Monday, May 12, 2014

In praise of bottom-feeders

A fascinating quote in today's Wall Street Journal: Warren Buffett to Tim Geithner just after the Bear Sterns bailout:
"I was sort of hoping you wouldn't do it, because then everything would have crashed and I would have been first in line to buy."
Buffett continued,
"It would have been terrible for the country, but I would've made a lot more money" 
Amen on number one. A's fire sale is B's buying opportunity. In the end, a lot of finance depends on flexible long-only money to come in and take risks when others are selling.

Absolutely wrong on number 2, Mr. Buffett. There is no more patriotic act an American sitting on a few billion dollars can perform, than to show up at a fire sale with a fat checkbook and a pen.


It would certainly have given courage to other wealthy investors, endowments, hedge funds, and sovereign wealth funds.

A bottom-feeders' frenzy might also have shown to the likes of Mr. Geithner the limits of constantly repeated stories of "no buyers," limitless "fire sales," "liquidity spirals;" the belief that that only highly-leveraged and panicky intermediaries set asset prices, so government must always bail out all creditors.

A good Bear Stearns failure might well have saved us from a bad Lehman failure.

19 comments:

  1. The story of "buyer of last resort" doesn't work if Buffet is there ready to buy at a good price.

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    1. But not quite as good as Geithner's price!

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  2. Are you sure Buffett's claim wasn't that the absence of any bailout would have been terrible for the country? Under that interpretation I am inclined to agree with him.

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  3. When Buffett said, "It would have been terrible for the country, but I would've made a lot more money," he may have meant the crash would have been terrible for the country--not his stepping in and making money.

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    1. Michael and Ben: Yes, I think I got the same interpretation -- and I'm suggesting that because he would have stepped in, it would not have been bad for the country. In fact it might have been great for the country by galvanizing the private bottom feeders.

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  4. Actually, Buffett did take advantage of the crisis, but as a rent-seeker, not a bottom-feeder. He took positions in troubled companies and then lobbied heavily for TARP.

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    1. A rent -seeker is a bottom feeder as his aim is to create a monopoly that aids only him and his gov cronies.

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  5. I like the point made by Joseph Stiglitz in his critique of HFT. Asking how much trading there should be, he notes that the social optimum allows traders to benefit from their information, especially when it is costly to produce. Perhaps you are making the same point.

    But I have little appreciation for bottom feeders if they are merely benefitting from financial frictions and their side effects, such as momentum and fire sales. We should try to eliminate those frictions, starting with the missing market for the savings of uninformed investors. In the current system, it is difficult to make naked bets on GDP, which leads people to save via housing or investment funds, many of which try to synthesize the market portfolio - because the asset that savers really need is not available. If it was available, and highly liquid, there would be fewer liquidity spirals - perhaps none. If we had a market for uninformed savers, then more of the trading in individual stocks would be based on information about those companies. Things might be even better if shares in the aggregate economy are used as the numeraire for stock prices.

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  6. "A good Bear Stearns failure might well have saved us from a bad Lehman failure."

    How do you figure? Lehman was going to fail no matter what happened to Bear Stearns. Lehman plowed a lot of leverage into soon to be worthless MBS. Then they sold the MBS portfolio on a REPO deal so they could buy even more MBS. When the REPO contract was due, Lehman had no way to make the payment. How could any policy vis-a-vis Bear Stearns have saved Lehman?

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    1. Saved us from bad, not from Lehman failure. I should have been clearer.

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  7. Doesn't make sense. Are you sure WB wasn't going to take losses in 09 and got saved by us gov.? This is Bear Stearns. He didn't know the extent of the problem

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  8. By this logic you must think the Lehman failure was a good thing, right? It seems to me to be a good thing that losses were allocated to where they should have been (equity, debt holders and not the tax-payer) but the knock on effects the the broader financial system (including raising costs of finance for solvent businesses) were net/net bad.

    The cost/benefit analysis is not so straightforward for finance as it is for other industries. I don't see much in the academic literature to help so a lot of the time this sort of argument comes down to priors. Yours are clearly laissez-faire but I don't see much here to convince me you are right..

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    1. Why do you have to pretend that financing is any different from other goods? The "bad" side of the equilibrium adjustment of rice prices to increased demand is that existing buyers have to pay higher prices for rice. No one complains about that (well except socialist morons, but assuming you aren't one)

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    2. It was the change in the cost and availability of mortgage financing (almost overnight, tirggered by a run on the shadow banking system) that re-priced housing markets, led to a collapse in their output and broader consumer confidence.

      Finance can trigger recessions in a way that other goods can't.

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    3. Abir,

      Debt is different than other goods. Its nominal price is protected by a legal system (bankruptcy law). The price of other goods is generally not legally protected unless the government invokes cost controls or supports (also known as socialism).

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    4. This comment has been removed by the author.

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  9. The World tried this in 1929, setting in motion the events leading to WWII and more than 100 million deaths. The argument made is not even wrong (Pauli); worse it is myopic. Who knows what countries and what destabilization would have followed.

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    1. How is it "not even wrong"? As far as I can tell, you would view it as simply wrong.

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    2. It's a serious stretch to atttribute WW2 purely or largely to 1929's aftermath. Germany's disastrous hyerinflation rpeadtes it, for isntance. Not to mention the VersaillesTreaty, fall-out of the Bolshevik revolution, etc. The liquidationist approach that Prof. Cochrane advocates is not politically realistic, I think, at present, but from a suppyl-side economics standpoint, it worked pretty adequately in the "long 19th century".

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