Tuesday, March 10, 2009

What Jon Stewart and Rick Santelli are really fighting about

Posted By on 03.10.09 at 12:15 PM

Continuing my occasional series: an English major who failed his collegiate math-entrance exam (seriously, I would have ended up in pre-calc if I hadn't discovered a Java-class loophole for my math requirement) discusses the complexities of the financial crisis.

So: you are probably now aware that a financial trader-turned-CNBC-reporter, Rick Santelli, made waves by unleashing a rant about homeowner bailouts. The Trib covered the aftermath. Then Jon Stewart invited Santelli on his show; Santelli accepted, then bailed. The Trib covered this, too. (Memo: I think the lesson here is that direct populist outrage generates traffic, post-hoc metacoverage less so.)

This was framed as a fun little feud. But you may ask yourself: where is my beautiful house wha?

You can watch Santelli freak out here. Let's address it briefly. Santelli asks, and it is a perfectly fair question that people should be asking, why should my tax money go to bail out my neighbors?

I am a renter so I could say let 'em eat cake, my rent will go down. But here's a thought experiment: let us say that you are not one of Santelli's "losers." You reliably pay a mortgage that you can afford on the house of your dreams as George Washington would want you to.

Now your loser neighbors start defaulting (it is significant that Santelli specifically uses the word neighbors). As their houses get repossessed, they get boarded up, the grass gets high, and your suburb turns into a squatter village as it returns to nature. Now your dream house is worth fuck-all and the mortgage on the house you are paying on a house you don't want anymore is much greater than its value. And good luck selling it. See where this is a problem? And that's just on the most selfishly microeconomic level.

In short, Santelli is a moral hazard fundamentalist. And moral hazard is important--it keeps people from doing dumb things. But it gets much more complex in the interconnected world of finance. Applying moral hazard broadly can punish people who are not deserving recipients. As Kevin Carey puts it, moral hazard itself can be a hazard. Moral hazard's going out the window at all levels, especially after letting Lehman Brothers eat it increasingly looks like a terrible mistake.

The other unfortunate thing about this whole imbroglio has been that lots more attention has been focused on Stewart's skewering of CNBC (which is needed and quite good) and not his fine interview with Joe Nocera, whose recent column on AIG ("Always Invest in Garbage" or "Always Insure Garbage") is a must-read. Stewart is very good at asking smartly dumb questions, and you can watch him reframe Nocera's own expert thinking with logical, basic questions.

The ongoing bailout of AIG, which comes up in Stewart's bit on CNBC, is probably the most important story in the financial crisis, at least in the immediate present. Basically, we're not so much bailing out AIG as the people who bought AIG insurance on their shitty high-finance bets. Which isn't really insurance, since AIG didn't have enough money to insure these deals. And we don't know who those people are, and the administration isn't telling us.

Talking Points Memo made a great catch: video of Maria Cantwell asking Tim Geithner who AIG's counterparties are--i.e. the people who we are actually bailing out. He dodges, and not very adroitly, and Cantwell gets frustrated and gives up. It's excruciating to watch.

It's not that Geithner is bullshitting per se, it's just that he's unwilling to be terribly specific about where the money to AIG ends up. And a TPM reader makes what sounds to my dumb ass like a reasonable defense of Geithner: AIG insures a lot of things. Because of specific finance laws, which the reader explains, many of AIG's largest creditors aren't stayed by bankruptcy--essentially, if you have a certain type of relationship with AIG, a bankruptcy court can't tell you to shove off, you can just claim your money from whatever's left of the company. Then policyholders go OH SHIT and there are worldwide bank runs as people try to get their money before it's literally gone, now that they know the relationship of their financial institution to AIG.

To wrap up that argument with the Cantwell video in one metaphor: Cantwell is standing outside a burning house, demanding to go in and see what the problem is. Geithner's trying to keep her out so that she doesn't touch the wrong thing and cause it to blow up and set the neighborhood on fire.

The counter-argument is that a lack of transparency might allow the short-sighted geniuses who caused this mess to rip us off, as Simon Johnson explains. This has resulted in a lively back and forth at TPM.

TPM is doing a fantastic job trying to unravel the AIG bailout, building off of reporting from the NYT and the WSJ. Zachary Roth rounds up some of the likely culprits here.

It's quite complicated, but the point is that the Santelli-Stewart-Cramer-CNBC thing isn't happening in a vacuum. What's at stake is no less than the American big-bank system--whether it's broken, whether it's worth saving. I read When Genius Failed over the weekend, a compelling history of the collapse of the hedge fund Long Term Capital Management, and it's remarkable how similar the problems were to this much greater crisis. In short, very smart people misapplied brilliant mathematical formulas (Black-Scholes vs. David X. Li's Gaussian copula formula), bet way too heavily on the market to go in one direction basically forever (stability vs. increasing home prices) without properly hedging against the opposite scenario, overextended risk into comparatively unpredictable markets (corporate-merger arbitrage vs. adjustable-rate mortgages) when investing opportunities in more stable markets ran out and the beast needed to be fed, and created a rat's nest of derivatives that tied together the world's largest financial institutions.

So a lot of people are asking: if big banks are going to keep making these stupid mistakes, do you try to prevent the mistakes, or do you try to keep the banks from getting big enough to bring down the American economic system when they make stupid mistakes?

NB: A few days ago someone asked me what blogs are good at making sense of all this. Here's a short list: Krugman, Naked Capitalism, The Baseline Scenario, Brad DeLong, Nouriel Roubini, Planet Money, Calculated Risk, Eschaton. They're various degrees of wonky, but all mostly followable even by a layman like me.

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