Comments (17)

• David Roemer

  Thank you for explaining what the bailout is. What is missing from your analysis is why there is so much government interference. Doesn't everyone now know bankruptcy and capitalism are good? Nobody wants a planned economy. Everyone was against the recent farm bill.

  Published: October 28, 2008 9:45 AM

• Mike Tabony

  Sirs,

  I am continually surprised and disappointed that you support the present capitalistic system we have in the US without the slightest mention of the "naked shorting" of stocks allowed by the present SEC. I can find no better description of this practice than "counterfeiting of stock certificates". Recently several of the hedge funds have used this technique (creating supply) to pound the stock price of certain companies so low that the companies had to declare bankruptcy. These practices have no place in any economic system; in fact they will destroy the trust that holds an economic system together. Yet the Mises Institute has nothing to say.

  As I said I'm continually surprised and disappointed.

  Published: October 28, 2008 9:56 AM

• David Walker

  Thank you, Captain Obvious.

  I have some massive callouses and bruised cuticles from honest, hard work. The government and Wall Street types like Al Gore could use about five years of planting their own sustanence, getting re-acquainted with the agrarian roots of our once free nation.

  When will we finally learn that beseeching government to take care of the problems we cause IS the problem?

  Published: October 28, 2008 9:57 AM

• Scott Fox

  A great article for newcomers like myself. The plain language and clear logic is appreciated.

  Published: October 28, 2008 10:17 AM

• Jacob Steelman

  I take exception to the author's thesis that it is somehow praiseworthy to go bankrupt - it is not.
  Bankruptcy laws are acts of state intervention to allow individuals and companies to avoid payment of their debt obligations. Far from attempting to take care of stockholders as much as possible (as the author suggests) bankruptcy laws are designed not for stockholders protection but for the protection of creditors - secured and unsecured creditors and then preferred shareholders ("silent" stockholders). Bankruptcy laws for corporations generally allow for reorganizations - attempts to restructure debt and equity in order to maintain viability of a company and its continued operation. If the reorganization is not successful then liquidation of the company takes place. When companies reorganize they are allowed to continue operations but usually burdened by much less debt. This allows such companies to frequently have a competitive advantage such as happened in the telecom industry in 2001-2002 following the Global Crossing bankruptcy. Soon a large number of the fibre optic telecom companies were forced to declare bankruptcy in an effort to remain competitive and attempt to continue to operate under reorganization. Tens of billions of dollars of shareholder value were wiped off the books as were tens of billions of dollars of bondholder and creditor value wiped out as well. There is nothing praiseworthy in hiding behind the state to remove a company's or individual's obligation to repay its debt to its creditors. Bankruptcy laws should be abolished as should any other state intervention in the economy. Companies who are no longer able to continue operations should be liquidated and the remaining assets used to pay off creditors, preferred shareholders and if any assets remain, common shareholders.

  Published: October 28, 2008 10:19 AM

• Michael A. Clem

  Be careful. Isn't there a difference between company bankruptcies and personal bankruptcy?

  Published: October 28, 2008 10:21 AM

• Greg

  Bankruptcies are basically a state sponsored rip off the the public. Just look at US Air! Furthermore, it is not responsible for the current downturn, nor is allowing it going to get us out of our condition. The problems and solutions are a little more involved than one can put into a blog response, but Mike is close to the root cause with the naked short selling issue.
  Each financial, investment and insurance company must maintain a specific capital reserve based on the quality of their investments or loans. As the markets became stressed, so did their reserves, but they could still manage them. Then came the naked short sellers that targeted these firms one by one. As their stock price fell, rating agencies downgraded their firms. It was these downgrades that required the firms to increase their reserves and over night, they had to come up with cash. The only way to get this cash fast was to sell assets which started the tumble in the markets.
  Other problems such as over leverage, over speculation and explosion of trading markets helped to cause this problem. And the solution is a protection of property rights of everyone that owns part of a company.

  Published: October 28, 2008 11:16 AM

• eli cryderman

  @ Mike Tabony re: short selling

  please take a minute and read these articles on short selling and see if your opinion on the act remains unchanged.

  http://mises.org/daily/3066
  http://mises.org/daily/2527
  http://mises.org/daily/3139

  Published: October 28, 2008 11:42 AM

• eli cryderman

  Care to provide any evidence as to the following two claims? which hedge funds? which companies were targeted? which firms were targeted? I am very interested and I'm sure other parties would be too (SEC perhaps?). If fraud is being perpetrated, let it be prosecuted.

  "Recently several of the hedge funds have used this technique (creating supply) to pound the stock price of certain companies so low that the companies had to declare bankruptcy."

  "Then came the naked short sellers that targeted these firms one by one."

  Published: October 28, 2008 11:50 AM

• Greg

  Eli
  You need to go further into the mechanics of option trading. You can buy a put at a specific strike price that is driven by the supply (people that control shares that they are willing to sell an option against) and the demand (people that want to buy the option to aquire the shares at a lower price and sell them back at the higher strike price). If the demand for these puts go up or the supply goes down, these puts get more expensive. Now throw in a naked short which is not backed by shares is outside the supply and demand structure making it easier for people to target a specific company.
  Operating outside the supply and demand structure causes huge swings in the price of a stock. For example, today Porsche announced they are going to purchase VW. The short position was so large that when they started to cover their shorts, they pushed the price up to $1,200 a share briefly making VW the largest company in the world in market cap. If those shorts had to operate within the actual supply of shares avaliable for shorting, the price would have held down the number of shorts. While the price going up on the surface is good, there is more people getting screwed by the fluctuation than those that benefit. Such is the world of buying options, 10% winners, 90% loosers.

  Published: October 28, 2008 12:05 PM

• Charleston Voice

  How do a people prevent deadbeats and non-property owners from voting themselves a living?

  Published: October 28, 2008 12:23 PM

• Riz Din

  Not only did the government 'assist' the public with subsidised mortgages, but many states also seem to have effectively underwritten these purchases with incentive skewing, non-recourse loans. I'm pretty amazed at these semi-free options for buyers as there is nothing of the sort in the UK and other countries, at least as far as I am aware. I'd be interested if anyone in the know could provide brief comment on how easy it is to walk away from a property if it is underwater and whether these non-recourse rules are going to change going forward.

  Published: October 28, 2008 12:25 PM

• eli cryderman

  Greg,
  Thank you for your response, although the question still remains; which companies or firms have been targeted for bankruptcy? it seems that VW might have, but (possibly) due to the information provided by all the puts (and many other factors) Porsche saw an undervalued asset (VW) and gobbled it up, effectively beating the naked short sellers to the profit, forcing them to cover. in my opinion, you have unwittingly made the case for the legitimacy of short sellers in your VW example. What is VW's price per share now? Who gambled on information and what happend?

  "Now throw in a naked short which is not backed by shares is outside the supply and demand structure making it easier for people to target a specific company." Like, target a specific company that is severly over valued? what is the harm in this? If prices are 'manipulated' down even when their true value is much higher, why doesn't a savvy trader pick up the stock at a bargin, disallowing further devaluations and reap the benefits on the rebound? And if the stock really is overvalued, why can't the short position profit from his correct recognition of this fact? From the first article I linked:

  "Traders aren't stupid. They understand the possibility of manipulative schemes, and can take defensive actions accordingly. For example, if a trader believes someone else is engaging in a "short and distort" operation, he can buy the stocks on the cheap, preventing them from falling significantly in price."

  Did you bother to read any of the three articles I previously linked? I suggest you do and then we can continue the discussion thereafter. I am by no means an expert and may no be making the most informed case (hence the linked mises.org articles), so if anyone out there has a better grasp and can make points more clearly than I, by all means, go ahead.

  Published: October 28, 2008 1:13 PM

• george

  Bankruptcy is a good thing it is a recognition of an ugly and painful REALITY. Creditors and Debtors both need discipline bankruptcy provides this. Government at its core is the removal of discipline. In the case of the current bankruptcy, law courtesy of the Bush administration, chapter 7 has largely been eliminated for consumers. This has the effect of making the government the collection agent for Visa/MasterCard, among others. Lenders are every bit to fault as debtors in the current mess. Government has exacerbated this problem by protecting creditors that did nothing more than belly up to the discount windows and loan money to bad risks without having to pay the price for their misdeeds: Wachovia and WaMU are prime examples of this malfeasance. As Americans saw executives were looting the company through perks, bonuses, salaries and parachutes while the result of their policies were devastating communities, families and ultimately the whole credit infrastructure. The truth is most consumers do not need consumer credit it is an enticement to buy something they really do not need, when they cannot afford it (pay cash), for the benefit of a manufacturer and their allies the hogs at the Federal Reserve discount window.

  Both sides of this system creditors and debtors need the discipline of bankruptcy. The gov't, the most irresponsible borrower of all, is not the correct place to find any solutions other than no more borrowing, which could be the end result of the current debacle which in he long run may be a good thing.

  Published: October 28, 2008 4:23 PM

• Sharon Smith

  Thanks for the simple version. Why does government want to do all these things for us? That is how Politicians buy our votes and keep their power...making some people feel like they are getting "benefits" from the government keeps them voting the same ol' same ol''s into office.
  

  Published: October 28, 2008 9:38 PM

• David Carlson

  Sharon - so true. When politicians campaign, the easy sell is that they are going to DO this or that, they are going to help you out in this way or do this for these people. Then when they are in office, they want to DO something for people so that people get the false impression that what the government is doing is truly best for America. Politicians voted for the bailout to hedge their bets and hope that people think they did the 'NECESSARY' thing, but of course they "don't like the bill" but it was 'necessary.'

  What i think is necessary is for politicians to get into office who are going to DO something, but that something is slash the size of government, get rid of the income tax, change foreign policy, end the war on drugs, and generally just decrease the size of government and protect US from the government!

  David Carlson
  http://www.davidcarlsonpolitics.com

  Published: October 28, 2008 11:13 PM

• Steve Stip

  "Banks make money by borrowing from lenders at a low interest rate and lending to borrowers at a higher interest rate."

  Uh, wait. Don't banks create money out of thin air for the loans they make and then charge interest for it? It must be hard to lose money under those circumstances.

  Why shouldn't borrowers repay their bank debts with thin-air?

  Published: October 30, 2008 6:37 PM