The founder and manager of the Elliott Associates hedge fund, Paul Singer, was one of my partners in the New York Sun and is the chairman of the Manhattan Institute. He recently passed along some perspectives on the financial crisis and public policy that our readers may find of interest. Before I dig into the details, one overall point is worth making – this is a climate in which people who invest for a living are spending a lot of time thinking about politics and policy, because the government is such a big player in the economy now that it's often hard to make reasonable investment decisions without making judgments about how government will act.
Much of Mr. Singer's document is an analysis and criticism of the financial regulation bill passed by the House of Representatives, the Wall Street Reform and Consumer Protection Act of 2009. Mr. Singer notes drily that the bill has already been passed by the House, notwithstanding the fact that the Financial Crisis Inquiry Commission that Congress created and tasked with investigating the crisis isn't scheduled to report until December 2010. There's some precedent for this; Congress passed the Patriot Act long before the 9/11 Commission reported. But it does seem a bit backward.
One complaint Mr. Singer has with the legislation is its creation of a "bailout fund" to be filled with "unlimited assessments on banks over $75 billion and hedge funds over $10 billion" in assets. Mr. Singer says this won't work:
the government will not actually generate substantial revenues from hedge funds from the assessments contemplated by H.R.4173, because for many firms it will be out of the question to run a fund which is subject to open-ended assessments. Whether the assessment is a fraction of 1% of capital, 5%, 10%, or some bigger number, is completely unknowable. Many hedge funds potentially subject to this would reduce their size to under $10 billion, or move out of the US. Being subject to potential changes in taxation is one thing. Taxes are generally forward looking, applying to money more or less earned after announcement or enactment of the rule changes. But the H.R.4173 "bailout" fund assessment is something else entirely.
The simple fact is that in the long-term, this assessment policy will not ultimately result in the collection of sufficient revenues because financial jobs and activities will be driven offshore. Capital goes where it is welcome, well-treated, and subject to understandable and rational regimes of rules, laws and taxes. It will not go where the game is rigged, corrupt, or stacked.
Another concern is with the "resolution process," which, under the bill, would allow the FDIC and the Treasury "astonishing and nearly uncontrolled discretion." Mr. Singer writes:
You have to read the bill to check our outlandish (but true) assertion that these two organizations can basically seize any American enterprise and do whatever they want with it, including determining whether similarly situated creditors should receive the same or different returns notwithstanding the consonant nature of their claims. The bill's resolution process would unnecessarily throw most of the existing bankruptcy code into the garbage where certain financial institutions are involved. The protections, practices and procedures of the bankruptcy code have grown up over decades, and they work to provide an understandable framework for reorganizing or liquidating companies, from dry cleaning shops to multinational enterprises. What is broken in the bankruptcy code certainly can be fixed, but the events of the last two years should not provide an excuse for government to swing toward complete discretion and concentrated power.
Mr. Singer also warns of inflation:
Fiat money (currency not backed by hard assets) is devilishly hard to maintain as a store of stable value over long periods of time. Convincing people to accept fiat money requires trust, which is hard to establish and preserve when the money has no underlying tangible reality. And, when politicians engage in the kind of cheating which is endemic with fiat currencies (debasing it; promising too much in the future in order to buy votes or influence today), trust can be utterly destroyed. When trust is destroyed in fiat currency regimes, the denouement can be stupefyingly rapid, especially compared with the lengthy buildup of trust-eroding actions. During the buildup period in which policies are pursued that will ultimately undermine fiat currencies, it appears to politicians that they can promise anything, because almost every promise is met by belief. Truly, to the politicians, it feels like a free lunch. They keep promising more (way in excess of the country's capability and willingness to pay), people keep voting for politicians who promise more, and nothing bad happens. The interest rate may not even re-adjust higher to anticipate the expected future debasement, nobody does the arithmetic proving that claims cannot be paid without currency debasement, and politicians think they can get away with it forever. But the seeds of distrust and doubt are being planted, and when conditions change and the realization dawns that the structure, the promises, and the currency are unsound, things can (and will) unwind rapidly… The loss of confidence in fiat money is likely to be lightening-quick once it begins, a dam bursting rather than a long drawn-out gradual increase in reported inflation.
I don't agree with everything Mr. Singer has to say. He's a fan of the Interstate Highway system: "A fine example of the kind of stimulus spending that has multiplier effects in unlocking sustainable growth was the Eisenhower-era interstate highway system. The program built the backbone of America, and stimulated growth and jobs for decades. Towns and cities literally sprang up along the highway. It is illustrative of our point even though it was motivated primarily by national defense rather than economic stimulus." I think one has to reckon with the downside of that highway system, too; Michael Sandel describes it in his book Justice as "reliance on the private automobile, suburban sprawl, environmental degradation, and living patterns corrosive to community." Or as Amity Shlaes conceded in a pro-highway column on Bloomberg, "The outcome of the interstate highway program wasn't optimal. It favored truckers over cities. The roads cut off some downtowns from the commerce that had heretofore sustained them. Minorities pointed out that their communities often bore the brunt of construction. According to Rose, some black political and business leaders spoke of white men's roads going through black men's bedrooms. As for budgeting, the interstate so far outran its original cost estimates that Senator William Proxmire awarded it his so- called golden fleece prize for federal profligacy." Never mind the fact that road-building might have been left to state governments or private companies.
Mr. Singer supports "a global, comprehensive increase in margin, reserve and capital requirements to limit leverage," a limit on "all institutions, not just 'regulated entities." He insists that "such limitations are not an unnecessary impingement on freedom. They are not harsh restrictions imposed on a previous state of pristine and peaceful utopian bliss." I tend to disagree that such limits are necessary, desirable, or workable, for reasons I explain more fully here, here, here, here and here.
Mr. Singer writes, "The winners and losers in the financial engineering epoch of the last ten years grew so far apart that the disparity framed the societal anger now coursing through the political system." I actually don't think the anger is rooted in the disparity between winners and losers. Poor and middle class people aren't angry at winners like Oprah, the Google guys, Bill Gates, or Warren Buffett. Again, Professor Sandel, quoting President Obama, has a point: "This is America. We don't disparage wealth. We don't begrudge anybody for achieving success. And we certainly believe that success should be rewarded. But what gets people upset – and rightfully so – are executives rewarded for failure, especially when those rewards are subsidized by U.S. taxpayers." So maybe the anger relates less to the last ten years but to the last year and a half, and less to winners but to losers who are paid like winners, and with tax dollars.
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