Monday, December 22, 2008

The Law of Money

Nothing has value in a transaction unless all participating parties agree it has value. This is the first law of money, and the reason why bailouts in general are a bad idea. The nation is facing, effectively, four crises at the same time:

1. A general recession of the economy, which boils down to falling production of goods and services, indicating a collapse of consumer confidence;
2. A credit crisis in the banks, as banks are risk-averse to the point that they are making fewer loans and requiring much stricter terms, even from customers who should be considered worth the deal;
3. A mortgage crisis, with high risk of foreclosure and loan defaults; and
4. The major automakers’ crisis, as the three largest automakers plea for aid from Congress.

The last one is the real squirrel. It includes Ford, who claimed to need the money in order to survive, but which backed off once it saw the terms Congress would place on the deal, Chrysler which is still partly owned by Cerberus, a company best-known for sucking cash out of companies it owns and which could have infused needed cash into Chrysler but chose not to, and GM, which annual reports for the last three years’ running have include material changes of their accounting practices, a proven inability to make a profit off their core operations, and a demonstrated arrogance against admitting that their business model is not only insufficient to their needs, it is causing at least some of their most serious problems. Another point to analyzing these crises, is to understand that they are inter-related; you cannot solve them just one at a time, but on the other hand an effective solution for one of the four crises will improve conditions for resolving the others.

Which brings us back to the first law – something does not have value unless both the seller and buyer agree on that value. And that is the nut to be worked out in the whole mess. For mortgages, after all, part of the problem is that many of the homes in trouble simply cannot be sold for anything like the price of the mortgage. If the people who live in those homes now were to work out a way to pay off those mortgages, they would still lose money because the homes’ present value is less than the amount they paid. Similarly, an objective accounting of the true net value of the car companies would produce a number much lower than the billions they hope to receive from Congress over the next several years (because we all know at some level that this crisis will not be resolved quickly or cheaply, not even at the 50 billion dollar level tossed around not very long ago). The bottom line for both the mortgage and auto crisis, is that someone is going to have to take a large loss. Some want everyone to feel pain to some degree, and of course every special interest group puts out an argument that everyone but them should pay. And of course the most common argument is that the taxpayer should pay, simply because the most money is there, never mind that this argument would have innocents paying off crooks. The essential argument in front of Congress is how to spin this last option. It’s the easiest short-term fix, if also the least ethical.

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