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So, Congress passed the bailout financial rescue bill on Friday. 58 House members changed sides, and it sailed through… although both support and opposition remained genuinely bipartisan.

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…

What next?

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Tags: bailout, economy, financial crisis, Paulson, Stiglitz

So, what did John McCain accomplish with his grand gesture, as he swept into Washington Thursday to “help” his colleagues in Congress work out a deal on how to approach the economic crisis? Well, he went to the high-profile meeting he’d insisted that Bush call, at which…

…he sat silently for more than 40 minutes, more observer than leader, and then offered only a vague sense of where he stood, said people in the meeting.

Meanwhile, the tentative deal Congressional leaders had already announced that morning dissolved around him. (The “Agreement on Principles” Senate Banking chair Christopher Dodd had released was far from perfect—including nothing at all on how to value the “toxic” corporate assets, nor on what sort of new regulations are necessary—but it did include valuable progress on formal oversight of the process, on taking equity shares in return for public funds, and on limiting executive compensation, all steps in the right direction. Of course, at last report, Bush was still threatening to veto any bill with that last item in it.)

From all reports Sen. Obama took a more active role in the discussion than did Sen. McCain. The real obstacles, however, came from the House Republicans, seeing an opportunity to distance themselves from Bush on an unpopular measure. At what cost? Well,

According to one GOP lawmaker, some House Republicans are saying privately that they’d rather “let the markets crash” than sign on to a massive bailout.

“For the sake of the altar of the free market system, do you accept a Great Depression?” the member asked.

And needless to say, the Democratic leadership isn’t about to let any version of the Bush/Paulson plan reach the floor unless the GOP is backing it. Even though Hank Paulson reportedly went down on one knee and pleaded with Nancy Pelosi.

So what was the takeaway? Well, after the meeting McCain’s campaign issued a statement saying,

“We’re optimistic that Sen. McCain will bring House Republicans on board without driving other parties away, resulting in a successful deal for the American taxpayer.”

Yet somehow, at the same time, McCain’s friend and ally…

[Sen.] Lindsey Graham of South Carolina – said Thursday night that McCain joined House Republicans in opposing [the compromise] proposal.

I guess where McCain stands is anybody’s guess at this point. Maybe McCain will show up to explain himself in Mississippi tonight. Or maybe not.

—

Meanwhile, just to keep the pot boiling…

In a move initiated by scholars from the University of Chicago, 166 economists from across the political spectrum, including three Nobel Prize winners, released an open letter opposing the Bush/Paulson plan, criticizing its fairness, its ambiguity, and its long-term effects. Of particular note is this remark:

“I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,” said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.

That’s a sobering thought—that Paulson and his former industry colleagues may be deliberately spreading FUD to save their own hides.

Then again, lest we grow too cynical, there’s ample evidence that things really are growing worse, not just on Wall Street but on “Main Street” (and as an aside, I’m already torn between appreciating the frequent use of that metaphorical contrast as a sign of growing public awareness of American class conflict, and being sick to death of its sheer repetitiveness and mind-numbing lack of imagination). But, the point: as the New York Times reports, mortgage lending and small-business credit has already entered a “lockdown”:

For nonfinancial firms during the first three months of the year, the outstanding balance of so-called commercial paper — short-term IOUs that businesses rely upon to finance their daily operations — was growing by more than 10 percent from a year earlier, according to an analysis of Federal Reserve data by Moody’s Economy.com. From April to June, the balance plunged by more than 9 percent compared with the previous year.

This week, the rate charged by banks for short-term loans to other banks swelled to three percentage points above the most conservative of investments, Treasury bills, with the gap nearly tripling since the beginning of this month. In other words, banks are charging more for even minimal risk, making credit tight. …

[In one midwestern city], as people try to refinance mortgages to hang on to homes and extend credit cards to pay for gas for their job searches, the local credit union is saying no.

And as you’ll surely have heard before reading this, the big news last night was that Washington Mutual went under. The nation’s biggest S&L became the biggest bank failure ever, as it was taken over by the FDIC and promptly sold off to JPMorgan Chase at fire-sale prices. (Customers, of course, are assured that business will go on as usual. At least one lesson learned in the Depression seems to have stuck.)

What are the side effects from all this? Well, even without a bailout—but possibly even moreso with one, given the effect on the Treasury—the rest of the world (i.e., the countries that buy our bonds and pay our bills) is getting more than a little nervous. The news from China late Wednesday was that Chinese regulators had told their banks to stop lending to U.S. financial institutions; by Thursday the Chinese government was categorically denying the report; yet by late Thursday, after the WaMu news broke, it was announced that “China’s banks are limiting foreign- exchange transactions with U.S. and European financial companies on concern tighter global credit markets will cause more failures.” Make of it what you will. Meanwhile, the German Finance Minister has accused “Anglo-American capitalism” of “endangering global stability,” and warns that “the US will lose its superpower status in the global financial system.”

Certainly, it’s not hard to imagine that if our foreign creditors lose confidence and decide to cut their losses rather than continuing to prop up U.S. capital markets, then in order to keep the country nominally solvent in the face of massive federal deficits (made even larger by the bailout under discussion), the Fed would have no choice but to monetize the debt (read: print money in very very large batches). At which point the dollar would stop being the global reserve currency, its exchange value would drop through the floor, inflation would skyrocket, more banks would fail, more jobs would disappear, and American standards of living would quickly evoke the 1930s.

The Bush years have vividly shown us the logical endpoint of the mania for deregulation begun in the Reagan era. Play the game without a ref, and everybody winds up getting injured.

Yeesh, and I started out thinking that this would just be a quick “news survey” post. Interesting times, indeed…

Tags: bailout, economy, George W. Bush, McCain, Paulson

As the credit crisis evolves, the administration seems to be having a problem keeping everyone on the reservation in terms of talking points, and it’s not exactly doing much to bolster Treasury Secretary Henry Paulson’s credibility as the Wise Head who will Save Us All. For instance, Forbes reports…

…some of the most basic details, including the $700 billion figure Treasury would use to buy up bad debt, are fuzzy.

“It’s not based on any particular data point,” a Treasury spokeswoman told Forbes.com Tuesday. “We just wanted to choose a really large number.”

Doesn’t that just fill you with confidence? But maybe this will help: Roll Call reports that…

White House Deputy Press Secretary Tony Fratto… insisted that the plan was not slapped together and had been drawn up as a contingency over previous months and weeks by administration officials. He acknowledged lawmakers were getting only days to peruse it, but he said this should be enough.

How many months might that be? Because as recently as May 16, according to the AP…

[Paulson] predicted the economy will be rebounding by the second half of this year. …

“In my judgment, we are closer to the end of the market turmoil than the beginning,” he said. “Looking forward, I expect that financial markets will be driven less by the recent turmoil and more by broader economic conditions and, specifically, by the recovery of the housing sector.”

Clearly, whether Congress chooses to “peruse” the situation quickly or slowly, Henry Paulson is simply not the guy in whom we should place our trust to deal with it.

Tags: bailout, economy, Paulson

So the word is that Bush is planning a prime-time address to the nation tonight about the financial crisis. Better late than never in terms of talking to the public, I suppose, but I think it goes without saying that whatever he has to offer might just as well go without saying. His credibility these days is somewhere south of the average late-night infomercial host, after all.

Meanwhile, McCain is trying to use the situation as an excuse to back out of Friday night’s debate with Obama. Because, you know, in times of crisis it’s not like people need to hear from those who aspire to make decisions for them, right? Somehow I don’t see this move gaining much traction with the public.

At any rate, here’s where things stand:

There is a real risk of a broadening credit freeze that would weigh down businesses and jobs across the country. Not a guaranteed outcome, by any means, but a legitimate risk.

However, the fact remains that the parties most directly on the brink of disaster—and in line to benefit most directly from a bailout—are not “Main Street” businesses or banks, but the big Wall Street financial houses (like Hank Paulson’s alma mater Goldman Sachs) that are overexposed to the kind of unregulated “toxic waste” securities that they themselves and their political allies worked enthusiastically to create.

Thus, the finance industry’s bargaining position here amounts to putting a gun to its own collective head and saying “give me what I want or I’ll shoot!” If it wants cooperation, especially in the face of tremendous pushback from the general public, the industry—and the administration, both personified by Paulson—really has no choice but to accept the kind of reasonable quid pro quos that economists and politicians are talking about, including but not limited to:

• Equity shares in any companies getting help, to keep the reigns in the hands of the government and help make the taxpayers whole
• Strict limits and “clawbacks” on the compensation of the millionaire executives who created this situation
• Stringent oversight of how and where public funds are spent, rather than just handing carte blanche to Paulson (or anyone else)

However, these are not the only conditions that should be imposed. It’s worth remembering that the grand total of “toxic waste” securities out there on the balance sheets has a nominal value in the tens of trillions, even as its actual value is impossible to determine; in comparison $700B is a drop in the bucket, and indeed it’s not at all clear how Paulson even arrived at that figure. Thus, the open question is whether any version of this proposal will actually work to stabilize the markets (in contrast to earlier and smaller band-aid efforts over the past year or so)… or simply turn into more money dumped down a hole, its only effect to bankrupt the treasury and cripple the federal government.

In light of that paramount concern, there are several other prerequisites that should be imposed as part of any bailout legislation. (A hat tip here to Karl Denninger at the site FedUpUSA; the site’s rhetoric may be a bit overheated, but the quiality of the research and analysis is impressive.) It seems clear that one of the key underlying causes of the current crisis was the SEC’s 2004 move to deregulate the debt-to-net-capital ratios firms were required to maintain, which until that point had a cap of 12-to-1. In the intervening years firms pushed their ratios to unprecedented levels—as high as 40-1 at Merrill Lynch, 80-1 at Fannie and Freddie—creating a situation where even a slight drop in underlying values could topple the whole highly leveraged house of cards. Another factor was allowing firms to use controversial “mark-to-market” pricing for Level 3 assets (the kind of securities under discussion), despite the fact that there was no liquid market for such assets, essentially inviting inflated, frankly imaginary nominal valuations.

The combined result was trillions of dollars (supposedly) of assets on balance sheets, with no regulated exchange, no central clearing house, no margin supervision, to keep things in line and ensure a minimum level of trust between parties in financial contracts. Under those circumstances, it’s understandable why people are unwilling to lend, buy, or sell. The case can be made that no matter how much money you pump into the system at this point, it won’t circulate effectively unless and until a basic level of trust has been restored.

How can that be done? Where can one look for underlying value? Paulson seems to be looking at the top of the market: to prop up the value of the questionable assets themselves by providing a buyer of last resort. As already discussed, though, the government doesn’t have enough revenue on hand to do this in any comprehensive sense, and even if it did it would just be propping up a collective fiction.

On the other hand there’s the bottom of the market, the real estate that underlies most of these derivatives (beneath multiple levels of leverage). The problem there is that housing prices are falling for real and legitimate reasons. Many people simply can’t afford to pay their mortgages, in the wake of lost jobs or health-care emergencies or adjusted ARMs that they can’t refinance as expected. Others, upside-down on properties they bought at the top of the market, are simply making the rational decision to walk away rather than continue paying more than their homes are worth. And as noted in my previous post, most experts agree that housing values still have some way to fall. Even now, in most parts of the country median prices are well above the traditional “three times household income” rule of thumb that has traditionally marked the affordable middle-class mortgage. Even if it were possible to keep housing values artificially high, then, rather than letting them revert to the historical mean, doing so would only serve to exacerbate the real problem.

The true solution is to find a way to deleverage the “toxic waste” that writes its value down to rational levels without causing a downward spiral of panic selling and bankruptcies. What Congress should do to achieve this, before approving any bailout funds, is threefold:

• Insist on a return to the 12-1 leverage ratio, stepped down gradually over a period of months leading up to a hard deadline, with frequent progress reports. This will help restore public confidence, especially in those firms that are (relatively) less excessively leveraged.
• Eliminate the mark-to-market fictions used to hide losses, and require all firms to make full disclosure to CUSIP (the securities clearing system) of the formulae used to value their Level 3 assets, so that prospective investors can judge the legitimacy of any claimed values.
• Require all over-the-counter derivatives to be moved to a formal exchange, cleared by the Options Clearing Corporation or an equivalent, again by a date certain—or written down to zero.

These steps would gradually but decisively reduce the uncertainty about the value of the questionable securities out there—while still providing the opportunity to recapture and declare as much legitimate value as possible, rather than simply imploding the system with a rush to the bottom that may let that value go to waste and create undesirable ripple effects. This approach would get the bad debt out of the system, preserve the good debt, and put the credit markets back on a rational footing. And it would prevent taxpayer money from being invested in any securities that are genuinely worthless.

There may be even better, or additional, steps that Congress could take toward the same ends. If so, I have yet to read about them anywhere. There’s been considerable talk about the need for new regulation, but very little discussion of what kind, or how or when it should be imposed. Thus far, the steps outlined above seem to offer the best available answer.

Tags: bailout, economy, financial crisis, George W. Bush, McCain, Paulson

(Following on from my previous post about the economic crisis and what to do about it…)

It’s a short bill Paulson and Bush have presented to Congress. Glenn Greenwald sums it up concisely and accurately:

“(1) The Treasury Secretary is authorized to buy up to $700 billion of any mortgage-related assets (so he can just transfer that amount to any corporations in exchange for their worthless or severely crippled “assets”) [Sec. 6]; (2) The ceiling on the national debt is raised to $11.3 trillion to accommodate this scheme [Sec. 10]; and (3) best of all: “Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency” [Sec. 8].

“Put another way, this authorizes Hank Paulson to transfer $700 billion of taxpayer money to private industry in his sole discretion, and nobody has the right or ability to review or challenge any decision he makes.”

$700 billion is a vast amount of money, more than most people can really grasp. To put this in perspective: if you were assigned the onerous task of spending $1000 a day, every day, without fail, you would spend a million dollars in two years and nine months… and hell, even a million is more than most of us ever have to come to terms with. However, spending at that same rate, it would take you more than 1,917,808 years to spend $700 billion.

(And let us note that $700B is not the full cost of the government’s reaction to this crisis; it’s merely the largest and latest in a long list of expensive measures, including last year’s housing bill, the Fannie Mae and Freddie Mac bailouts, the AIG loan, and many more. Reuters puts the cumulative total at $1.8 trillion… so far.)

Paulson’s goal is to stop the downward spiral, setting a floor on asset values by purchasing the finance sector’s risky debt. And on those limited terms, it may work… but it’s by no means a silver bullet for the underlying problem. Even analysts optimistic about the proposal expect that housing values would continue to fall by another 10-20% over the next year.

When it was first announced last Friday, the proposal seemed to receive broad welcome, and the market surged: things had seemed on the verge of collapse, and here was someone with a solution. On closer examination, however, enthusiasm outside Wall Street has waned, on both sides of the aisle.

By far the most direct objection to Paulson’s proposal, coming from many directions, is to Section 8 of the bill, the unlimited discretion it would give to Paulson himself—another reach for power by the executive branch, explicitly sidestepping any and all oversight from Congress or the judiciary. As Robert Kuttner puts it in The American Prospect,

“The deal proposed by Paulson is nothing short of outrageous. It includes no oversight of his own closed-door operations. It merely gives congressional blessing and funding to what he has already been doing, ad hoc. He plans to retain Wall Street firms as advisers to decide just how to cut deals to value and mop up Wall Street’s dubious paper. There are to be no limits on executive compensation for the firms that get relief, and no equity share for the government in exchange for this massive infusion of capital. Both Obama and McCain have opposed the provision denying any judicial review of decisions made by Paulson — a provision that evokes the Bush administration’s suspension of normal constitutional safeguards in its conduct of foreign policy and national security.”

Even some conservatives normally loyal to the administration are taking exception to this aspect, rediscovering the dangers of unfettered power and the virtue of checks and balances in a way I hadn’t expected to see until after next January 20th. When I find myself agreeing with statements made by people like Bill Kristol—or even Newt Gingrich, at least insofar as he advises Congress take a larger role and “slow down and have an open debate”—I know political times are complicated.

Even aside from abstract matters of principle, this aspect of the bill raises thorny pragmatic questions. Whose assets would Paulson choose to purchase? What would his criteria be? What prices would he offer—those most advantageous to the taxpayers, or those preferred by the financial firms? Would he be hiring “experts” from these firms themselves to administer the nuts and bolts? The conflicts of interest here are not merely potential but pervasive, as is the lack of accountability.

Some die-hard market libertarians are so completely sour on the proposal that they advise simply “letting the market work,” advising for instance that “what the Fed, Treasury, and SEC should have done was to let the chips fall as they may by allowing healthy financial institutions survive and the weak ones go bankrupt or be forced to merge.” Ron Paul has what seems to be a fairly clear take on the causes of the problem, until he quixotically blames most of it on “stifling laws and regulations that allowed the boom to form in the first place.” One might admire the ideological purity of this position, but only from a distance; it’s far too cavalier about the practical consequences for the real-world economy, including for people who were in no way culpable for the problem.

Bottom Lines

So here is what we’ve arrived at: we cannot afford to do nothing, but we also cannot afford to accept this proposal as presented. Paulson emphasizes that he wants it to be passed “quick and clean” (meaning this week, on his terms), but it’s far more important to get it right. Congress has acquiesced in the past when the Bush administration pleaded that the sky was falling, but the assertions of imminent doom have always been overwrought and the results anything but examples of responsible and effective government. The PATRIOT Act, the Military Commissions Act, the Protect America Act… and let us not forget the invasion of Iraq. We should not make another hasty mistake modeled after these.

Fortunately, there have been more open, more accountable, more balanced proposals put forward, both before and after Paulson’s. Last winter, Benn Steil, director of international economics at the Council on Foreign Relations, proposed that the government set up a new independent agency, charged to

“…evaluate mortgage-backed securities and classify those presented for sale in one of five tiers.

“The government would offer to pay 70 cents on the dollar for Tier A assets, 60 cents for Tier B, and so on down to 30 cents for Tier E. The goal of this setup, Steil says, is to put a floor under asset values — an event that should bolster the credibility of financial companies’ balance sheets. Setting a floor on the value of these assets could also entice the deep-pocketed opportunists who have largely kept to the sidelines — namely hedge funds and private equity funds — to enter the market, perhaps in some cases outbidding the government for the assets and thus limiting taxpayers’ exposure.”

More recently, as Sebastian Mallaby points out in a Washington Post op-ed, economics scholars have been weighing in with other alternatives:

“Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments… Second, the government should tell all healthy banks to issue new equity… banks resist [these steps] because they don’t want to signal weakness and they don’t want to dilute existing shareholders. A government order could cut through these obstacles.

“Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks’ bad loans but by buying equity stakes in the banks themselves. Whereas it’s horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.”

That latter point is important, as purchasing debt without an equity share not only minimizes the possible return to taxpayers but also lengthens the time it would take to see any such return. Equity, by contrast, could be used by the government to exert leverage until conditions improve, then sold off at a profit once they do. The NY Times cites this advice from multiple experts, including Douglas Elmendorf, a former Treasury and Federal Reserve Board economist, who points out that “a similar approach was used successfully in Sweden in the early 1990s when its financial system melted down.” Dean Baker of the Center for Economic and Policy Research puts it more bluntly, in terms of economic justice: “It absolutely has to be punitive… If they sell us the junk, then we own the company. This isn’t a way to make these companies and their executives rich. This should be about keeping them in business so the financial system doesn’t collapse.”

Robert Reich agrees about equity and adds some other prudent conditions, most notably that “all Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers.”

Kuttner likewise echoes the point about equity, and also recommends several other ways Congress could improve the rescue effort:

Government equity in firms receiving assistance, in rough proportion to the amount of aid extended.

Limits on executive compensation paid by any firm receiving the public aid.

A recapture of the cost to the government, to be extracted from the firm’s future profits.

A six-month sunset provision, so that the treasury secretary’s bailout authority would expire by next April 1. Any extension would be conditional on across-the-board re-regulation of financial institutions of all types.

Creation of a small independent board, which must review and approve Paulson’s proposed deals.

A narrower treatment of court challenges to Paulson’s actions.

A parallel program to refinance sub-prime mortgage loans and to provide funding to municipalities and community-based nonprofits to acquire, restore, and repopulate foreclosed properties.

At least $200 billion of new economic stimulus, in the form of aid to states, cities, and towns, for infrastructure rebuilding, more generous unemployment compensation and retraining benefits.

Several of these ideas have already been taken up by lawmakers. Senator Bernie Sanders writes that

“The current financial crisis facing our country has been caused by the extreme right-wing economic policies pursued by the Bush administration. These policies … have resulted in a massive redistribution of wealth from the middle class to the very wealthy.

“This is the most extreme example that I can recall of socialism for the rich and free enterprise for the poor. …In my view, we need to go forward in addressing this financial crisis by insisting on four basic principles:

(1) The people who can best afford to pay and the people who have benefited most from Bush’s economic policies are the people who should provide the funds for the bailout. …the government should:

a) Impose a five-year, 10 percent surtax on income over $1 million a year for couples and over $500,000 for single taxpayers. That would raise more than $300 billion in revenue;

b) Ensure that assets purchased from banks are realistically discounted so companies are not rewarded for their risky behavior and taxpayers can recover the amount they paid for them; and

c) Require that taxpayers receive equity stakes in the bailed-out companies so that the assumption of risk is rewarded when companies’ stock goes up.

(2) There must be a major economic recovery package which puts Americans to work at decent wages. Among many other areas, we can create millions of jobs rebuilding our crumbling infrastructure and moving our country from fossil fuels to energy efficiency and sustainable energy…

(3) Legislation must be passed which undoes the damage caused by excessive de-regulation. That means reinstalling the regulatory firewalls that were ripped down in 1999…

(4) We must end the danger posed by companies that are ‘too big too fail,’ that is, companies whose failure would cause systemic harm to the U.S. economy. If a company is too big to fail, it is too big to exist. We need to determine which companies fall in this category and then break them up.”

In the House Financial Services Committee, Rep. Barney Frank “wants to make sure members have a chance to debate the bill on the House floor” and “reiterated the demand of many Democrats to see limits on executive compensation.” His emphasis is on a bottom-up rather than exclusively top-down solution; as of today, the committee reports that he “convinced Treasury Secretary Henry Paulson that a bailout should include a way to help prevent foreclosures on mortgages the government acquires,” declaring that “the government would ‘use its authority as investor’ to encourage mortgage servicers to minimize foreclosures through existing federal programs. The proposal would help renters stay in homes headed for foreclosure and require federal agencies to report every 90 days on efforts to turn bad loans into performing ones.” This approach echoes the priorities of much of the general public: to quote one poster on a NY Times discussion page,

“What is the matter with The US Treasury? Why do they want to buy loans and securities based on loans at a steep discount and then sell the foreclosed properties to speculators? Why not a plan to allow home buyers to keep their homes, rescue their financial standing and continue to pay their obligations at the same price to the financial institutions?”

Paul Krugman suggests intervention at an intermediate point, by providing a straight infusion of capital rather than buying debts—and, again, taking a share of equity in return.

Perhaps the most comprehensive alternative proposal is the one put forward by Sen. Chris Dodd, who also took a bold stand against the administration in last winter’s FISA reform battle. Dodd’s bill:

“…requires Treasury to take an equity stake equal to the purchase price of the assets being bought. If the company isn’t publicly traded, the government would take senior debt instead, placing it in the front of the line of debt holders for repayment in the event of a bankruptcy.

“Dodd’s proposal also would create a five-member oversight board to supervise the Treasury secretary’s purchase and sale of distressed mortgage debt. It would consist of the chairmen of the Federal Reserve, Federal Deposit Insurance Corp. and the Securities and Exchange Commission as well as two members from the financial industry designated by congressional leaders.

“…The Treasury secretary would also be required to issue weekly public reports on the amount of assets bought and sold by the U.S. …

“Dodd is proposing to penalize executives who take ‘inappropriate or excessive’ risks. The executive compensation and severance packages could be reduced if that is ‘in the public interest,’ the proposal says. It would also force executives to give back profits they earned that were based on company accounting measures that are later found to be inaccurate [i.e., fraudulent].”

Dodd’s plan also involves stabilizing the market at the grass-roots level, “buying up mortgages for 15% less than the current market value of the house, then reissuing a clean mortgage to homeowners helps the banks while still giving them a slight haircut (but only slight, odds are home prices will drop more than 15% before the slide is over.)” Meanwhile, Dodd’s colleague Patrick Leahy (he of the excellent cameo in The Dark Knight) has contributed to the bill as well, insisting on “no dictatorial powers for Paulson without court review. Anything Paulson or anyone else does can be reviewed by judges during or after the fact.”

The most objectionable addition to Paulson and Bush is simultaneously the one most popular with the general public: limits on executive compensation. For obvious reasons, no one (outside of Wall Street circles) wants to see “emergency” tax appropriations going to pay for executives’ golden parachutes.

As Paul Krugman neatly summed it up, “Treasury should now be required to explain why this isn’t a much, much better way to do this rescue.”

Economic and Political Fallout

While the alternatives being proposed have much in common in terms of greater openness, accountability, and fairness, another common thread most of them share is that they are unfortunately not significantly less expensive. An expenditure of this magnitude can only be financed by a huge increase in the federal debt, even if some of it is recouped later. But there’s hardly a guarantee of that rosy outcome, considering some of the possible economic side-effects. Things could, indeed, get worse.

After all, much corporate and federal debt today is financed by foreign nations, who watch the U.S. economy closely and participate in it out of self-interest, not charity. As financial analyst Rolfe Winkler points out in the Baltimore Sun, the only option may be to monetize the debt (as the Fed has already been doing quietly, sub rosa, for years, as demonstrated by the ongoing fall of the dollar on currency markets):

“If the U.S. financial system relies on government funding to borrow, what will happen if the federal government’s creditors take a walk? Consider Argentina, which in 2002 devalued its currency to pay off a crushing debt burden. Foreign capital fled the country, the banking system collapsed, inflation hit 80 percent and unemployment reached 25 percent as the economy sank into a depression.

“Under no scenario can Uncle Sam raise the trillions it needs to meet all these obligations. No tax rate is high enough, no discretionary spending cuts draconian enough. And there is no creditor of last resort for the U.S. Treasury.”

Even more bleak is the long-term assessment from Paul Craig Roberts, former Assistant Treasury Secretary in the Reagan administration:

“The open question is: what do these new liabilities do to the Treasury’s own credit standing? …

“The current financial problems have pushed into the background the larger problems of the US budget and trade deficits. Goods and services for American markets that US corporations outsource offshore return as imports, which widen the US trade deficit. Moving production offshore reduces US GDP and employment and increases foreign GDP and employment. …

“Therefore, how is the trade deficit to be closed? One way is through the dollar’s loss in exchange value, which would reduce American consumers’ real incomes and leave them too poor to purchase the offshored goods and services. …

“A country that had intelligent leaders would recognize its dire straits, stop its gratuitous wars, and slash its massive military budget, which exceeds that of the rest of the world combined. But a country whose foreign policy goal is world hegemony will continue on the path to destruction until the rest of the world ceases to finance its existence.

“Most Americans, including the presidential candidates and the media, are unaware that the US government today, now at this minute, is unable to finance its day-to-day operations and must rely on foreigners to purchase its bonds. The government pays the interest to foreigners by selling more bonds, and when the bonds come due, the government redeems the bonds by selling new bonds. The day the foreigners do not buy is the day the American people and their government are brought to reality.”

For that matter, even in the short term, mortgage-backed securities are not the only risky paper cluttering up corporate America’s balance sheets. There are similarly vast amounts of securitized auto loans, credit-card debt, and other forms of borrowing that are liable to see higher default rates as prices rise and employment slips, and many investors fear that they may be the next domino to fall. But don’t worry:

“…over the weekend when most people were snoozing, the Treasury dramatically expanded its bailout plan to include buying student loans, car loans, credit card debt and any other “troubled” assets held by banks.

“The changes, which were included in draft language that also opened the bailout program to foreign banks with extensive loan operations in the United States, potentially added tens of billions of dollars to the cost of the program.”

While this might actually be considered a forward-looking move for a change, it certainly does nothing to instill confidence that Paulson is being straight with the public about the scope of either the problem or his “solution.”

Meanwhile, speculation is all over the map as to the political costs and benefits of a bailout. Digby fears that the GOP might move en bloc to vote against the plan as a way to distance themselves from the administration before the election—although that seems unlikely, given how indebted the party is to Wall Street… not to mention the Democratic leadership’s ability to preempt such a strategy, since they need not even bring a bill to the floor unless bipartisan support is guaranteed. David Brooks, with a certain touchingly naive faith in the power elite, imagines that “a new center and a new establishment is emerging,” in which “the country… will turn to the safe heads from the investment banks. … We’re entering an era of the educated establishment, in which government acts to create a stable — and often oligarchic — framework for capitalist endeavor.” He seems to neglect that the “time-tested advisers” he hails are the same ones who let this situation fester into a crisis in the first place.

There do at least seem to be two related and painfully clear forms of hypocrisy on display here—this much was evident when I first heard of the plan, even before studying the details, and remains even more obvious now—and neither of them reflects at all well on the Republican establishment that’s been running the country for most of the last 30 years.

One: The doctrine that the market not only can but must take care of itself, that government is inherently less efficient—practically an article of faith in some quarters since the Reagan years—has been tossed out the window, for a level of federal involvement that makes the New Deal pale in comparison. Suddenly government isn’t the problem, it is the (only available) solution.

Two: The reason conservatives’ principled opposition to government “interference” in the market has disappeared is that their own ox is being gored. Consider, for instance, how much more stable the economy might be today if only a fraction of the cost of this bailout had been devoted to national single-payer health care a few years back. American industry would be more competitive; public health would be improved and its costs reduced; citizens would enjoy both greater personal well-being and greater job mobility. But no! That would be socialism, and you can’t have socialism if it only benefits, well, everybody. …On the other hand, when major Wall Street corporations have their necks on the line? Well, then, socialism for the capitalists is just fine. It’s a glaring double standard.

This kind of hypocrisy was always there under the surface, as Kevin Phillips has written about, but now it’s out in the open. The damning phrase “privatize the benefits, socialize the risks” has been heard quite a bit in the last few days, and with absolute accuracy.

The whole crisis, from causes to response, exemplifies textbook right-wing behavior. The conservative movement ideologue wastes no thought on advance planning, makes no attempt to level the playing field, gives no heed to nuances like “externalities” or “moral hazard” or “unforeseen consequences.” He just forges ahead with a short-term, look-out-for-number-one approach—until he finds his back against the wall, his ideology undermined by its own logical consequences. Then he turns to “solving” the “emergency,” with top priority placed on covering his own ass. Extra credit if he can externalize the costs of the “solution,” too, forcing the victims to bear the brunt of the burden.

Progressive commentators are celebrating this as a learning moment. Jared Bernstein crows,

“You hear that implosion reverberating through financial markets? It’s the sound of decades of conservative ideology collapsing.

“…progressives have a rare opportunity to change the economic debate in this country by injecting some glaringly obvious truths into the fray, such as:

–Deregulated markets cannot police themselves; they tend toward speculation, vastly underpriced risk, and deeply damaging bubbles;

–An economy that generates growth while leaving most families behind is a broken economy;

–We can neither achieve broad prosperity nor compete globally without robust growth in key sectors which we have ignored or underfunded, including manufacturing, green production, and cradle-to-retirement public education; crafting evermore clever financial instruments will not pave the way to dependable, broadly shared growth;

–No private sector firm should be too big to fail; any firm of that magnitude must be nationalized;

–Capital markets are dysfunctional; borrowing and lending standards are ignored; lax capital requirements lead to constant over-leveraging; shadow accounts thwart transparency;

–We apparently can quickly find (or borrow) the money to do the stuff the authorities deem necessary, be it war or bailout; thus, we can also find the money we need for investment in people, from health care to education to infrastructure, etc.

–Supply-side, trickle-down economics does not work; it exacerbates already excessive levels of market-driven inequalities and defunds government, which leads to:

–Clearly, we need government to be amply funded; as is the case today, we will always turn to federal government to meet the toughest challenges, and if the money isn’t there, we’ll borrow from the future. This means taxes cannot only be lowered; they must sometimes be raised.”

Arianna Huffington writes that:

“In the course of selling us on buying, the market-worshippers shredded the modern social contract, the hard-fought consensus that had emerged since the New Deal, which ordered our political priorities, and expressed both our communal concern for the most vulnerable members of society and our disapproval of huge inequalities. We were now supposed to believe that all could be left up to the soulless, self-correcting calculus of supply and demand. Government involvement was an anachronism, regulatory oversight an impediment.

“The last few weeks have demolished that notion. In the battle over the proper role of government, the forces of the Right, the high priests of the church of the Free Market — including Bush, Paulson, and the Masters of Wall Street — have suffered a monumental defeat.”

Douglas Rushkoff opines:

“The problem for us is that if the Fed doesn’t bail out banks and insurance companies, we all lose our money. But if they do bail out the banks and insurance companies, we all have to pay for it. If the Fed runs out of money to do this, they have to print more money. So the money they insure our bank accounts with ends up worth very little. …

“All this means is that you can’t count on capitalism anymore. Your wealth is not how many paper assets you have. It’s not even how much land you have (or think you have). It’s what you can do. It’s your value to other people.

“The real economy need not suffer in the downfall of the speculative economy. If anything, the real economy has been repressed by the speculative economy. …

“The opportunity here, while the big boys are down, is to rebuild the genuine, local commercial infrastructure. To make shoes, clothes, food, education, healthcare and everything else we can in a bottom-up fashion. While speculators enjoy the economy of scale, we inhabit an ecology scaled to the human being that was lost in the corporatist equation.”

Naomi Klein, more cynical, views this as a manifestation of her “Shock Doctrine” theory and warns that

“…rest assured: the ideology will come roaring back when the bailouts are done. The massive debts the public is accumulating to bail out the speculators will then become part of a global budget crisis that will be the rationalization for deep cuts to social programs, and for a renewed push to privatize what is left of the public sector. We will also be told that our hopes for a green future are, sadly, too costly.”

…but even she quickly acknowledges the counterpoint:

“What we don’t know is how the public will respond. … This spectacle necessarily raises the question: if the state can intervene to save corporations that took reckless risks in the housing markets, why can’t it intervene to prevent millions of Americans from imminent foreclosure? By the same token, if $85bn can be made instantly available to buy the insurance giant AIG, why is single-payer health care — which would protect Americans from the predatory practices of health-care insurance companies — seemingly such an unattainable dream? And if ever more corporations need taxpayer funds to stay afloat, why can’t taxpayers make demands in return — like caps on executive pay, and a guarantee against more job losses?

“Now that it’s clear that governments can indeed act in times of crises, it will become much harder for them to plead powerlessness in the future.”

For the moment, at least, the public seems to be responding well. As of September 22, “a new CNN/Opinion Research Corporation Poll suggests that by a 2-to-1 margin, Americans blame Republicans over Democrats for the financial crisis that has swept across the country the past few weeks.” Eighty-eight percent are either concerned or scared about the financial crisis. Obama has increased his margin over McCain, and picked up majority support among both men and senior citizens. The short-term political tea leaves are favorable.

The opportunity for a longer-term political phase shift is unquestionably there. The downside — as raised by both Roberts and Klein above — is the question of how exactly we are to take advantage of it, with a mushrooming federal debt on our hands just to keep things marginally stable. Many of the best programs proposed by an Obama administration might seem fiscally risky in an age of forced austerity.

Still, it was always clear that the next president’s main job would be to staunch the bleeding caused by the many open wounds the Bush years have inflicted on us; to (pardon the mixed metaphor) stop digging the hole deeper and start climbing out. That task has just grown harder, but it is a difference of degree, not of kind. It will take a serious long-term vision to overcome the short-term hardships, no question… but this crisis may just facilitate the shift in public sentiment necessary to support such a vision, rather than merely a return to the discredited “business as usual.”

(Whew! Writing an information-heavy, link filled pair of posts like this is genuinely exhausting. I don’t know how Glenn Greenwald does it on a regular basis. Then again, he does get paid for it.)

Tags: bailout, economy, financial crisis, Paulson

I’ve hesitated to posted about the mushrooming financial crisis and the proposed federal bailout until I felt that I could muster an informed opinion. I’m not an expert economist by any means, and this is a devilishly complicated situation that’s evolving from day to day. Still, after some diligent background reading, certain things are becoming clear. I just hope that our Congresscritters, as they prepare to debate the scope of the problem and the proposed solution(s), have put in at least as much effort.

That things are bad is not in doubt. But the causes and effects are complicated, and the usual partisan and ideological lines don’t seem to apply here. In the wake of Treasury Secretary Henry Paulson’s proposal last Friday for an unprecedentedly massive bailout of Wall Street, both liberal and conservative voices have come out both in favor of the proposal and in opposition.

Public opinion is likewise divided. People are scared but skeptical. Just a week ago, even as the $85 billion AIG bailout was being arranged, only seven percent of Americans polled supported public bailouts for troubled financial firms, across all political lines. By Monday, after a weekend of a no-holds-barred PR push from Paulson and saturation media coverage, the numbers were higher, although different polls found radically different levels of support, from 28% up to 62%. The public is following the story closely, but large numbers remain undecided, and even supporters fear that taxpayers will get the short end of the stick.

It’s no surprise that opinions are in flux. People are playing catch-up to events, barely getting a grip at this point on how things got to this point, let alone what’s likely to happen next and how, why, or whether the bailout is necessary. In a nutshell, it’s the result of leverage piled on leverage, risk piled on risk—the banking and investment industry turning small amounts of equity into huge amounts of debt, and using it to purchase unregulated exotic securities, derivatives that were themselves based on small amounts of equity and huge amounts of debt. Behind all this lay real estate, and as long as property values kept increasing, it was possible to keep rolling over the debt and reaping profits. But this was a pattern that incentivized greater and greater levels of risk, and anyone could (or should) have seen that the bubble would pop at some point. Some companies did, and have avoided the worst of the fallout. Most just put their blinders on and kept going. Now, just like a homeowner upside-down on a mortgage, most of Wall Street is undercapitalized as well, on the hook for debts that far exceed the value of its assets.

None of this happened by accident. It’s a result of deliberate policy choices made by those in power, officials of both parties with cozy ties to Wall Street. For years, Alan Greenspan insisted that there was no housing bubble, even as he facilitated the easy money that kept it growing. Back in the ’90s, Senators John McCain and his close friend and former economic adviser Phil “nation of whiners” Gramm were behind the deregulation that undid Depression-era safeguards and made this kind of industry-wide speculation possible. Just like Paulson, Clinton’s Treasury Secretary Robert Rubin was a former chairman of investment banking giant Goldman Sachs, and lobbied hard against stricter regulations. Paulson himself, along with Greenspan’s successor Ben Bernanke, was insisting until just weeks ago that the economy was stabilizing and the market could take care of itself.

For more than two decades now, the American economy has based its “growth” on one speculative bubble after another, rather than on goods and services with tangible value. A lucky few have accumulated vast wealth this way, while most Americans have based their lifestyles on increasing levels of consumer debt as real household incomes stagnated, and (in a perverse feedback loop) our GDP grew increasingly dependent on that unsustainable consumer spending. It doesn’t have to be this way: many European nations have charted a different course, and today have a far more stable banking sector, grounded in actual public savings. But far be it for U.S. policymakers to take any lead set by Europe, which have routinely been maligned for placing insufficient trust in “the market.”

Still, blame aside, the current crisis is real. What is the likeliest fallout? This goes far beyond distressed mortgages. It’s called a “credit crisis” because undercapitalized lenders can’t afford to lend, and those who can afford to are nevertheless afraid to due to unmeasurable risks. Without flows of credit to grease the wheels of commerce, even legitimate and responsible borrowers—individuals and businesses alike—are stopped in their tracks. Productivity falls, jobs disappear, consumer spending dries up (even more than they already have). As Paul La Monica of CNNMoney.com observes, “you’ve got nearly 11 million people, or just under 10% of the entire nation’s labor force, working in industries that could be directly (and negatively) affected if the financial services sector and housing market were left to just sort themselves out.”

So as archconservative William Kristol blithely sums it up in his New York Times column, “We’re going to have a recession. Unemployment will go up. Credit is going to be tighter. The challenge is to contain the damage to a ‘normal’ recession — and to prevent a devastating series of bank runs, a collapse of the credit markets and a full-bore depression.”

That’s not a worst-case scenario—that’s what happens no matter what, barring a miracle. What the financial sector desperately needs is “deleveraging”—but that’s almost impossible to achieve without triggering a vicious negative feedback loop. As PIMCO Managing Director Paul McCulley put it in a widely-read article earlier this summer,

“Once the double bubbles in housing valuation and housing debt burst a little over a year ago, everybody, and in particular, every levered financial institution – banks and shadow banks alike – decided individually that it was time to delever their balance sheets. At the individual level, that made perfect sense.

“At the collective level, however, it has given us the paradox of deleveraging: when we all try to do it at the same time, we actually do less of it, because we collectively create deflation in the assets from which leverage is being removed. Put differently, not all levered lenders can shed assets and the associated debt at the same time without driving down asset prices, which has the paradoxical impact of increasing leverage by driving down lenders’ net worth. …

“[The Fed's] monetary easing is of limited value in breaking the paradox of deleveraging if levered lenders are collectively destroying their collective net worth. What is needed instead is for somebody to lever up and take on the assets being shed by those deleveraging. It really is that simple.“

In other words, the government is left to step in as a “buyer of last resort.” That was the principle underlying last week’s AIG bailout: per CNNMoney.com, “it gave AIG time… to unwind its sprawling operations — it has $1.1 trillion in assets and 74 million clients — in an orderly manner. Had the company been forced into bankruptcy, it would have to unload its subsidiaries quickly and at a deep discount.” This would have dragged the market down even further, undermined the asset values of other similar firms, and exacerbated the credit crunch.

This is the same philosophy behind Paulson’s proposed $700 billion sector-wide bailout. Paulson, and the Bush administration, have consistently tried to portray it as a necessary evil, a better alternative than “doing nothing.” But is it really the only available solution, much less the best one? Indeed, will it even work?

(More to come. This post is growing excessively long, and I need to break it in two.)

Tags: bailout, economy, financial crisis, Paulson