GameStop and Bailouts

The ruling class is shocked, shocked, that gambling is going on at Robinhood, the stockmarket app that helped rocket failing retailer GameStop into the stratosphere and apparently ruined hedge fund Melvin Capital that had shorted GameStop.

Of course, for us deplorables this is all great fun, and "far-right" writer Vox Day, wants to go all the way and suggests

One thing is clear from all of this. The America public is not going to support another bank bailout once the next financial crisis begins. They'd rather see Wall Street burn, and rightly so.

Er, no. The trouble is that when Wall Street burns, we the people get nuked. Big time. As in the Great Depression, when the Fed failed to bail out the banks. As in the Great Recession of 2008-09, when Little Ben Bernanke failed to bail out Lehman Brothers.

Yes, I'd like to see the malefactors of great wealth taught a lesson they will never forget. But I don't want to be caught in the blast zone.

And as far as I can determine, it is just not possible to design the credit system so there is no chance of a meltdown.

Most credit, as far as I can see, is the anticipation of income in normal trade. Thus, a merchant borrows money against the sale of his merchandise at a future date. The question is: how much borrowing is safe? One hundred percent of the anticipated sale price? Fifty percent?

The problem is that, 99 times out of 100, borrowing 100% of the anticipated sales price is perfectly safe. Until the day that your ship gets wrecked, or the market price of the merchandise takes a tumble before you sell it.

Then, if the merchant doesn't have other resources, he is bankrupt and his creditors may go bankrupt and their creditors go bankrupt, and so on.

It is all explained in Walter Bagehot's Lombard Street. Everything is copacetic in the credit system so long as borrowers make their payments and that loans can be liquidated by selling the collateral. But if the borrower can't pay, or the sale of the collateral isn't enough to liquefy the defaulting loan, then you got trouble right here in River City.

Bagehot's Big Idea in Lombard Street is that the central bank should be the "lender of last resort." So when a financial institution goes broke the central bank steps in and buys it. Thus the illiquid debt of the defaulting institution is diluted in the capital of the central bank. But Bagehot recognizes a further risk. What if the central bank can't absorb the defaulting debt of the defaulter? Well, the answer is that the central bank is backed up by the state, and its ability to issue debt.

But what if the state doesn't have the capital or the "confidence" of the market? Like, say Venezuela? 

Exactly. That is why it is best to make sure that the credit system does not allow hedge funds and other reckless investors to put the whole system at risk. That is why an ordinary stock investor is only allowed to borrow 50 percent of a stock's value "on margin." That is why, back in the day, before the gubmint got into the act with Fannie Mae, Americans could only borrow 50 percent of the value of a home.

Yes but what if the Wall Street smarties have come up with another way of "laundering" low-quality debt like they did back in the 2000s with their derivatives and credit default swaps. It looked like a good idea until it wasn't.

That is probably the Big Problem. Wall Street smarties are always thinking up new ways of sailing too close to the wind. And usually, their folly is only discovered after it is too late, and the system is already in meltdown. This is what happened with default swaps and derivatives in the 2008 meltdown. It turned out that the financial legerdemain did not in fact make all those high-risk mortgage bonds into low-risk bonds. Oh dear.

That is why we are always going to need that "lender of last resort."

Here's the thing though, as you can see from my report on the 2008 bailouts. The biggest item was not the bailouts, of monies lent to weakened banks and financial mastodons. The biggest item was $16.9 trillion in guarantees for money market mutual funds.

Yeah. And the cool thing about the guarantees was that the Federal government didn't have to shell out a penny in debt or outlays. All that was needed to keep the money market mutual fund business going was the guarantee that the Feds would keep it lubricated. How cool is that?

Very cool, until our ruling class figures out how to take advantage of it.