Friday, March 20, 2009

"Never Waste a Good Crisis"

So say Rahm Emanuel and Hilary Clinton. Very Chinese of them (the Chinese characters for "crisis" are said to be the characters for "danger" and "opportunity").

Something similar could have been said by a spokesperson for the Bush administration concerning 9/11. It was certainly used to achieve policies that would have been next to impossible to achieve (such as the launch of the Iraq war) without it.

Lincoln certainly did the same. Is there any doubt that the 13th, 14th and 15th amendments would not have been added to the constitution without the crisis of the civil war and the absence of southern representation in Congress?

FDR certainly did. Consider the various New Deal programs and the great depression.

Occasionally, someone attempts to steal not only second but third. Consider FDR's court-packing scheme.

Taking advantage of opportunity (whether borne of crisis or not) is very natural for politicians. Occasionally, opportunity is not taken because the politician does not see the opportunity, or is not truly committed to the goal. He is truly worthy of ridicule. Eben's comment about Arafat comes to mind, "he never missed an opportunity to miss an opportunity" [ make peace.]

Indeed, the rare thing (and the thing that helps to define true character, often) is when the opportunity is perceived but the advantage is not taken, because the politician understands that the long term damage is not worth the short term gain.) Consider, for example, Lincoln's refusal to heed the advice of his Republican advisers who urged him, in the dark days of 1863 and early 1864 (when it seemed almost certain that he would not be re-elected in November 1864), to postpone the election until the war was over.

In other words, the rare and laudable thing is self-restraint. A commodity in short supply right about now.

But the phrase "never waste a good crisis" also has deeper and more sinister implications. I will explore these in my next post.

Monday, March 16, 2009

The Return of "Know-Nothing" Politics

AIG was bailed out for one reason, and one reason only. It was not bailed out because it was a flagship insurance company. It was not bailed out because it employed many people. It was not even bailed out because of its long-standing cozy relationship with the American intelligence community. It was bailed out because, in the judgment of the Fed and the Treasury, its failure would have posed a “systemic risk”.

What is meant by “systemic risk”? Simply that AIG was so interconnected with other financial institutions, through various and myriad counter-party relationships, that its failure would trigger a cascade of losses which might cause other institutions to fail, which, in turn, would bring down more institutions, and so on.

The mechanism of transmission here is breach of contract. If AIG had gone bankrupt, institutions that had open contracts with AIG would have found those contracts dishonored. What kind of contracts were these? They were insurance contracts against the risk of default of other institutions, for example, Lehman.

So what is the difference between a bankrupt and a bailed-out AIG? The bailed-out AIG honors the contracts and therefore pays out to its counter-parties on the default swaps.

So the sleeping giant of American politics, “know-nothing protectionism”, having awoken, finds it shocking that a majority of the funds injected into AIG have been “funneled” to various financial institutions and municipalities throughout the world. In order to turbo-charge the outrage factor, the reporting of this fact is conflated with the news that lots of money was also paid out by AIG as bonuses.

The only thing these two facts may have in common is that they may both involve honoring the terms of pre-existing contracts.

If a financial institution, which was bailed out on the theory of preventing systemic risk, did not pay out a majority of the Government funds to other institutions pursuant to the terms of pre-existing contracts, then the bailed out institution did not represent a systemic risk and was bailed out in error.

One can argue about whether the bail out of AIG was wise, necessary or fiscally prudent. One can ask whether it enhanced "moral hazard" to an unacceptable degree. One can even take issue with the notion that its failure would pose a systemic risk. And finally, one can ask whether it was wise for a regulated industry to be allowed (by the regulation and the implimenting regulators) to make risk bets that were of "bet the ranch" magnitude. All of these questions could be discussed intelligently.

What can not be intelligently discussed is the notion that "AIG paying billions to other financial institutions" is evidence of wrong doing.

Saturday, March 7, 2009

Russia - A follow-Up

How much effort was invested by Clinton and her team on the "re-set" button gag? Clearly, not enough to avoid displaying complete incompetence. But, in fact, no energy should have be invested on such frivolous stunts. The only thing more dismaying than the embrassment of having a State Department that lacks a fluent Russian speaker and a culture of quality control is the thought that this is what these folks think will impress their opposite numbers and advance American interests.

Europeans and Asians generally think of America, on the diplomatic stage, as an overweight muscle-bound blind giant staggering around. Very dangerous, but not effective and easily outsmarted.

Part of what Obama was trying to sell was a return to "adult" behavior, a return to highly educated competence at the helm. (Shades of the "best and the brightest.")