Coyote Blog

I sat this weekend and pondered the pending financial bailout.  A number of fairly smart people who know more about Wall Street than I seem to think it a necessary evil, and this includes several folks who are nearly as libertarian as I.  Is a sort of knee-jerk libertarianism preventing me from accepting a necessary step to avert economic Armageddon?

I don't think so.  By the light of day on Monday morning, I still think it a bad idea.

Here is some of my thinking (to some extent my last point is the one that is most important to me -- if we want liquidity, let's put it in the right place).

• I am tired of businesses heading to the government bailout trough and arguing that the continued functioning not only of their industry, but of all the existing players in their industry, is critical to the health of the US economy and thus requires some sort of government subsidy/bailout/protection.  Coyote's first law of rent-seeking is that companies will always claim that failure of their business will have a disproportionately negative effect on the economy.  Coyote's first corollary to this law is that Congress usually accepts this argument at the exact point in time when it is no longer true.
• This bailout is even more grotesque than a normal industrial bailout.  GM can be said to have honestly tried to make the right cars, and just failed.  I don't like bailing them out, because I don't particularly like diverting capital into the hands of organizations that are proven failures at using capital well.  But the financial investors that we are bailing out today knew they were taking a lot of risk by purchasing risky securities and then leveraging them up on their balance sheets.  They lived high for years off of the fat returns for taking this risk, arrogantly explaining that they made lots of money because they were smarter than everyone else and because they were being rewarded for taking on risk.  But then they come running to the government when the returns on their risky securities turned south, which just makes me sick.  They were paid for taking this risk, so take it.  I am sorry that you have no cushion because all those earlier returns are already spent on Maserati's for your mistresses, but that is what chapter 7 is for.
• As many as 300,000 small businesses go bankrupt every year (this number is very, very hard to pin down, as it is hard to separate personal from business bankruptcy with small business).  Something like 299,998 of them do not get bailed out by the feds.  Why do the other 2 get special treatment vs. other US taxpayers?  Because they are better at lobbying Washington that they are essential?
• Yes, the government created the Alt-A and sub-prime mortgage markets,and caused them to flourish via Fannie and Freddie aggressively asking for and buying these loans.  And the feds, via tax policy, and local governments, via zoning, helped pump up the housing bubble.  But nothing forced private companies, particularly highly leveraged institutions like banks, to load up their balance sheets with these things, or, crazily, to write insurance policies on their value.  Libertarians want to use these government interventions as an excuse for the bailout, but it doesn't wash. I do think many banks reasonably have lawsuit material against ratings agencies Moodys and S&P, which is fine.  I think new blood in that business would be a very good thing.
• The total market capitalization of traded equities of public corporations on NYSE and NASDAQ is between $15 and $20 trillion.  That means that the first $150 billion of the bailout is equivalent to about a 1% price move on the exchanges, something that occurs almost every day.  Have we really close-coupled everything so tightly that a cumulative balance sheet hole on the order of magnitude of a 1% move on the stock market can bring down the whole financial system?  If so, we should just let the whole thing come down and rebuild itself in a more robust form.
• Wall Streeters pat themselves on the back all the time for how creative they are financially.  So get creative here.  Create some sort of new entity and have banks contribute toxic mortgages into the entity in exchange for equity.  Find some pension funds to invest in the new entity at a deep discount.
• These banks, who are experts in this stuff, claim they cannot value these failing, complex, illiquid mortgage packages.  OK, that may be true.  But how is the government possibly going to do any better?  Such a situation cannot possibly end well for the taxpayers. 
• I saw folks writing in fear last week that the commercial paper market might dry up.  The commercial paper market dries up all the time.  It comes back eventually.  People treat lending markets like they are charities or something, and they fear that lenders will give up and never come back.  But they are not charities.  They serve just as much of a purpose for lenders and for borrowers.  Businesses and folks with capital need to make money on short term cash.  They are not going to stop lending forever.  Even capital markets dry up from time to time.  The IPO market has disappeared several times, including several years in the post-Internet-bubble period. The junk bond market comes and goes.
• What is the government really worried about?  I presume that they are worried that liquidity will dry up and the ability of main street businesses to borrow will be impaired.  OK, then save the freaking $700 billion and if main street starts to have trouble borrowing, have the government participate somehow in that lending market.  Buy corporate bond issues, and/or increase the limit on SBA loan guarantees by a $100 billion  (this latter would allow a million new $100,000 SBA loans, and would actually generate money now in guarantee fees and only potentially cost money much later if the loans fail).  This way, we are investing liquidity in successful companies trying to grow rather than in failing banks that got us all into this.  Let's invest in success rather than in failure.

The Arizona Republic had another of its cheerleading articles on light rail this morning.  In it was a chart that, contrary to the intent of the article, summarized exactly why Phoenix light rail is doomed.  Below is a chart of the employment density (top chart) and population density (bottom chart) at each stop along the first rail route.  Note that this line goes through what passes for the central business district of Phoenix and the oldest parts of town, so it was chosen to run through the highest density areas - all future extensions will likely have lower numbers.  Unfortunately, they do not reproduce this chart online so here is a scan:

Take the population density chart.  As a benchmark, lets take Boston.  The average density for all of the city of Boston is 12,199 people per square mile.  Phoenix's light rail line cut through the highest density areas of town has only one stop where density reaches this level, and most stops are less than half this density.  And this is against Boston's average, not against the density along its rail routes which are likely much higher than the average.

Rail makes zero sense in a city like Phoenix.  All this will do is create a financial black hole into which we shift all of our bus money, so the city will inevitably end up with a worse transportation system, not a better one.  Cities that build light rail almost always experience a reduction in total transit use (even the great God of planners Portland) for just this reason - budgets are limited, so since rail costs so much more per passenger, other transit is cut back.   But the pictures of the train will look pretty in the visitor's guide.

Postscript: Phoenix's overall average density is around 2,500 per square mile.  Assuming that the 12,000 in the chart above is one of the densest areas of Phoenix, this gives a ratio of about 5:1 between peak and average density.  This same ratio in Boston would imply peak density areas of 60,000 per square mile.  This may be high, but indicates how much higher route densities on Boston rail should be.  Oh, and by the way, Boston rail is losing a ton of money.

Other city densities here from 1990.  People think of LA as spread out, but LA has a density over three times higher than Phoenix!

I stand by my no-McCain vow I made years ago after his role in campaign speech limitation.  But Obama does not look like a very promising alternative:

The Obama campaign disputes the accuracy of the advertisement, which is
fine. It has also threatened regulatory retaliation against outlets
that show it, which isn't fine. Instead of, say, crafting a response
ad, Obama's team had general counsel Robert F. Bauer send stations a
letter [pdf]
arguing that "Failure to prevent the airing of 'false and misleading
advertising may be 'probative of an underlying abdication of licensee
responsibility.'" And, more directly: "For the sake of both FCC
licensing requirements and the public interest, your station should
refuse to continue to air this advertisement."

In particular, I would love to see Obama actually say what positions that are ascribed to him on gun control are false, and what his actual, specific positions are.  A vague, gauzy support for the second amendment does not necessarily mean he has walked away from his earlier positions.  In fact, I am sure that McCain would say he supported the First Amendment but I would certainly feel comfortable pointing out how he fails to do so in the details.

Much has been made of the bailout legislation provision that the administration would be immune to any scrutiny of any sort for any decision made vis a vis the $700 billion in bailout funds and the resulting spending decisions.  But I thought this was equally telling of the over-broad power grab that is going on at Treasury:

The SHR [senior House Republican] calls this an insurance program and the original Paulson plan a
purchase program. He says Treasury Department people have told him that
they considered an insurance program but decided that a purchase
program would be better. But he also added that in the draft
legislation Paulson has advanced, the Treasury would have the authority
to set up such an insurance plan without congressional authorization.
From what he said, it struck me that both courses could be followed.
After all, neither purchases nor insurance is contemplated to take
place unless and until a financial institution comes forward and
requests one or the other.

Jeez, how much latitude are they asking for?  Is the bill really so broad that the secretary of the treasury could set up an entirely new government insurance program for financial assets without further Congressional approval?

While I think Cantor is being overly-optimistic about the near-term cash flow of his insurance proposal, it does seem to be at least an incremental improvement over Paulson's plan.

From John Allison, CEO of BB&T  (via TJIC).  Here is a taste:

Download bailout_critique.pdf

So, apparently the US government is going to authorize up to $700 billion taxpayer dollars to purchase distressed financial assets.  I had an email today that said, to paraphrase, couldn't the government make money off these assets if they buy them for the right price?

My first thought was that this was theoretically possible, though my internal cynic found it unlikely in a pricing game run by elected officials between the taxpayer and powerful Wall Street interests that taxpayers would get the upper hand.

But then I realized there was no possible way this will end well for taxpayers.  Because the government cannot exercise discretion in day to day financial decisions.  It establishes rules and benchmarks and the typical bureaucrat is punished far worse for violating these processes and rules than he/she ever is for reaching a bad result.  So the government will establish rules and benchmarks for what price at which they will buy assets (this will be all the more true given the great rush everyone seems to be in).  And having set this in place, do you know what assets will be put to them?  All the ones that the current holders think are worth less than the benchmark.  This is the winners curse on steroids.

Update from Megan McArdle:

there's a gigantic asymmetrical information problem:  the owners of
these securities know much more about them than the Fed.  And there
isn't (obviously) a large liquid market for the Fed to check against.
So the Fed is likely to overpay, because there won't be a lot of
bidders in any one auction.

Megan, of course, reluctantly supports the bailout where I do not.  But she has her eyes open about what she is buying into. 

In her wild and somewhat bizarre polemic aimed at Milton Friedman, Naomi Klein argues that major historic crises have always been manufactured by capitalists to slip free market principles into action against the wishes of the socialist-leaning masses. 

Really?  In what crisis, ever, did the government end up smaller?  What about the current crisis and the government response to it carries any good news for free marketeers?  History is a series of problems created by government intervention but blamed on the free market, which can supposedly only be solved via more government intervention.

Update:  Critique of Klein here.  Seriously, it is amazing that this rings true with anyone:

Klein's basic argument is that economic liberalization is so unpopular
that it can only win through deception or coercion. In particular, it
relies on crises. During a natural disaster, a war, or a military coup,
people are disoriented, confused, and preoccupied with their own
immediate survival, allowing regimes to liberal-ize trade, to
privatize, and to reduce public spending with little opposition.
According to Klein, "neoliberal" economists have welcomed Hurricane
Katrina, the Southeast Asian tsunami, the Iraq war, and the South
American military coups of the 1970s as opportunities to introduce
radical free market policies. The chief villain in her story is Milton
Friedman, the economist who did more than anyone in the 20th century to
popularize free market ideas.

As is typical, Klein confuses support for capitalism with government support of individual capitalists.

I liked this bit in particular:

Think of Wall Street as a poker game and Goldman as the
smartest player. It's sad when you think about it this way that
so much of the dumb money on Wall Street has been forced out of
the game. There's no one left to play with. Just as Goldman was
about to rake in its winnings and head home, the U.S. government
stumbles in, fat and happy and looking for some action. I imagine
the best and the brightest inside Goldman are right this moment
trying to figure out how it uses the Treasury not only to sell
their own crappy assets dear but also to buy other people's
crappy assets cheap

Update:  LOL, via Q&O:

In fact, some of the most basic details, including the $700 billion figure Treasury would use to buy up bad debt, are fuzzy. 

"It's not based on any particular data point," a Treasury spokeswoman told Forbes.com Tuesday. "We just wanted to choose a really large number."

Could these be the dumbest guys in the room?   

I am tired of watching the free markets trashed by people who claim to champion capitalism and free enterprise.  Better, I am starting to think, to have free markets trashed by someone who does not pretend to support them.  Besides, the Republicans in Congress tend to be much stronger supporters of small government, low taxes, and light regulation when they are in opposition.  Except possibly for Jeff Flake, who always seems to have his head in the right place.

Update:

"When
it comes to this I should prefer emigrating to some other country where
they make no pretense of loving liberty - to Russia, for instance,
where despotism can be taken pure, without the base alloy of hypocrisy."

            -- Abraham Lincoln

Been smugly thinking that you were smart enough not to take out an interest only mortgage to finance a house at the peak of the market?  Or savvy enough not to invest your savings in a mortgage portfolio or some sort of interest rate swap?

Sorry, think again.  Because GWB and the US Congress have decided to force you to be an investor in crappy, devalued investments.  To the tune of at least $700 billion.

Four years ago, privatization of Social Security was scuttled in large part because Congress thought it unfair to toss the average taxpayer into the volatile marketplace with his/her retirement savings.  Now, the government is forcing us all to participate in the financial markets, but only allowing us to invest in the worst assets.  Just great.

One of the reason my posting has been light of late is that I was working on a climate presentation for the California Regional Council of Rural Counties.  That's behind me now, but you can read a brief report on the meeting and download my presentation here.

I have been on a Civil War reading binge lately, which began when I read "Time on the Cross", which is a really interesting economic analysis of American slavery.  Since I have read a number of other Civil War and Ante-Bellum history books, including James McPherson's excellent one volume Civil War history.

I was struck in several of these books by the reaction of British textile manufacturers to the war and, more specifically, the informal southern embargo of cotton exports in 1860-61.  These textile producers screamed bloody murder to the British government, demanding that they recognize the Confederacy and intervene on their behalf, claiming that the lack of cotton would doom their industry and thereby doom the whole country.  On its face, this was a credible argument, as textiles probably made up more of the British GDP at the time than any three or four industries account for in the US today. 

Fortunately, the British chose not to intervene, and risked the economic consequences of not supporting the textile industry by jumping into the American Civil War.  As it turned out, the British economy was fine, and in fact even the textile industry was fine as well, as demand was still high and other sources around the world stepped up (because of the higher prices that resulted from the Southern boycott) with increased cotton supplies.

Saul Hansell at the NY Times has an interesting article about why risk assessment programs in investment banks were not sounding the alarm coming into the recent turmoil.  The article contains this gem:

Ms. Rahl said that it was now clear that the computers needed to
assume extra risk in owning a newfangled security that had never been
seen before.

"New products, by definition, carry more risk," she said. The models
should penalize investments that are complex, hard to understand and
infrequently traded, she said. They didn't.

I continue to see parallels between recent problems and the meltdown at Enron.  In fact, in many ways events in the natural gas trading market were a dry run for events in the mortgage market.   One filmmaker coined the phrase "Smartest Guys in the Room" to describe the hubris of the guys who ran Enron.  To some extent the phrase was absolutely true - I knew Jeff Skilling at McKinsey and he was indeed the smartest guy in the room.  But everyone can be wrong, and sometimes the smartest guys can be spectacularly wrong as they overestimate their ability to predict and control complex events.  I think this is a fair description of what went on in Wall Street over the past several years.

Via Scrappleface:

The foundation of the U.S. economy could crumble, President George
Bush said today, if Congress fails to approve a U.S. Treasury plan to take over
foundering financial firms, a proposal which the president called "a
much-needed 21st-century civil rights act for stupid people."

"To sustain this shining city on a hill," Mr. Bush said, "we need to rescue
the ignorant, irresponsible folks "” from Wall Street to Capitol Hill to
Main Street "” who got us to where we are today. We must guarantee that no American suffers the soft bigotry of being forced to live with the consequences of his bad decisions."

The president, in remarks to the news media clearly aimed at
reluctant Republicans in Congress, said, "Our financial system rests on
a foundation of huge banks, brokerage houses and quasi-governmental
agencies that followed Washington's lead by gambling on long-shot,
poorly-collateralized investments. Now this glorious way of life is
threatened, and we must act to preserve it."

"We need to guarantee that the structures, systems, people and
products that got us to this point won't be tossed on the ash heap of
history," said Mr. Bush. "If these giant companies fail, then America
will be left with nothing but thousands of small to mid-sized financial
firms that made prudent investment decisions during the past 15 years."

Via Carpe Diem, comes this September 30, 1999 NY Times story:

In a move that could help increase home ownership rates among
minorities and low-income consumers, the Fannie Mae Corporation is
easing the credit requirements on loans that it will purchase from
banks and other lenders.

The action, which will begin as a
pilot program involving 24 banks in 15 markets -- including the New
York metropolitan region -- will encourage those banks to extend home
mortgages to individuals whose credit is generally not good enough to
qualify for conventional loans. Fannie Mae officials say they hope to
make it a nationwide program by next spring.

Fannie Mae, the
nation's biggest underwriter of home mortgages, has been under
increasing pressure from the Clinton Administration to expand mortgage
loans among low and moderate income people and felt pressure from stock
holders to maintain its phenomenal growth in profits.

In
addition, banks, thrift institutions and mortgage companies have been
pressing Fannie Mae to help them make more loans to so-called subprime
borrowers. These borrowers whose incomes, credit ratings and savings
are not good enough to qualify for conventional loans, can only get
loans from finance companies that charge much higher interest rates --
anywhere from three to four percentage points higher than conventional
loans.

''Fannie Mae has expanded home ownership for millions of
families in the 1990's by reducing down payment requirements,'' said
Franklin D. Raines, Fannie Mae's chairman and chief executive officer.
''Yet there remain too many borrowers whose credit is just a notch
below what our underwriting has required who have been relegated to
paying significantly higher mortgage rates in the so-called subprime
market.''

Demographic information on these borrowers is
sketchy. But at least one study indicates that 18 percent of the loans
in the subprime market went to black borrowers, compared to 5 per cent
of loans in the conventional loan market.

In moving, even
tentatively, into this new area of lending, Fannie Mae is taking on
significantly more risk, which may not pose any difficulties during
flush economic times. But the government-subsidized corporation may run
into trouble in an economic downturn, prompting a government rescue
similar to that of the savings and loan industry in the 1980's.

''From
the perspective of many people, including me, this is another thrift
industry growing up around us,'' said Peter Wallison a resident fellow
at the American Enterprise Institute. ''If they fail, the government
will have to step up and bail them out the way it stepped up and bailed
out the thrift industry.''

Those heartless free marketing guys at the AEI -- always predicting doom every time we open our hearts to poor people.  Bailout?  What ridiculous scare-mongering.

I really enjoyed the game last night in Green Bay.  It is impossible on TV to communicate the energy and decibel level of that crowd, particularly in the first half before Dallas opened up a large lead.  But even with victory pretty much out of reach with 5 minutes to play, virtually no one left  (our Arizona fans would already have been out of the parking lot by then).

The game featured a 72,000 person crowd in a town of 100,000.  In a world where traditional groups are increasingly fragmented, the entire town is united in their dedication to the team.  The Packers are ubiquitous in town, so much so I can't even think of any good major-city analogy.  The best analogy I can come up with is that the game was more like a
high school football game in west Texas than a typical NFL game.  Even the cheerleaders look like a high-school cheer squad with girls in jumpers and guys with megaphones, in a world where the other 30+ teams all have pinup girls with breast enhancement. 

A government job can be a great deal.  Likely it pays more than a comparable private job, it's generally impossible to get fired from, and it has outrageously good medical and pension plans.  And, if you don't shy away from a bit of perjury, can be made to pay off spectacularly:

During the workweek, it is not uncommon to find retired L.I.R.R. [Long Island Railroad]
employees, sometimes dozens of them, golfing there. A few even walk the
course. Yet this is not your typical retiree outing.

These
golfers are considered disabled. At an age when most people still work,
they get a pension and tens of thousands of dollars in annual
disability payments "” a sum roughly equal to the base salary of their
old jobs. Even the golf is free, courtesy of New York State taxpayers.

With  incentives like these, occupational disabilities at the L.I.R.R. have become a full-blown epidemic.

Virtually
every career employee "” as many as 97 percent in one recent year "”
applies for and gets disability payments soon after retirement, a
computer analysis of federal records by The New York Times has found.
Since 2000, those records show, about a quarter of a billion dollars in
federal disability money has gone to former L.I.R.R. employees,
including about 2,000 who retired during that time.

97 percent?  Wow!  And just to demonstrate that year was not some kind of outlier:

In each year since 2000, between 93 percent and 97 percent of employees
over 50 who retired with 20 years of service also received disability
payments.

The article goes on to demonstrate that this is occurring at what appears, from the injury statistics, to be one of the safest railroads in the area.  Say what you will about the NY Times, but when they get their teeth into local corruption they can still do a masterful job, as evidenced by this long article discussing many apparently ridiculous payroll situations at the LIRR.

I can say from experience that there is a group of people in this country for whom getting a lifetime disability payment (e.g. from the Social Security Administration) is as good as hitting the lottery.  I remember one time I got a survey form from the SSA asking about a former employee.  I didn't pay much attention to the form's purpose as I filled it out -- I get all kinds of such government wastepaper with breathless admonishments about the urgency of my reply.  Anyway, about 2 weeks later I got a very threatening letter from the attorney for this former employee, threatening me with all kinds of dire consequences if I did not immediately retract my (honest) answers to the SSA inquiry.  Apparently, I was endangering a lifetime disability determination that this person had been working on obtaining for years. 

Every day, in fact, I get job applicants who try to cut deals with me of one sort or another (e.g. can you pay me under the table in cash?) because they say they are fully able to do outdoor maintenance work but they can't show any income because it might endanger their lifetime disability payments.  In a similar vein, I have three cases I know of in my company today where workers filed workman's compensation claims of injury several days after they were terminated.

I've said it before, but the reckoning is coming on state and local government pensions, which in most cases are unfunded, undisclosed liabilities of startling magnitude.  The disaster that is fast approaching in these state and local government finances will make Social Security's problems look pitiful by comparison.

Postscript:  Railroad labor law is just weird and a total mess.  Being the first major industry, and the first major industry that was regulated, a whole regulatory structure was put in place for railroads that (fortunately) has been applied to few other industries.  Whatever the problems we have with state workman's comp programs, they are models of governance compared to how things work in the railroad industry.

For example, I remember when I worked for a railroad in the 1990's, carpel tunnel claims were common.  By the nature of the comp system, workers got cash payments for injuries in addition to medical treatment (I recall a figure at the time of $7500 per wrist for carpel tunnel, but that may be off).  It was a common piece of advice among railroad workers that if one wanted to get the money together for a down-payment on a new pickup truck, one only had to go to Dr. X or Y and get a carpel tunnel diagnosis.

I would blog on the most recent bank bailout, but I don't really understand what the proposal is.  The administration apparently wants to take $700 billion and ... do something with it.  Frankly, I would prefer them to just let the banks totter over and spend the money, if they really feel it necessary, to clean debris up afterward, as they did with the RTC in the 1980s.   At least that way we would avoid the moral hazard and know the money was going to cleaning up the worst messes.  My guess is that $700 billion pseudo-randomly injected into whatever companies can cry the loudest at the treasury's door is not only creating bad incentives, but is probably going to waste at least half of the money.

I am here in Green Bay checking off another item on my sports bucket list: seeing a game at Lambeau Field.  And it should be a really good one. 

We went out last night on the town to various bars, mostly on Washington street, after a ritual visit to "fuzzy's."  (Packers fans can tell me later if we were on the right track with these choices).  My friend (who lives in DC) and I were shocked to pay only $2 a beer at the first bar we were at.  It turned out that this was virtual price gouging in the local market.  We never paid more the rest of the evening than $1 for a mug of draft, on a Saturday night yet.  Yet another good reason to stay off the coasts.

For the record, Green Bay is really a very nice, tidy little town.  Kind of quiet, like many small towns -- they set all the traffic lights to flashing yellow last night about 8PM.  The only difference between it and any other nice midwestern town is that every single business has "packers" in its name somehow and roughly 30% of the population at any one time is wearing something with "FAVRE" on the back.  Who is this Favre guy?  I thought he played in New York  ;=)

Click to enlarge.  From here.

I am seeing an increasing number of articles of late about differential inflation rates, and how changes in income inequality may be overstated by using a single inflation rate for rich and poor.  The argument goes that lower income folks who spend a relatively high share of income on goods that Wal-Mart and China have made cheap are experiencing a lower inflation rate than wealthier folks who have seen huge price increases at their favorite Four Seasons resort.  Mark Perry has two interesting articles along these lines.

I think the incentives issue has been beaten to death pretty well, but there is another problem with bailout:  They leave the productive assets of the failed company in essentially the same hands that failed to make good use of them previously.  Sure, the management has changed, but a few guys at the top of these large companies don't really mean squat.  To this point:

A corporation has physical plant (like factories) and workers of
various skill levels who have productive potential.  These physical and
human assets are overlaid with what we generally shortcut as
"management" but which includes not just the actual humans currently
managing the company but the organization approach, the culture, the
management processes, its systems, the traditions, its contracts, its
unions, the intellectual property, etc. etc.  In fact, by calling all
this summed together "management", we falsely create the impression
that it can easily be changed out, by firing the overpaid bums and
getting new smarter guys.  This is not the case - Just ask Ross Perot.
You could fire the top 20 guys at GM and replace them all with the
consensus all-brilliant team and I still am not sure they could fix
it. 

All these management factors, from the managers themselves to
process to history to culture could better be called the corporate
DNA*.  And DNA is very hard to change.  Walmart may be freaking
brilliant at what they do, but demand that they change tomorrow to an
upscale retailer marketing fashion products to teenage girls, and I
don't think they would ever get there.  Its just too much change in the
DNA.  Yeah, you could hire some ex Merry-go-round** executives, but you
still have a culture aimed at big box low prices, a logistics system
and infrastructure aimed at doing same, absolutely no history or
knowledge of fashion, etc. etc.  I would bet you any amount of money I
could get to the GAP faster starting from scratch than starting from
Walmart.  For example, many folks (like me) greatly prefer Target over
Walmart because Target is a slightly nicer, more relaxing place to
shop.  And even this small difference may ultimately confound Walmart.
Even this very incremental need to add some aesthetics to their
experience may overtax their DNA.

David Leonhart (via Carpe Diem) argues that this was exactly the long-term downside of the Chrysler bailout:

Barry Ritholtz "” who runs an equity research firm in New York and writes The Big Picture,
one of the best-read economics blogs "” is going to publish a book soon
making the case that the bailout actually helped cause the decline. The
book is called, "Bailout Nation." In it, Mr. Ritholtz sketches out an
intriguing alternative history of Chrysler and Detroit.

If
Chrysler had collapsed, he argues, vulture investors might have swooped
in and reconstituted the company as a smaller automaker less tied to
the failed strategies of Detroit's Big Three and their unions. "If
Chrysler goes belly up," he says, "it also might have forced some deep
introspection at Ford and G.M. and might have changed their attitude
toward fuel efficiency and manufacturing quality." Some of the
bailout's opponents "” from free-market conservatives to Senator Gary
Hart, then a rising Democrat "” were making similar arguments three
decades ago.

Instead, the bailout and import quotas fooled the
automakers into thinking they could keep doing business as usual. In
1980, Detroit sold about 80% of all new vehicles in this country.
Today, it sells just 45%.

As I wrote about GM:

Changing your DNA is tough.  It is sometimes possible, with the
right managers and a crisis mentality, to evolve DNA over a period of
20-30 years.  One could argue that GE did this, avoiding becoming an
old-industry dinosaur.  GM has had a 30 year window (dating from the
mid-seventies oil price rise and influx of imported cars) to make a
change, and it has not been enough.  GM's DNA was programmed to make
big, ugly (IMO) cars, and that is what it has continued to do.  If its
leaders were not able or willing to change its DNA over the last 30
years, no one, no matter how brilliant, is going to do it in the next
2-3.

So what if GM dies?  Letting the GM's of the world die is one of the
best possible things we can do for our economy and the wealth of our
nation.  Assuming GM's DNA has a less than one multiplier, then
releasing GM's assets from GM's control actually increases value.
Talented engineers, after some admittedly painful personal dislocation,
find jobs designing things people want and value.  Their output has
more value, which in the long run helps everyone, including themselves.

I know that most non-financial folks, including myself, have their head spinning after this past few weeks' doings on Wall Street.  Doug Diamond and Anil Kashyap have a pretty good layman's roundup on Fannie/Freddie, Lehman, and AIG.  My sense is that their Lehman explanation also applies to Bear Stearns as well.  Here is just one small piece of a much longer article:

The Fannie and Freddie situation was a result of their unique roles
in the economy. They had been set up to support the housing market.
They helped guarantee mortgages (provided they met certain standards),
and were able to fund these guarantees by issuing their own debt, which
was in turn tacitly backed by the government. The government guarantees
allowed Fannie and Freddie to take on far more debt than a normal
company. In principle, they were also supposed to use the government
guarantee to reduce the mortgage cost to the homeowners, but the Fed
and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits
and squeeze the private sector out of the "conforming" mortgage market.
Regardless, many firms and foreign governments considered the debt of
Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly. 

Fannie and Freddie were weakly supervised and strayed from the core
mission. They began using their subsidized financing to buy
mortgage-backed securities which were backed by pools of mortgages that
did not meet their usual standards. Over the last year, it became clear
that their thin capital was not enough to cover the losses on these subprime
mortgages. The massive amount of diffusely held debt would have caused
collapses everywhere if it was defaulted upon; so the Treasury
announced that it would explicitly guarantee the debt.

But once the debt was guaranteed to be secure (and the government
would wipe out shareholders if it carried through with the guarantee),
no self-interested investor was willing to supply more equity to help
buffer the losses. Hence, the Treasury ended up taking them over.

Lehman's demise came when it could not even keep borrowing. Lehman
was rolling over at least $100 billion a month to finance its
investments in real estate, bonds, stocks, and financial assets. When
it is hard for lenders to monitor their investments and borrowers can
rapidly change the risk on their balance sheets, lenders opt for short-term lending. Compared to legal or other channels, their threat to refuse to roll over funding is the most effective option to keep the borrower in line.

This was especially relevant for Lehman, because as an investment
bank, it could transform its risk characteristics very easily by using
derivatives and by churning its trading portfolio. So for Lehman (and
all investment banks), the short-term financing is not an accident; it
is inevitable.

Why did the financing dry up? For months, short-sellers were
convinced that Lehman's real-estate losses were bigger than it had
acknowledged. As more bad news about the real estate market emerged,
including the losses at Freddie Mac and Fannie Mae, this view spread.

Lehman's costs of borrowing rose and its share price fell. With an
impending downgrade to its credit rating looming, legal restrictions
were going to prevent certain firms from continuing to lend to Lehman.
Other counterparties
that might have been able to lend, even if Lehman's credit rating was
impaired, simply decided that the chance of default in the near future
was too high, partly because they feared that future credit conditions
would get even tighter and force Lehman and others to default at that
time.

A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments.
While its core insurance businesses and other subsidiaries (such as its
large aircraft-leasing operation) were doing fine, these contracts,
called credit default swaps (C.D.S.'s), were hemorrhaging.   

Furthermore, the possibility of further losses loomed if the housing
market continued to deteriorate. The credit-rating agencies looking at
the potential losses downgraded A.I.G.'s debt on Monday. With its lower
credit ratings, A.I.G.'s insurance contracts required A.I.G. to
demonstrate that it had collateral to service the contracts; estimates
suggested that it needed roughly $15 billion in immediate collateral.

A second problem A.I.G. faced is that if it failed to post the
collateral, it would be considered to have defaulted on the C.D.S.'s.
Were A.I.G. to default on C.D.S.'s, some other A.I.G. contracts (tied
to losses on other financial securities) contain clauses saying that
its other contractual partners could insist on prepayment of their
claims. These cross-default clauses are present so that resources from
one part of the business do not get diverted to plug a hole in another
part. A.I.G. had another $380 billion of these other insurance
contracts outstanding. No private investors were willing to step into
this situation and loan A.I.G. the money it needed to post the
collateral.

In the scramble to make good on the C.D.S.'s, A.I.G.'s ability to
service its own debt would come into question. A.I.G. had $160 billion
in bonds that were held all over the world: nowhere near as widely as
the Fannie and Freddie bonds, but still dispersed widely.

In addition, other large financial firms "” including Pacific
Investment Management Company (Pimco), the largest bond-investment fund
in the world "” had guaranteed A.I.G.'s bonds by writing C.D.S.
contracts.

Given the huge size of the contracts and the number of parties
intertwined, the Federal Reserve decided that a default by A.I.G. would
wreak havoc on the financial system and cause contagious failures.
There was an immediate need to get A.I.G. the collateral to honor its
contracts, so the Fed loaned A.I.G. $85 billion.

Update:  Travis has an awesome post with his own FAQ about what is going on.  Here is a taste:

Lots of financially naive folks think that we can remove all risk,
inflation, etc. by only ever trading apples for chickens on the barrel
head, and doing away with paper money (so that all money is gold) and
doing away fractional reserve banking, so that when I deposit one gold
coin in the bank, the bank can then take that actual physical gold coin
and loan it to someone else. It turns out that the friction involved in
doing things this way is so huge that the effect would make The Road
Warrior look like a children's bedtime story. You want to borrow money
to buy a car? The bank can't just loan money that's been deposited in
someone else's checking account - the bank has to get that person to
sign a note saying "yes, I understand that this money is on deposit
until that dude buying the card pays the bank back IN FULL". And the
lender, if he wants his money out ahead of time, is SOL. And even then,
there can be a flood, and your car gets totaled, and you get
Legionaire's disease, and you can't make the payments.

or this:

Now, for the next complication, let's also imagine that there are
300 million other people watching all of this, thinking "How bad is
this? Should I go down to the gun store, stock up on .223 and 12 gauge
shells, then stop by the veterinarians to see how much antibiotics I
can cadge before heading to the hills" ?

And the Feds really don't want 300 million armed folks heading
for the national forests, so they first try to tell everyone who owns a
bicycle "Hey, the value of your bike didn't really drop! It's still
worth $9!".

But no one wants to believe that.

So then they go to the guy who's writing insurance policies on
the value of bikes and they say "if you got $100 million, would that
calm things down a bit?".

"I think it was exciting to some that she was a woman"

- Bill Clinton on Sarah Palin  (via)

Someone noticed that just before certain stocks crash in value, there is a lot of short-selling.  So the US government has banned short-selling, at least temporarily.  Classic cargo-cult logic. 

Boy this sure makes perfect sense in a time when we are concerned about speculative bubbles -- let's ban one of the most important tools that exist for bubbles to be shortened and made less, uh, bubbly.  Here is why (very briefly and non-technically) short-selling takes the edge off speculative excesses.

At the start of the bubble, a particular asset (be it an equity or a commodity like oil) is owned by a mix of people who have different expectations about future price movements.  For whatever reasons, in a bubble, a subset of the market develops rapidly rising expectations about the value of the asset.  They start buying the asset, and the price starts rising.  As the price rises, and these bulls buy in, folks who owned the asset previously and are less bullish about the future will sell to the new buyers.  The very fact of the rising price of the asset from this buying reinforces the bulls' feeling that the sky is the limit for prices, and bulls buy in even more. 

Let's fast forward to a point where the price has risen to some stratospheric levels vs. the previous pricing as well as historical norms or ratios.  The ownership base for the asset is now disproportionately
made up of those sky-is-the-limit bulls, while everyone who thought
these guys were overly optimistic and a bit wonky have sold out. 99.9% of the world now thinks the asset is grossly overvalued.  But how does it come to earth?  After all, the only way the price can drop is if some owners sell, and all the owners are super-bulls who are unlikely to do so.  As a result, the bubble might continue and grow long after most of the world has seen the insanity of it.

Thus, we have short-selling.  Short-selling allows the other 99.9% who are not owners to sell part of the asset anyway, casting their financial vote for the value of the company.  Short-selling shortens bubbles, hastens the reckoning, and in the process generally reduces the wreckage on the back end.

Update:  From Don Boudreaux:

To ban short-selling of stocks is to short-circuit an important
mechanism through which people share their knowledge and expectations
with others.  Banning a mechanism that better allows share prices to
reflect the expectation that the underlying assets are not worth as
much as current market prices suggest does nothing to change the
underlying reality.  Such a ban merely distorts knowledge of this
reality