Nobody, including the supporters, seems very happy about it. Even in the Senate, where the deal was forged and the bill passed on Wednesday, everyone seemed to insist that given a little time, the relevant committees could have crafted a far better proposal. Secretary Paulson’s approach benefited from well-chosen timing: as the first past the post when the crisis arose, it became the model around which all debate was focused.
But now that it’s law (in a revised version), we seem to be stuck in a perplexing and anticlimactic moment. We’re groping blindly through history, unable to return to the status quo ante, but equally unable to point to any desirable future. Thus the big question remains…
Will It Work?
The most pressing issue is whether this bailout will solve the problems at hand—stabilize the credit markets, and keep the wheels of the economy turning at least well enough to prevent the need for yet another “rescue” down the line. I’ve continued to do a lot of reading and research: this is not an issue where reacting from the gut serves any purpose. So far, in Washington and on Wall Street, there’s lots of hope but little confidence.
For one thing, $700B simply may not be enough. Remember that the real heart of the problem here isn’t shaky mortgages, but the layers upon layers of leveraged debt that Wall Street has piled on top of those mortgages—tens of trillions worth. The housing market was just a bottom card in the house of cards that’s now crumbling. But even looking just at the housing market, this bill offers little hope of stability in the near term, illustrating why those who still call this a “subprime crisis” are behind the times:
Compared to the size of the Alt-A, Pay Option ARM, Second Mortgage and Jumbo Prime universes, Subprime is miniscule. With prices down so much in such a short period of time, most that bought, refinanced with cash out, or put a second mortgage on their property since 2002-03 in these ‘higher’ paper grades suddenly find themselves stuck in their homes without the ability to refinance or sell. …
…[If] this new $700bb bailout is suppose to clean up banks past troubles, what is left for the potential $1tt in current defaults coming over the next two years? This plan is being debated today in Washington as if mortgage and housing crisis was over and they are trying to clean up the aftermath. I am sure many there really think this is about the real estate market.
Perhaps this program will grease the wheels, everyone will begin lending again and home values will soar making it so home owners can freely sell or refinance. But given the data I see daily, I am betting against that. The problem is, anything short of physical real estate being a liquid asset once again or an across the board principal balance reduction and new terms on every loan in America, and the housing crisis remains front page indefinitely as the negative equity feedback loop continues and more borrowers are forced into loan default each month.
Meanwhile, as far as the capital markets go… the Treasury plan passes the risk of toxic assets on to the taxpayer and pulls firms back from the brink of collapse, but it can’t force banks to resume normal lending, which they won’t do unless they trust each other’s balance sheets. (The Fed has already reached the limits of what it can do to loosen the money market, but it hasn’t worked—and none of this would be necessary if it had; lenders haven’t responded, and LIBOR has hit record highs.) There’s a very delicate problem here: if Treasury buys assets at prices high enough to recapitalize participants and stabilize those balance sheets, the taxpayer is likely to take a bath; if it buys at substantially discounted “auction” prices (as one might expect for a buyer of last resort), the hole in the balance sheets remains, and credit stays frozen. There may be some price level that avoids both problems, but it’ll be different for each institution and set of assets, and finding it will be anything but simple.
Furthermore, the bill itself does little to assuage any of these concerns. It’s a somewhat better bill than the carte blanche version Paulson originally proposed, but not as much as its defenders would have us believe. A supposed-to-be-secret-but-this-is-the-Internet-age conference call on September 29 between Treasury and selected financial services industry execs makes it fairly clear that the “improvements” to the bill are more rhetoric than substance: the oversight provisions are mostly toothless; the tranching can easily be sidestepped; the limits on executive compensation won’t have clawback provisions and simply won’t apply in most circumstances; and Treasury describes its approach to asset pricing (the “delicate problem” described above) as a “balancing act”—one which the bill does nothing to clarify, even allowing purchases at full book value, leaving open the possibility of “sweetheart deals.”
As for taxpayer protection, the bill authorizes but does not require the Secretary to sidestep asset purchases and instead conduct direct capital injections in exchange for preferred shares (a simpler approach many economists prefer, akin to what was done with AIG). The public will get warrants (i.e., options) from most participants, but not actual shares; this allows for possible later recoupment, but gives the government less power over management (as the industry prefers, of course), and Treasury has “broad discretion” over the amount of warrants demanded.
So all told, at best, this bill may help lubricate the credit markets enough to prevent a complete economic catastrophe, if we’re lucky. We may get our money back in the end, if we’re even luckier. (On the other hand, it may not so much stop the bleeding as slow it to a trickle that lasts for years, as happened in Japan in the 1990s.) But even in a best-case scenario, no one pretends that it will prevent the deepening recession that everyone now admits we’re sliding into.
What Else Should Be Done?
Hard times are upon us. The dangers of unregulated capitalism have never been so painfully clear in living memory. Neoliberal economics have been thoroughly discredited, and we will likely never have a better chance to end its undeserved dominance and restore some democratic controls. And everyone agrees that this bill alone is no solution to our larger economic problems, leaving many tasks ahead: when the Congress returns next year under a new president, therefore,
…Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, said lawmakers will “do some serious surgery on the financial structure.”
It won’t be easy. For one thing, the right wing will attempt (as it always does) to sidestep responsibility, redirect the blame and retrench its own power. Already, the usual suspects—from Rush Limbaugh to Fox News to the Wall Street Journal—have attempted to blame the victims, castigating minorities and the poor, and, of course, “liberals” who attempted to ease the path to homeownership. They point fingers at the 1977 Community Reinvestment Act, as if an effort to end redlining and promote affordable housing 30 years ago somehow precipitated the abuses of the past eight years. The truth, of course, is far different:
…none of the reactionary cranks making this argument has seen fit to present even a single, solitary piece of statistical evidence to support their scapegoating of CRA. Evidence doesn’t matter. Simply saying it, simply insisting that it’s the black and the brown and the poor who are to blame is supposed to be enough. Sadly, for lots of Americans it will be…
First, the Community Reinvestment Act only applies to banks and thrifts that are federally-insured. This means that the independent mortgage brokers, who are responsible for half of all the nation’s sub-prime lending–and who have been writing such loans at more than twice the rate of banks and thrifts–aren’t even covered by the law. And make no mistake, it was the hand of the mortgage broker, more than any other, that precipitated the housing bubble. These are folks who were writing “stated income” loans (which means you don’t have to prove your income, you can just tell them a number and get the OK), not caring about whether the borrower might default, since they were going to turn around and dump the loan at a profit, onto the secondary market, by pawning it off to investors who were gobbling up debt, betting on the further expansion of home values. In this scenario, neither the original broker nor the investor who bought up the debt was concerned about what would happen to the borrower who took out the initial loan. After all, if a borrower defaulted, but the housing market was still going up in value, they could swoop in, foreclose and sell the house again at a profit.
On neither end of this equation were poor people to blame. The persons getting stated income loans were overwhelmingly middle class, perhaps hoping to keep up with the richer folks down the block, but certainly not the poor. Most poor folks are still renters, or just hoping to get a modest home. And let it suffice to say that none of the vultures snapping up the mortgage debt on the secondary market were poor, and very few were persons of color. These were affluent white people, willing to gamble on the potential misfortune of others.
…Looking at CRA-related loans, for instance, the fact is, these represent nearly one-fourth of all loans written, but less than 10 percent of the high-cost, high-risk loans that precipitated the current crisis. These loans actually have lower default and foreclosure rates than non-CRA connected loans, and are twice as likely to be retained in the portfolios of the banks that originated them than other loans. In other words, it is not CRA loans being dumped into the hands of greedy speculators, and then falling flat, taking the economy with them.
Finally, to the extent low-income folks of color are shuttled into the sub-prime market, and then unable to pay their house notes, this unhappy fact owes more to discrimination than anti-discrimination efforts such as CRA. As several studies have shown, banks often reject borrowers of color, even when they have credit records similar to whites with the same incomes. Then, these rejected applicants are steered towards sub-prime lenders which charge far higher interest and place the borrowers in great jeopardy by driving up the amount they must repay.
Worse, and more threatening, is the perception that the government may simply be hobbled by debt, unable to take more proactive steps to bolster the economy, much less launch new policy initiatives. Already, the recent presidential and vice-presidential debates have asked the candidates what initiatives they would be willing to sacrifice to “pay for” the bailout. Grover Norquist must be grinning to himself at the prospect of fulfilling his old goal of “drowning the government in the bathtub”… and even more at the prospect of pinning blame on the Democrats for the public pain and suffering that will infect the next several years.
We must not be deterred. We must not be paralyzed into inaction either by misplaced blame, or by a misplaced urge toward austerity.
It is important to remember where the real blame falls: on the 30-year Republican mania for deregulation, taking the refs out of the game and allowing the players to rig the results. It falls on the Commodity Futures Modernization Act that Phil “nation of whiners” Gramm helped shepherd through the Senate without debate in 2000, exempting credit defaults swaps and other derivatives from regulatory oversight. It falls on the 2004 SEC decision, spearheaded by Hank Paulson when he was still at Goldman Sachs, that exempted big investment banks from capital reserve requirements.
There are several important reforms and regulations that the new Congress and the incoming administration should make high priorities. I’ve already written of the need to restore capital reserve requirements, force disclosure of internal valuation models, and create an exchange-based trading platform to allow questionable assets to find a value and unwind overleveraged balance sheets; of the need to install a HOLC-style agency to restructure underwater mortgages and minimize future defaults.
In addition to those steps, there are many other sensible ideas I’ve seen proposed by multiple experts, including the following:
- Tax speculators. A tax of as little as 0.25 percent on securities transactions (as used today in the U.K. and Taiwan, and in the U.S. until 1966) would generate $100-150 billion per year of revenue, and have the additional salutary effect of discouraging short-term market volatility and encouraging longer-term investment based on fundamentals.
- Restore credibility to credit ratings. Stop letting comanies choose their own auditors and credit-ratign agencies (with all the conflicts of interest that brings), and let the SEC assign those responsibilities on a random basis.
- Increase transparency. Any and all steps taken by the Treasury department—and by any companies it helps rescue—should be fully disclosed to Congress, and to the public, at all times.
- Help states and municipalities. As property values fall, local tax revenues fall as well, as the current crisis in California makes clear. Federal revenue sharing would ease this burden.
- Reduce risk by spreading it. The ongoing consolidation of the financial industry is a step in the wrong direction; any companies that are “too big to fail” should be broken up.
- INVEST IN INFRASTRUCTURE. This may be the most important step. It’s abundantly clear now that you can’t run an economy on consumer debt and low wages. We need a program akin to the Depression-era RFC to inject life into the real, productive economy. Create jobs and save money by helping America bring its transit systems and public facilities and telecom up to par with the rest of the developed world. Support R&D into alternative energy, and the business models that can support it. Build a sustainable environmental infrastructure. And, yes, reform health care coverage. These are the steps that will really help the “Main Street” economy recover, and they deserve at least as much of a financial commitment as is currently being devoted to rescuing Wall Street.
Finally, allow me to offer a humble proposition: Nobel Prize-winning economist Joseph Stiglitz would be a superb candidate for the next Secretary of the Treasury.Tags: bailout, economy, financial crisis, Paulson, Stiglitz