Does the U.S. Have an Implicit Guarantee?

At the end of this article is this statement about the potential consequences of the U.S. government's decision to try to stabilize financial markets by transferring risk to taxpayers:

If the government’s responsibility for this risk starts to fray America’s finances in earnest, its backup plan is apparently to hope that the taxpayers’ creditors—including the Chinese government—continue to consider America too big to fail.

I'm not expecting we'll find out, but is the U.S. too big to fail?

I think that it probably is. It's not in China's interest, or in the interest of oil producing countries, to have a financial meltdown that causes the U.S. economy to go into a deep recession. A deep recession in the U.S. would likely have a large negative impact on the economies of these countries, so they ought to be willing to put some of their financial capital at risk to reduce the chances that a recession will occur.

Comments

[Alessandro]

You mean: once you are into a Ponzi scheme you have no way to get out unscathed.

You are right, they will try as hard as they possibly can, not to get out of the scheme, but at some point every Ponzi scheme must collapse. We just don't know when.

[Michael McKinlay]

Is the United States too big to fail ... yes ...

Do all the countries in the world have enough capital to rescue the United States ... not likely.

[a]

Alas, nothing is too big to fail.

[hari]

This is a very disingenous way to tame the over-consumption US economic model. Recession and a serious failure of the existing financial securitization and other derivatives model will more likely engineer the coorection required to get this huge economy back on its feet.

Nothing less will do now....

[Matt]

Mark Thoma's thesis puts us back to the beginning of the Great Depression when the US Fed thought Britain was too big to fail and we tried to link the dollar and pound. We soon got over that effort, and China has already begun to decouple.

Delinking the Chinese money from the dollar is well underway, and is irreversible.

China and India have enough to do, endogenously and together that they do not need the USA. Nor does the too big to fail thesis explain how they can support us when our oil usage, per capita, is about five times what theirs is.

[wimpie]

Was the USSR "too big to fail"?

[gaius marius]

dr thoma --

i can add to the discussion what i've garnered from private research -- which is that it is in fact deeply in the chinese interest to revalue the yuan higher and effectively end vendor financing.

we know that chinese inflation and hot money flows has a solution in a more powerful floating currency, and that is the usual argument for revaluation. the standard argument against is a combination of forex losses and exporter health.

but what we don't often consider is the strong economic gains for china that would offset these drawbacks. indeed, with a more powerful currency, china would virtually offset its forex losses in oil purchasing alone -- effectively trading public losses for private stimulus quid pro quo, and at a time of global economic downturn.

the low-end of the export sector is a problem, to be sure -- but china is already being beaten on cost at the low end by other east asian economies that is has crawled past. it is already in the necessary process of climbing the export ladder into markets closer to high-end finished goods -- automotive, semiconductor, et al -- where it faces basically no competition in taking share away from specializing western eocnomies. in these more complex industries, there is simply no probable competition for china in quantity and price from either above or below. with the decline in commodity input that would accompany the stronger yuan, these lines of business would likely experience improved profit margins as cost structure improves. and of course in china the export sector is growing ever smaller in comparison to the internal market -- china's burgeoning importers would find a boon.

there would also be the likelihood of the yuan displacing the dollar as the reserve currency of the asian region, with all the cost-of-borrowing benefits that implies.

i think these probabilities have dawned on the government of china already, which is why they've widened the trading band and are allowing the yuan to strengthen at an accelerating rate. there will be transient effects for china, to be sure, but their net benefit -- on all timescales, now that inflation is rampant -- is heavily on the side of a stronger currency.

we americans, for what its worth, are in the main whistling past the graveyard on this issue. its sometimes forgotten that china has been in the process of not only strengthening the yuan but accelerating that trend for months now, largely because it is in the chinese interest. i think we should at least prepare for a further acceleration, with all the terrible but inevitable and necessary fallout that would come with it.

[Wm Tolles]

The S&L bubble, and now the mortgage bubble (of FNM, FRE, etc.) have both been caused by a long-term government policy (in existence for decades) that inspires unstable feedback. That policy relates to deductions for interest payments on housing.

"They aren't making any more land." With more people, and more money in the system, the price of real estate invariably rises faster than inflation. Thus, it's a good investment in itself. But, to give a tax break to interest on loans for this asset only makes ownership more attractive, since an individual can borrow at rates lower than the increasing value on most real estate assets (due to inflation and decreasing availability). The consequent incentive is to go as deeply into debt as one can to maximize one's net worth (leveraging up maximizes gains). This works fine until the value of real estate begins to decrease – then incentives disappear until rates increase again. The feedback makes the system unstable. Gains with this Ponzi scheme are greatest for the wealthy, since they can borrow (with tax deductions) much greater amounts.

The net result is a system where most homeowners borrow at increasing amounts until real estate does not increase, then the incentives disappear, and declining values are a cause for further declines.

We need a system without this kind of feedback (how about limiting the deductions for mortgage interest?).

[zak822]

"It's not in China's interest, or in the interest of oil producing countries, to have a financial meltdown that causes the U.S. economy to go into a deep recession."

I keep hearing this, and it baffles me. Our perception of Chinas' best interests are likely very different than that of China's leadership. Geo-political or other considerations may make it tempting to simply wage economic war on the US, for reasons that are obscure to us. Ideology can be like that.

What does the communist state have to lose? Only things that matter to capitalist states and democracies.

[robertdfeinman]

I commented yesterday on the number of countries that "failed" in the 20th Century.

As a refresher: Germany 1923, a succession of Latin American countries pushed over the edge by the IMF, Thailand, Philippines and the USSR.

The US "failed" in 1929 and again in the 1970's. It all depends on what you mean by fail. Did the US renege on it's bonds? No, but inflation and a weakening dollar led to much less being returned to investors in terms of real purchasing power for the treasuries.

The same thing is happening now, just in slow motion. The popular story is that foreigners will keep investing in US bonds because of their "safety", especially compared to other national debt instruments. But there is a difference between accepting a low rate of return and a negative one.

Expect foreign debt holders to accelerate conversion of this into tangible US assets. Recent investments by Dubai are just the beginning. I hand you $10 billion in treasuries, you hand me 10% of Citigroup.

Now whose interests does Citi pursue in the future? The US stakeholders, or the foreign ones? A 10% "passive" investment in a firm still wields a lot of power.

If you don't like the prospects what do plan on doing about it? Stop borrowing to buy imported oil? Stop borrowing to fight foreign wars? Scale the economy back by cutting social services?

Gore's latest plan is impractical, but at least he has opened up a discussion, this is more than can be said for those running for office.

[hari]

Technically - you're right to ask if the US is too big to fail - because Paulson has singularly demonstrated (from the steps of the Treasury Building last Sunday) that he has the confidence of the Japanese, first, and also BoC.

Together they are holding, according to GRE Monitor, some $Trillion debt instruments on behalf of US Treasury.

The moral hazard in all this configuration is mutual - Japanese/Chinese can't lose their face either (Asian problem).

Bottomline - how long do you think this state of affairs, in US domestic finance, can be sustained indefinitely; and with what degree of certainty. Bernake is against *naked* short sells - 30days moratorium! - on banking sector....

[donna]

Gore doesn't just talk, he DOES. Looked at his investment fund lately for alternative energy production? This man was pushed out of the government and is busily creating a private sector that will do what he envisions. He would love government support for it and works with those within the government and within other governments that are receptive to his vision, but one way or another, he'll still get it done.

Others are just talk, Gore does it.

[daveNYC]

What does the communist state have to lose?

Political stability.

[Movie Guy]

Is the World economy too big to fall?

No.

Historically, have nations gone to war in order to dig themselves out of economic and financial messes?

Yes.

It might prove to be less expensive for other nations to assist the USA in its time of economic need as opposed to isolating or provoking the USA into a series of actions that could launch a regional or global war.

Or not.

[Lafayette]

Funny, or what?

MT: At the end of this article is this statement about the potential consequences of the U.S. government's decision to try to stabilize financial markets by transferring risk to taxpayers

Yes, and who is the taxpayer? In 2008, it will likely be almost a quarter from corporations and the rest from us. (Figures, here).

OK, that seems to justify the fact that WE will bear most of the burden. But, not alone. So, to my mind, this fact mitigates (only somewhat admittedly) the outrage at "bailing out BigFinance".

Whilst many sympathize with this outrage, I submit that it is better to consider the cause (mindless greed on the part of "Financial Engineers") and the corrective measures (confiscatory marginal taxation on excessive compensation). Which should make for less avarice amongst a certain class of people.

So, what's excessive compensation, meaning starting at how much?

That's the question no one here on this forum, or in Congress, seems to want to touch with a ten foot pole.

Funny, or what? All this indignation but when it comes to reining in a runaway horse, we all turn amazingly quiet ... don't we?

[anne]

"Geo-political or other considerations may make it tempting to simply wage economic war on the US, for reasons that are obscure to us. Ideology can be like that."

Rubbish can be like that.

[Blissex]

«I'm not expecting we'll find out, but is the U.S. too big to fail?
I think that it probably is. It's not in China's interest, or in the interest of oil producing countries, to have a financial meltdown that causes the U.S. economy to go into a deep recession.»

Well, the interests of oil producing countries and China can be very different.

For China a USA recessions means a large fall in commodity prices, including oil, and thus in its own high inflation rate. As Gaius Marius also says the export sector is getting smaller in China:

«and of course in china the export sector is growing ever smaller in comparison to the internal market -- china's burgeoning importers would find a boon.»

Saudi Arabia would see oil prices go down, but I can imagine they would not be too displeased. Because they are already terrified that oil prices are at the level where other energy sources are competitive, and new ones are worth developing.

The Saudis are probably more terrified of oil becoming as irrelevant as whale oil than of some price moderation consequent to a USA recession, which would also allow them to buy large amounts of USA assets at firesale prices.

[Blissex]

«So, what's excessive compensation, meaning starting at how much?»

As some important people say, what matter is exploitation, and insufficient compensation and thus incentives for those that are most productive:

http://online.wsj.com/article/SB121460589609712025.html
«Most of his former colleagues probably can't fathom why Wall Street bankers make tens of millions of dollars in salaries and bonuses each year. How would he justify these fat pay days? "It's simple," he lectures, sounding very much like the Texas A&M economics professor that he was in the 1970s: "In economics, we define labor exploitation as paying people less than their marginal value product. I recently told Ed Whitacre [former CEO of AT&T, who retired with a $158 million pay package] he was probably the most exploited worker in American history because he took Southwestern Bell, which was the smallest of the former Bell companies, and he turned it into the dominant phone company on earth. His severance package should have been billions."
Mr. Gramm says that today there is "a lucrative premium for talent. When we were all hunters and gatherers, and you were better with a bow and arrow than I was, there were limits on how much more game you could kill than me. Today, CEO decisions about whether to acquire or not acquire a company, to shut down one part of the company or not shut it down, get into a market, get out of a market, where those decisions mean billions of dollars, is it surprising that people are willing to pay tremendous amounts of money for people who make those decisions right?"»

So poor Ed Whitacre was brutally exploited and took home only a fraction of the value he created, and then the government swoops in, STEALS HIS MONEY and buys Cadillacs for the welfare queens and t-bone steaks for the strapping young bucks who laugh, laugh at those who work hard and create many billions of value.

[Real Person from the Real World]

Blissex, don't you realize the overpaid think they are actually underpaid and deserve even more? Rock Stars and Sports Stars, Sales people, and Business executives always try to negotiate for MORE, MORE, MORE. That's why they make more.