The $100 billion Term Asset-Backed Loan Facility is a reprise of a program launched in 2009 that enabled investors to buy bonds linked to consumer and business debt using money borrowed from the Federal Reserve. The central bank and other supporters say the program, known as TALF, helped unfreeze credit markets vital to the workings of the economy.
If it works as intended, TALF will jolt the market into reviving the issuance of new bonds, which spreads risk to investors and allows lenders to continue making loans. On the other hand, the Fed could face criticism for helping to super-charge returns for some of the biggest investors at a time when millions of Americans are losing their jobs as a result of the coronavirus pandemic.
In short, at a time when ordinary individuals and small businesses are getting only partial relief, these Wall Street activities will get a complete bailout. Moreover, this rewards the kind of behavior that Anti-fragile Arnold hates: financial engineering that results in privatized profits and socialized risks.
In Specialization and Trade, chapter 7, I explain the role of financial intermediation in the economy. On p. 105, I give a concise statement.
As households, we wish to hold safe, short-term assets and to issue risky, long-term liabilities. Financial interediaries accommodate that desire by doing the opposite.
As financial intermediaries expand, households and firms can engage in more economic activity. When they have access to credit, consumers can buy more durable goods, such as cars, and businesses can build more hotels and buy more airplanes. In good times, this works well.
But as financial intermediaries expand, the economy becomes more fragile. As households and businesses build up debt, they become more vulnerable in a downturn.
But the biggest increase in fragility is concentrated in the financial sector itself. Banks and other financial firms do really well when times are good, but they can collapse when things don’t go well.
As a society, we want the “right” amount of financial intermediation. Too little, and the good times are restrained. Too much, and in bad times the adverse effects get multiplied and bank bailouts take place at the expense of the general public.
In my view and in the view of others (I am sure that John Cochrane is on my side here), we have been erring on the side of too much financial intermediation with too much moral hazard. To be rewarding that behavior now and encouraging more of it in the future makes Anti-fragile Arnold angry.
We have institutionalize moral hazard a long time ago. We know this because we cycles on a semi-repeatable basis. Without the big investment banks the Senators are completely hopeless on budget management. So we have a value net that lings government debt. Been this way since the founding.
To make clear what is going on, these securities include subprime auto and student loan backed paper. Never mind underlying assets may be bad or perhaps even in default.
FYI, the “Specialization and Trade” link goes to “Three Languages of Politics.”
fixed. thanks
In the Temple of Orthodox Macroeconomic Theology, the hoary totem “Moral Hazard” has been curtained-off.
When convenient, the curtains will be withdrawn.