don't want to be trampled any more than you do.

5. Which smart people are predicting deflation? My favorite authors who have been right about the housing bubble (Rich, Soros, Schiff,...) are all in the inflation camp. A lot of so-called "smart" people predicted a "soft landing" for housing. My experience is that there is always a lag after the Fed does something. Bernanke has made his intentions so clear. He will just keep printing money. He'll look at a CPI number uncomfortably close to 3% and print more money, just to be safe, then one day, whammo! The lag after all that printing will have passed, and we'll see that he printed way too much. He will have succeeded in his goal of making sure that no one is holding dollars instead of circulating them. I haven't heard a "smart" person give a plausible scenario in which that won't happen (except maybe if Bernanke is fired in January by a possible new president), no more than I heard any plausible scenarios for how a soft landing would actually happen.

So there's my $0.02. Maybe closer to $3.54 after inflation.

You asked why we are so angry. I firmly believe this bailout is making matters worse, and is pushing the country I love that much more aggressively towards the fall of Rome. Not just impatient, as you suggest, but truly, agonizingly heartbroken. Painfully depressed at the destruction of my homeland at the hands of Bush, Greenspan, Paulson, Bernanke, et. al.

Submitted by patientrenter on October 3, 2008 - 11:08pm.


1) This is just a great piece. I am in the financial services industry. I've played a small role in building some of the rules for capital requirements for financial institutions, and I am currently involved in a small way with reorganizing some of the casualties that you've all read about recently. You show more understanding of the real issues than 99% of the people I work with, even though they are very smart, experienced and well educated. Your conclusion that they are incompetent more than dishonest is probably true.

2) But it is puzzling that very few people in professional regulatory roles, or political oversight roles, or in the businesses themselves, can see what you have explained here. Once explained, it is as plain as the nose on my face. I think that there is a subtle self-interested dishonesty going on here. People in these roles will all be more popular and successful for 34 out of the 35 years of their careers if they are optimistic and "get along". Skeptics leave are never go far up the chain. People running things self-select for optimism and being agreeable. They really do believe in optimistic explanations for things. If they are dishonest, they are dishonest with themselves also. But I suspect many really do know the version of reality you've outlined, and they just don't want to believe it because it requires hard choices to be made. Why choose that before you have to? And some are just plain dishonest.

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