Being a creditor is a thankless task. The worst offenders are governments, whose leaders constantly promise their peoples a free lunch, dinner, and more.
Argentina is a typical offender. One of the world’s richest nations at the end of World War II, the South American country embraced political authoritarianism and economic populism. In the most recent Economic Freedom of the World rating Argentina came in at 137 of the 152 nations rated.
The country’s worst measure is rule of law, which is reflected in its treatment of international creditors—and steadfast resistance to U.S. court rulings ordering Buenos Aires to pay its debts.
In 2001 Argentina defaulted on nearly $100 billion in debt. The Argentine people essentially had a wild party and woke up with a hangover. Their first reaction was to stiff the fools who had extended credit. Owners of roughly 93 percent of the debt gave in and restructured their paper, accepting huge write-offs.
But a few creditors, including NML Capital and Aurelius Capital Management, refused to concede. These creditors argued that Argentina should abide by its contract, which required it to obey U.S. court rulings.
Naturally, Argentina’s government cried foul, complaining about the violation to its sovereignty—after it enthusiastically sought (and spent!) the foreigners’ money. The politicians who wrecked the Argentine economy called the hedge funds “vultures.”
However, Buenos Aires didn’t prepare for tough American judges. As I noted in Forbes.com:
Although Argentine politicians can dispense with the rule of law in their home country, they cannot so easily ignore legal rules overseas. With the bonds issued under New York law, disgruntled creditors won more than 100 court judgments ordering Buenos Aires to pay up.
Last year’s federal district court judgment, NML Capital Ltd. v. Republic of Argentina in New York—upheld on appeal in February—prohibited Argentina from paying holders of restructured debt without paying off those holding original bonds. Buenos Aires sought review by the Supreme Court. But in early October the high court refused to grant of a writ of certiorari to take the case. Last week NML and Aurelius filed a motion in the appellate court requesting that it lift its stay of Judge Griese’s ruling, allowing enforcement against Argentina.
Misguided is support for Buenos Aires, particularly from those purporting to speak on behalf of the poor at home and abroad. For instance, after the Supreme Court said no to review the Jubilee USA Network Executive Director Eric LeCompte declared: “The faith community is saddened by the high court’s decision.”
However, no one forced the Argentine government to borrow money. No one forced the Argentine government to waste the money that it borrowed. And no one forced the Argentine government to default. Argentina’s economic problems originate in government offices in Buenos Aires, not hedge fund offices in New York.
Indeed, politicians in Buenos Aires are the true vultures. One can argue about proper standards for international debt restructuring. But the rule of law is the best and, indeed, usually the only effective protection for the poor.
Those who are wealthy and influential do well in any system. Redistributionist economic policies ensure that only the well-connected prosper.
Buenos Aires’ lawlessness puts everyone else at risk. Five years ago the Kirchner government confiscated nearly $30 billion in private retirement assets to raise cash.
The only consistent protection against rapacious politicians is the rule of law. Obviously the legal process doesn’t always work well, but as Judge Griese proved in ruling for private creditors, with independent courts vulture politicians don’t always win.
The New York legal battle is esoteric—but matters for all of us. Despite so much amiss in Washington, the Argentine debt case reminds us that the rule of law remains alive in the United States.
Yesterday in the New York Times, Josh Rosner, co-author of Reckless Endangerment, asked one of the questions that almost everyone in Washington is avoiding: how do the taxpayers get back their money, currently about $180 billion (including dividends), from Fannie Mae and Freddie Mac? Obviously Democrats do not want to be reminded that their social engineering of the mortgage market has been a disaster, but why have Republicans been quiet?
I suspect many Republicans, at least those not closely aligned with the real estate industry, are torn between wanting to immediately get rid of Fannie and Freddie and getting the taxpayers' money back. A common attitude in Washington also appears to be that the money put into Fannie/Freddie is gone, sunk, and will never be returned. I'm not so willing to just give up, on either getting rid of them or getting our money back.
First, let's accept that any wind-down would likely take a few years, say six or so. So I would suggest we immediately take Fannie and Freddie into receivership. Impose any future losses on creditors, but also continue to run the companies. And continue to buy and package mortgages during the receivership. This would minimize disruptions to the housing and mortgage market.
Instead of simply running the companies, business as usual, levy a surcharge on all their purchases and use that surcharge to pay back the taxpayer. Fannie and Freddie, combined, will likely purchase about a $1 trillion annually in mortgages over the next few years. Assuming a six year wind-down, that's $6 trillion. A 2 percent surcharge gets back most of the bailout. That's also high enough to encourage private money to come into the mortgage market and compete with Fannie and Freddie. If my Realtor friends feel this is a "tax on home-ownership" then they are free to drop their commissions by 2 percent, leaving buyers no worse off. Even better, they can encourage buyers to use a non-government mortgage.
Any forecast of housing activity is going to have some error. So the numbers above are likely off, in one direction or another. The point is a surcharge on the purchases made by these Government-Sponsored Enterprises can kill two birds with one stone: getting the taxpayers' money back and reducing the GSEs' footprint in the mortgage market.
Steven Pearlstein’s ready for the nuclear option. With the conviction of a man who knows he won’t be held accountable for the consequences of his prescriptions, Pearlstein says the time has come for action against China. Hopefully, those whose fingers are actually near the button will recognize Pearlstein’s suggestion for what it is: an outburst of frustration over what he considers China’s insubordination.
In his Washington Post business column yesterday, Pearlstein criticizes U.S. policymakers for blindly adhering to the view that China will inevitably transition to democratic capitalism, while they’ve excused market-distorting protectionism, mercantilism, and state dominance over the economy in China. Pearlstein writes:
Up to now, a succession of administrations has argued against directly challenging China over its mercantilist policies, figuring it would be more effective in the long run to let the economic relationship grow deeper and give the Chinese the time and respect their culture demands to make the inevitable transition to democratic capitalism.
What we have discovered, however, is that the Chinese don't view the transition as inevitable and that, in any case, they really aren't much interested in relationships. If anything, they've proven to be relentlessly transactional. And their view of business and economics remains so thoroughly mercantilist that they not only can't imagine any other way, but assume that everyone else thinks the way they do. To try to convince them otherwise is folly.
Pearlstein’s suggestion that the Chinese “aren’t much interested in relationships” strikes me as frustration over the fact that China is no longer a U.S. supplicant. Perhaps the truth is that China isn’t much interested in a one-way relationship, where it is expected to meet all U.S. demands, while seeing its own wishes ignored. Calling them “relentlessly transactional” is accusing them of naivety for missing the bigger picture, which, for Pearlstein, is that the U.S. is still top dog and China ignores that at its peril.
Pearlstein is not the first columnist to criticize the Chinese government for putting its interests ahead of America’s (or, more accurately, putting what it believes to be its best interests ahead of what U.S. policymakers believe to be in their own interests). In a recent Cato policy paper titled Manufacturing Discord: Growing Tensions Threaten the U.S.-China Economic Relationship, I was addressing opinion leaders who have staked out positions similar to Pearlstein’s when I wrote:
Lately, the media have spilled lots of ink over the proposition that China has thrived at U.S. expense for too long, and that China’s growing assertiveness signals an urgent need for aggressive U.S. policy changes….
One explanation for the change in tenor is that media pundits, policymakers, and other analysts are viewing the relationship through a prism that has been altered by the fact of a rapidly rising China. That China emerged from the financial meltdown and subsequent global recession wealthier and on a virtually unchanged high-growth trajectory, while the United States faces slow growth, high unemployment, and a large debt (much of it owned by the Chinese), is breeding anxiety and changing perceptions of the relationship in both countries….
Of course, the U. S. is the larger economy and the chief designer of the still-prevailing global economic architecture. But the implication that that distinction immunizes the U. S. from costly repercussions if U.S. sanctions were imposed against China is foolish. But that’s exactly where Pearlstein’s going when he writes:
Getting this economic relationship back into balance is the single biggest challenge to the global economy, not just because of its direct effects on China and the United States, but the indirect effects it has on the rest of the world. The alternative is a return to living beyond our means, a further erosion of our industrial and technological base and a continued loss of ownership of business and financial assets.
By balancing the economic relationship, presumably Pearlstein is speaking about the need to reduce the bilateral trade deficit, which spurs a net outflow of dollars to China, some of which the Chinese lend back to Americans, who in turn can then buy more imports from China, and the cycle continues. But to tip the scales in favor of the blunt force action he recommends later, Pearlstein characterizes Chinese investment in the United States as living beyond our means, losing ownership of “our” assets, and eroding our industrial and technological base. That is a paternalistic and inaccurate characterization of the dynamics of capital inflows from China.
First, let’s remember that the Chinese aren’t holding a gun to the heads of the chairs of our congressional appropriations committees demanding that politicians borrow and spend more on senseless programs. It’s absolutely priceless when spendthrift members of Congress, oblivious to the irony, blame the Chinese for having caused the U.S. financial crisis for providing cheap credit to fuel asset bubbles when it was their own profligacy that brought the Chinese to U.S. debt markets in the first place. Stop deficit spending and the need to borrow from China (or anywhere else) goes away.
Likewise, it is a sad commentary on the state of individual responsibility in the U.S. when a prominent business writer thinks the only way to keep consumers from living beyond their means is to deprive their would-be-creditors of capital. It sounds a bit like the same tactics deployed in the U.S. War on Drugs. Blame the suppliers. The fact that U.S. savings rates have been rising for two years suggests that responsible Americans are interested in rebuilding their assets without need of such measures.
There are other destinations for capital inflows from China, which (despite Pearlstein’s disparaging allusions) should be entirely unobjectionable. Chinese investment in U.S. corporate debt, equities markets, real estate markets, and direct investment in U.S. manufacturing and services industries does not erode our industrial and technological base. It enhances it. It does not constitute a loss of ownership of business and financial assets, but rather a mutual exchange of assets at an agreed price. When Chinese investors compete as buyers in U.S. markets, the value of the assets in those markets rises, which benefits the owners of those assets when there is an exchange. Chinese purchases of anything American, with the exception of debt, do not constitute claims on the future. Accordingly, the economic relationship can achieve the much vaunted need for rebalancing without need of attempting to forcefully reduce the trade deficit by restraining imports.
So if the urgent need is to rebalance the global economy by rebalancing the U.S.-China economic relationship, we are probably going to have to begin this process on our own. And that means establishing some sort of tariff regime that will increase the cost of imports not just from China, but other countries that keep their currencies artificially low, restrict the flow of capital or maintain significant barriers to imports of goods and services. The proceeds of those tariffs should be used to encourage exports in some fashion…
This relationship, however, is one that must be actively managed by the two governments. It should be obvious by now that their government is rather effective at managing their end of things. It should be equally obvious that we cannot continue to rely on free markets to manage our end.
So Pearlstein comes full circle. He wants the U. S. to impose tariffs on Chinese imports, subsidize U.S. exports, and institute top-down industrial policy. In other words, he wants the U.S. to be more like China.
Of course, I would argue, we already have something that encourages exports. They’re called imports. Over half of the value of U.S. imports are intermediate goods—capital equipment, components, raw materials—that are used by American-based producers to make goods for their customers in the U. S. and abroad. Furthermore, foreigners need to be able to sell to Americans if they are going to have the dollars to buy products from Americans. And finally, if the U.S. implements trade restrictions on China to compel currency revaluation or anything else, retaliation against U.S. exports is a given.
In short, imports are a determinant of exports. If you impede imports, you impede exports. So Pearlstein’s idea that we can somehow subsidize exports by taxing and reducing imports is not particularly well-considered. And though it may be tempting to look at China’s economic success as an endorsement or vindication of industrial policy, it is difficult to discern how much of China's growth can be attributed to central planning, and how much has happened despite it. But in the U.S., where one of our unique and core strengths has been the relative dynamism that has produced more inventions, more patents, more actionable industrial ideas, more freeedom, and more wealth than at any other time in any other nation-state in the world, it would be imprudent bordering on reckless to suppress those synergies in the name of industrial policy.
In the end, I rather doubt that Pearlstein is truly on board with the course of action he suggests. In response to a question presented to him on the Washington Post live web chat yesterday about how the Chinese would react if his proposal were implemented, Pearlstein wrote:
They'd make a huge stink. They'd cancel some contracts. They'd slap on some tariffs of their own. They'd launch an appeal with the World Trade Organization. It would not be costless to us -- getting into fights never is. But after a year, once they saw we were serious, they would find a way to begin accomodating [sic] us in significant ways, and if we respond with a positive tit for tat, things could finally improve. They've been testing us for years and what they discovered was that we were easy to push around. So guess what -- they pushed us around.
I’m willing to chalk up Pearlstein’s diatribe to pent-up frustration. But let me end with this admonition from that May Cato paper:
[I]ndignation among media and politicians over China’s aversion to saying “How high?” when the U.S. government says “Jump!” is not a persuasive argument for a more provocative posture. China is a sovereign nation. Its government, like the U.S. government, pursues policies that it believes to be in its own interests (although those policies—with respect to both governments—are not always in the best interests of their people). Realists understand that objectives of the U.S. and Chinese governments will not always be the same, thus U.S. and Chinese policies will not always be congruous. Accentuating and cultivating the areas of agreement, while resolving or minimizing the differences, is the essence of diplomacy and statecraft. These tactics must continue to underpin a U.S. policy of engagement with China.
The most interesting libertarian-related conversation I've read today comes from Rortybomb, by way of Andrew Sullivan, with commentary by Megan McArdle. Here's a challenge to libertarians from Rortybomb, aka Mike Konczal:
I want to pitch to the credit card and financial industry a new innovative online survey. It is targeted for older, more mature long-time users of our services. We’ll give a $10 credit for anyone who completes it. Here is a sense of what the questions will look like:
- 1) What is your age?
- 2) What day of the week are you taking this survey?
- 3) Many rewards offered are for people with more active lifestyles: vacations, flights, hotels, rental cars. Do you find that your rewards programs aren’t well suited for your lifestyle?
- 4) What is the current season where you live? Are any seasons harder for you in getting to a branch or ATM machine?
- 5) Would rewards that could be given as gifts to others, especially younger people, be helpful for what you’d like to do with your benefits?
- 6) Would replacing your rewards program with a savings account redeemable for education for your grandchildren be something you’d be interested in?
- 7) Write a sentence you’d like us to hear about anything, good or bad!
- 8 ) How worried are you you’ll leave legal and financial problems for your next-of-kin after your passing?
Did you catch it? Questions 1,2,4,7 are taken from the ‘Mini-mental State Examination’ which is a quick test given by medical professionals to see if a patient is suffering from dementia. (It’s a little blunt, but we can always hire some psychologist and marketers for the final version. They’re cheap to hire.) We can use this test to subtly increase limits, and break out the best automated tricks and traps mechanisms, on those whose dementia lights up in our surveys. Anyone who flags all four can get a giant increase in balance and get their due dates moved to holidays where the Post Office is slowest! We’d have to be very subtle about it, because there are many nanny-staters out there who’d want to coddle citizens here. . .
I smell money -- it’s like walking down a sidewalk and turning a corner and then there is suddenly money all over the sidewalk. One problem with hitting up sick people, single mothers, college kids who didn’t plan well and the cash-constrained poor with fees and traps is that they’re poor. Hitting up people with a lifetime of savings suffering from dementia is some real, serious money we can tap as a revenue source.
Clearly, only an evil person (or a libertarian!) would allow a scam like this one. Megan responds, I think rightly:
I'm not sure why this is supposed to be a hard question for libertarians. I mean, I might argue that preventing people from ripping off the marginally mentally impaired would, in practice, be too difficult. Crafting a rule that prevented companies from identifying people who are marginally impaired might well be impossible -- I'm pretty sure that if I wanted to, I could devise subtler tests than "What day of the week is it?" And while the seniors lobby is probably in favor of not ripping off seniors, they're resolutely against making it harder for seniors to do things like drive or get credit, which is the result that any sufficiently strong rule would probably have.
But it's pretty much standard libertarian theory that you shouldn't take advantage of people who do not have the cognitive ability to make contracts. Marginal cases are hard not because we think it's okay, but because there is disagreement over what constitutes impairment, and the more forcefully you act to protect marginal cases, the more you start treating perfectly able-minded adults like children.
The elderly are a challenge precisely because there's no obvious point at which you can say: now this previously able adult should be treated like a child. Either you let some people get ripped off, or you infringe the liberty, and the dignity, of people who are still capable of making their own decisions.
I'd add two responses of my own.
First, I can't believe there's all that much money to be had here. Anyone who wanders into Tiffany's and back out again without remembering what they bought is, generally speaking, a bad credit risk. Mildly irresponsible people -- those who slightly overspend, then have to make it up later -- those are probably great for creditors. Lesson learned: If you're not demented, don't be irresponsible. (If you are demented, you're not going to follow my advice anyway.)
Second, I am always amazed at how border cases are dragged out, again and again, as if they proved something against libertarianism. Border cases -- How old before you can vote? How demented before a contract doesn't bind? -- are a problem in all political systems, because all systems start with a presumed community of citizens and/or subjects. We always have to draw boundaries between the in-group and the outliers before we have a polity in the first place.
What makes the classical liberal/libertarian approach so valuable is in fact that it draws so few boundaries. Where other systems depend on class boundaries, race boundaries, religious boundaries, and so forth -- with annoying boundary issues at every stop along the way -- libertarians make it as simple as I think it can be. We presume that all mentally competent adults are worthy of liberty until they prove themselves otherwise.
The boundary cases are still there, but they are fewer and more tractable. Konczal just wandered into one of them. It proves much less than he thinks.
Further to Ilya Shapiro’s post this morning, let me also point you to a concise chronology of events culminating in the government’s robbery of Chrysler creditors.
The story is that of Richard Mourdock, Treasurer of the State of Indiana and the man responsible for stewardship of the state’s pension funds, some of which were victimized by the Obama administration’s pre-packaged and then forced-fed bankruptcy deal for Chrysler. I strongly urge you to read Mr. Mourdock’s testimony, which is at once revealing, sobering, compelling and, regrettably, a frightening sign of the times.
Mourdock will be speaking on this very topic at Cato, along with bankruptcy law expert David Skeel, on Thursday, October 15 at noon. Reserve your seat now.
Jeffrey A. Miron explains in Reason why a government bail-out of most everyone was neither the only option nor the best option:
When people try to pin the blame for the financial crisis on the introduction of derivatives, or the increase in securitization, or the failure of ratings agencies, it’s important to remember that the magnitude of both boom and bust was increased exponentially because of the notion in the back of everyone’s mind that if things went badly, the government would bail us out. And in fact, that is what the federal government has done. But before critiquing this series of interventions, perhaps we should ask what the alternative was. Lots of people talk as if there was no option other than bailing out financial institutions. But you always have a choice. You may not like the other choices, but you always have a choice. We could have, for example, done nothing.
By doing nothing, I mean we could have done nothing new. Existing policies were available, which means bankruptcy or, in the case of banks, Federal Deposit Insurance Corporation receivership. Some sort of orderly, temporary control of a failing institution for the purpose of either selling off the assets and liquidating them, or, preferably, zeroing out the equity holders, giving the creditors a haircut and making them the new equity holders. Similarly, a bankruptcy or receivership proceeding might sell the institution to some player in the private sector willing to own it for some price.
With that method, taxpayer funds are generally unneeded, or at least needed to a much smaller extent than with the bailout approach. In weighing bankruptcy vs. bailouts, it’s useful to look at the problem from three perspectives: in terms of income distribution, long-run efficiency, and short-term efficiency.
From the distributional perspective, the choice is a no-brainer. Bailouts took money from the taxpayers and gave it to banks that willingly, knowingly, and repeatedly took huge amounts of risk, hoping they’d get bailed out by everyone else. It clearly was an unfair transfer of funds. Under bankruptcy, on the other hand, the people who take most or even all of the loss are the equity holders and creditors of these institutions. This is appropriate, because these are the stakeholders who win on the upside when there’s money to be made. Distributionally, we clearly did the wrong thing.
It's too late to reverse history. But it would help if Washington politicians stopped plotting new bail-outs. At this stage, most every American could argue that they are entitled to a bail-out because most every other American has already received one.
While the majority of Chrysler's senior creditors sacrificed their fiduciary duties and caved into political pressure in accepting the Obama Administration’s pre-packaged bankruptcy of Chrysler, a small group of state pension funds in Indiana has challenged the Obama plan and is asking the Supreme Court to review said plan. As in the 1930s, the protection of contractual rights, one of the most basic pillars of a free society, along with the rule of law, is now in the hands of the Supreme Court.
As discussed in today’s Washington Post, these pension funds believe their rights were infringed by the Administration’s placing of junior creditors in a preferred situation to senior creditors. It doesn’t take Ms. Manners to remind us that cutting in line, whether in traffic, at the grocery store, or in a bankruptcy, is plain rude. To have the government re-order the line for you is even worse.
To re-build confidence in our markets, trust in our institutions must be re-stored. Not simply in our private institutions, but also in our government. If players believe the game is going to be rigged, fewer will be willing to play. And while the Administration has portrayed Chrysler’s senior creditors as nothing more than greedy speculators, the Indiana request exposes that myth. President Obama should clearly articulate why retired state employees, such as teachers and firefighters, should have their pension funds raided solely for the benefit of the auto unions. Here’s to hoping Indiana goes all the way in this Court.