corporate “raider/traders”…

Posted on Friday 6 March 2009


The Art of Looting and Tunneling
the left coaster

by eriposte

As the search for AIG’s counterparties continues, it’s worth remembering what AIG and the rest of the Too Big to FailTM gang did in the last few years. For that we turn to the abstract (emphasis mine) of the 1994 paper by George Akerlof and Paul Romer:
    Looting: The Economic Underworld of Bankruptcy for Profit

    During the 1980s, a number of unusual financial crises occurred. In Chile, for example, the financial sector collapsed, leaving the government with responsibility for extensive foreign debts. In the United States, large numbers of government-insured savings and loans became insolvent – and the government picked up the tab. In Dallas, Texas, real estate prices and construction continued to boom even after vacancies had skyrocketed, and the suffered a dramatic collapse. Also in the United States, the junk bond market, which fueled the takeover wave, had a similar boom and bust. 

    In this paper, we use simple theory and direct evidence to highlight a common thread that runs through these four episodes. The theory suggests that this common thread may be relevant to other cases in which countries took on excessive foreign debt, governments had to bail out insolvent financial institutions, real estate prices increased dramatically and then fell, or new financial markets experienced a boom and bust. We describe the evidence, however, only for the cases of financial crisis in Chile, the thrift crisis in the United States, Dallas real estate and thrifts, and junk bonds. 

    Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Sounds like a good description of what we’ve seen play out more recently, although the "underworld" operated quite openly. Simon Johnson at Baseline Scenario observes that given the current trajectory of the Obama Treasury department, the looting will be followed by tunneling – "borderline legal/illegal smuggling of value out of businesses". He concludes:
    Confusion in policy breeds disorder in companies, and disorder leads to the loss of value. This is the reality of severe crises wherever they unfold; we have not yet reached the worst moment. And, of course, there are many more shocks heading our way – mostly from Europe but also potentially from Asia.

    The course of policy is set.  For at least the next 18 months, we know what to expect on the banking front.  Now Treasury is committed, the leadership in this area will not deviate from a pro-insider policy for large banks; they are not interested in alternative approaches [I’ve asked].  The result will be further destruction of the private credit system and more recourse to relatively nontransparent actions by the Federal Reserve, with all the risks that entails. The road to economic hell is paved with good intentions and bad banks.
Now tell me the bad news.
Not that any of us have any more room in our minds for bad news, but this little piece by eriposte is the answer to a question. The question is, "Why can’t economists give us useful models to help us predict the economy?" The answer is that our current  free-market fundamentalist economy is filled with people studying it endlessly to find the holes to drain money out of it. Whatever it is today will change tomorrow in response to any intervention. In the world of "techies," antivirus companies hire virus writers to find the holes to plug. Maybe we need a think tank of corporate "raider/traders" to help us figure out what’s going on.
  1.  
    Carl
    March 7, 2009 | 1:11 AM
     

    “The company, bogged down by the legal fees over the FTC challenge, had posted a drop in first-quarter profit that wasn’t as bad as Wall Street had expected.”

    The Federal Trade Commission has pursued the case of Whole Foods for at least the past TWO years. They are concerned perhaps that the market for organic sour cream will be cornered and that the fat cats at Whole Foods will wind up dominating the free markets of the world with their pernicious brand of organic hippie pinko communistic socialism. How much did Bernie Madoff make off with in the past couple of years? Do you remember the criminal CPA from Enron who cut a deal in exchange for leniency?….Andrew Fastow his name was….about to be sprung out of jail just months after his co-conspirator spouse….assets untouched except for the usual market movements….so the 50 million that he socked away being criminal is probably worth as little as 25 million if he had it all in the typical 401k . Economists are academics in ivory towers. It’s the Fastows of the world that are calling the shots and moving markets.

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