2011年9月20日星期二

System Failure

The Congressional Budget Office has issued an analysis of the fiscal impact of the bill to rescue the financial system, the Emergency Economic Stabilization Act of 2008. Here’s the meet of the analysis:

CBO expects that the Treasury would use most or all of the $700 billion in purchase authority within two years (after which the authority to enter into agreements to purchase various troubled assets would expire). To finance those purchases, the Treasury would have to sell debt to the public. Federal debt held by the public would therefore rise by about $700 billion, although the government would also acquire valuable financial assets in the process. As noted above, CBO expects that since the acquired assets would have some value, the net budget impact would be substantially less than $700 billion; similarly, net cash disbursements under the program would also be substantially less than $700 billion over time because, ultimately, the government would sell the acquired assets and thus generate income that would offset much of the initial expenditures.

In addition to any net gain or loss on the purchase of $700 billion or more in assets, the government also would incur administrative costs for the proposed program. Those costs would depend on the kinds of assets purchased or insured. On the basis of the costs incurred by private investment firms that acquire, manage, and sell similar assets, CBO expects that the administrative costs of operating the program could amount to a few billion dollars per year, as long as the government held all or most of the purchased assets.

Other provisions in the legislation would on net increase the budget deficit. For example, the legislation would allow the Federal Reserve to pay interest immediately on certain reserve balances of depository institutions, rather than starting on October 1, 2011, as allowed under current law. CBO estimates that, over the next three years, the provision would reduce the Federal Reserve’s payments of its profits to the Treasury, which are classified as revenue in the federal budget.

In addition, a number of provisions in the bill would affect federal revenues by changing tax law, including provisions that would limit the deductibility of executive compensation for certain firms selling assets; allow losses incurred by certain taxpayers on preferred stock in Fannie Mae and Freddie Mac to be treated as ordinary rather than capital losses; and exclude from income amounts attributable to the cancellation of mortgage debt of individuals in certain circumstances. The Joint Committee on Taxation estimates that, on net, these provisions would reduce federal revenues.

Enacting the legislation could also affect other federal spending—including, for example, outlays from the operations of Fannie Mae, Freddie Mac, federal housing programs, and deposit insurance. Some of those effects would be related to how TARP would be used to purchase assets (including what kinds of assets would be acquired and from what types of institutions), and how successful the program would be in restoring liquidity to the nation’s financial markets.

Basically, the final tab could be substantially larger than the $700 billion number that’s being thrown around due to additional expenses and the cost of administration of the plan. The difference in the budget is expected to be made up by borrowing. That’s a heckuva lot of borrowing.

Like Mark Thoma, I’m not happy but the problem is real and needs to be addressed on an urgent basis:

I’m with everyone else. The proposal could be better, but as I’ve argued all along, the problems are real and if this is the best we can get – and it appears that’s the case – then it will have to do.

I don’t believe that this is the end of this affair, rather the end of Act I. I’m not certain what the next act will be.

It may well be additional bank failures. The collapse of Fortis, the Belgo-Dutch banking and insurance group which was partially nationalized in response to the crisis. The problems at Wachovia provide additional evidence.

I wouldn’t be surprised if governments didn’t experience substantial problems. Falling real estate prices will themselves tend to depress state and local government tax revenues while a slowing economy will produce additional clamoring for services. Sales tax revenues and income tax revenues are also likely to be depressed and raising the marginal rates is only likely to depress them even farther.

I’ve got a swarm of ideas buzzing around my head this morning all related to systems and synchronization. I’m not sure I can sort all of them out but I want at least to get them committed to writing. First, at the very least we have a failure of the financial system that’s occurred as a consequence of a positive feedback loop. A positive feedback is a feedback loop system in which the system responds to a perturbation in the same direction as the perturbation. The example that’s given is a donkey being urged forward by dangling a carrot on a stick in front of this nose. The hypothetical donkey continues to move forward until he collapses from exhaustion. A Ponzi scheme is another example of a positive feedback condition.

There are really only two ways to deal with an out of control system like this: let it go to flinders or impose an external control (take the carrot away). We don’t know how the problems in the financial system will play out in the more general economy but the risks of letting the problem explode are pretty high.

Have you noticed how both candidates are referring to “taxpayers” as thought it meant the same thing as “citizenry”? It doesn’t. Something like 45 million tax filers pay no taxes, roughly a third of the total. That means that we actually have two distinct groups, taxpayers and non-tax-paying stakeholders. That means that our fiscal system has two inter-related subsystems, one a positive feedback system and one a negative feedback system.

A negative feedback system is one in which the system responds to a perturbation in the direction opposite the perturbation and reaches an equilibrium. The government’s revenue-producing system, taxation, is such a system. People resist paying taxes.

The expenditure side of the government’s fiscal house is just the opposite: it’s a positive feedback system. For non-tax-paying stakeholders or those whose taxes are less than the benefits they derive from the government there is no disincentive for clamoring for more.

Back in the days before the Sixteenth Amendment when the only constitutional form of personal tax levied by the federal government was a head tax, the federal government’s fiscal system was virtually guaranteed to reach equilibrium. Now it is almost guaranteed to fly out of control. It’s a positive feedback system with no intrinsic dampening control mechanism, all the more so as the number of non-tax-paying stakeholders rises as a proportion of the population.

That’s the idea behind a balanced budget requirement: an external discipline that prevents the system from flying out of control.

There are all sorts of objections to any method of fiscal control, that they’re unjust or racist or whatever. It hasn’t always been that way. I remember that when I filed my first federal income tax return on an income of $1,400 I paid taxes. There’s an odd set of ideas floating around these days. Nowadays what constitutes justice seems to vary depending on your income. It’s even been asserted that paying taxes is patriotic. Doesn’t that mean that non-tax-paying stakeholders are unpatriotic, at least in a relative sense?

My final thought in this post is that I’ve heard it said that with the aid of a computer in a fraction of a second you can make an error that it would have taken you years to produce by hand and I can’t help but wonder if that isn’t the case with the financial crisis. For one thing I can see how the online trading systems might have put stress on the traditional investment banks’ business model. In response to that they adopted the complicated derivatives and mortgage-backed securities that have accounted for so much of their revenues lately. Were these things being computer-constructed? I suspect they were and that could possibly explain the rapidity of the collapse. I’m thinking of some sort of demonic philosopher’s dinner in which not only were the positive feedbacks of greed and rising real estate prices driving the system but there was an ever-increasing computer-assisted tempo which accelerated the collapse.

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