Bailout

by hilzoy

I'm sure everyone knows about this already:

"The Bush administration has proposed granting unfettered authority for the Treasury Department to buy up to $700 billion in distressed mortgage-related assets from private firms as part of a program that Treasury Secretary Henry Paulson said "has to work.""

Some reactions: Dean Baker, Paul Krugman (1, 2, 3), CalculatedRisk, Douglas Elmendorf, Ed Paisley, Henry Blodget, Yves Smith, Mish, Willem Buiter, Luigi Zingales, William Greider, Sebastian Mallaby, Robert Reich.

Obama has called the proposal "a concept with a staggering price tag, not a plan", and has laid out the principles that he thinks should govern a bailout here. McCain was noncommittal on the administration's proposal, but criticized Obama.

Deciding what to do about the present financial crisis is beyond anything remotely resembling my expertise. However, like Steve Benen, I've been reading around, and I can't find a single decent economist who likes the plan. That scares me, since I expect that the political dynamics will go something like this: Paulson has proposed a plan; not to accept it would deeply damage confidence in the markets and make things much worse, regardless of whether it's a good plan or not; therefore, it will be passed. I hope the Democrats try to get some decent regulation and structural reform for all that money.

In the meantime, I do have a few other reactions:

First: throughout all this, I've been torn between believing in market discipline and wanting to avoid moral hazard on the one hand, and thinking that of course that commitment flies out the window if we're seriously threatened with economic collapse, on the other. But it's worth remembering that we could have avoided having to choose between these unfortunate options. All we needed to do was have people in government who believed in good regulation.

Second: if anyone ever tells me that Republicans are the party of fiscal discipline ever again, I will either dissolve in laughter or bite their heads off. I don't know which. You have been warned.

Third: in particular, if any Republican ever tells me that a hundred million or so is just too much to pay to make sure that kids have health insurance, I will definitely bite his or her head off.

Fourth: I do not want to hear people tell me that regulation cripples the economy, unless they are willing to admit that a lack of regulation can also cripple the economy. Not ever. I don't understand why anyone is so much as tempted to think that "regulation" is good or bad, as a whole: to me, that's like being for or against "things" or "people". Some regulations are good, some are bad; obviously, we want people in government who can tell the difference, and implement regulatory systems that work well. However, altogether too many of my fellow citizens were willing to listen to ideologues, and now we all get to pay for their mistakes.

Fifth: if Obama wins, he and the Democrats will, in all probability, have to be the grownups once again. Reagan spent us blind; Clinton got us out of debt again. Now Bush has spent us even blinder, and we will be tempted, yet again, to put our ideas and aspirations on hold for the sake of the country.

I would like to hear one Republican, just once, acknowledge this fact.

I should also say: as people go, I am pretty willing to step up and be a grownup, even when other people aren't. But I am just about at the end of my rope. What that means, in practical terms, is that while early in the 90s I was willing to put various plans on hold for the sake of the country and its fiscal stability, I now think: Democrats' willingness to be sane and fiscally responsible just enables the Republicans. I am not willing to play that game. So don't count on me to think that universal health insurance is something we just can't afford any more.

Republican fiscal conservatives: if you've lost me, you've lost a whole lot of people. Because this is not a way of thinking that comes naturally to me at all. So step up to the plate and reform your party. You can't count on us to do your dirty work.

Sixth: Paulson seems to me to be one of the better members of this administration. (A low bar, I know.) But he still answers to Bush and Cheney. They have already abused our trust too often. There's a price for that: not being trusted when you really need it. It's not Paulson's fault. Too bad.

Last, and certainly least: I'm hilzoy, and I approve this message:

"I also find myself drawn to provisions that would serve no useful purpose except to insult the industry, like requiring the CEOs, CFOs and the chair of the board of any entity that sells mortgage related securities to the Treasury Department to certify that they have completed an approved course in credit counseling. That is now required of consumers filing bankruptcy to make sure they feel properly humiliated for being head over heels in debt, although most lost control of their finances because of a serious illness in the family. That would just be petty and childish, and completely in character for me."

I've always been partial to the idea of using the stocks for special occasions, when both exemplary punishment and the opportunity for ordinary citizens to tell lawbreakers what they think of them seem appropriate. Now seems like a pretty good time.

Comments

[bobbyp]

Dean Baker nails it.

[bobbyp]

"I would like to hear one Republican, just once, acknowledge this fact."

Alas, that is a wish that will go unfulfilled, and that says all you need to know about the current version of the party of Abraham Lincoln.

[now_what]

in the 90s I was willing to put various plans on hold for the sake of the country and its fiscal stability, I now think: Democrats' willingness to be sane and fiscally responsible just enables the Republicans. I am not willing to play that game. So don't count on me to think that universal health insurance is something we just can't afford any more

Welcome to the reality based community. Although you may, at some point, regret your decision to take the red pill.

In all seriousness, an impressive post.

[efgoldman]

Brava, Brava, Brava!! Hilzoy!!!

Adult common sense: Probably won't work but I'm awfully happy to see it, especially expressed so well.

I commented on an earlier post that Barney Frank (D-MA), chairman of the House committee that is likely going to write the legislation, would be a very important person in the process. He has always been a liberal, but never doctrinaire or textbook. He has more common sense in his thumbnail than most of the rest of Congress put together. I hope he isn't steamrollered by Pelosi and Hoyer.

Of course, we need to remember that one Senator of either party can stop the thing. I think it is more likely a repub, if the democrats can get fatcat penalties and little guy protections into the bill.

[efgoldman]

Brava, Brava, Brava!! Hilzoy!!!

Adult common sense: Probably won't work but I'm awfully happy to see it, especially expressed so well.

I commented on an earlier post that Barney Frank (D-MA), chairman of the House committee that is likely going to write the legislation, would be a very important person in the process. He has always been a liberal, but never doctrinaire or textbook. He has more common sense in his thumbnail than most of the rest of Congress put together. I hope he isn't steamrollered by Pelosi and Hoyer.

Of course, we need to remember that one Senator of either party can stop the thing. I think it is more likely a repub, if the democrats can get fatcat penalties and little guy protections into the bill.

[ThatLeftTurnInABQ]

I already posted my bit (on another thread but which really belongs in this thread) so:

this, IMHO.

nadezhda posted a comment that I strongly recommend (including the links) here.

And, what now_what said, here.

The angry mob with pitchforks and torches at John Cole's blog is a sight to behold for pure entertainment value and some commenters there are also posting links worth following.

I think Saruman may have disturbed the Ents one time too many with this bailout proposal. Let's hope so.

[liberal japonicus]

Of course, we need to remember that one Senator of either party can stop the thing.

I loved the Matt Stoller link from the anonymous lawmaker, but I also draw attention to a comment in the thread, which is

IMHO, the anonymous congressman does not have the intelligence to serve in Congress, and I am ashamed to be a member of the same party. He's ready to give a $700 billion gift to Wall St., and the only thing he wants in return is... to make the execs feels bad? Are you kidding... they'll all be high-fiving each for years as they dance in their $700 billion pool of money.

This bill needs to be flat-out killed. It can't be "fixed" by imosing punitive measures on Wall St. $700 billion. Is your family really ready to send a $10,000 gift to Wall St. because President Bush told you there is a crisis?

It's all lies. More lies. It's the fear game again, and the democrats are falling for it, lock stock & barrel.

Kill this bill. No way, no how, no bailout.

You know, if the bill were bad enough, Obama filibustering the bill until they get it right would be a memorable image. Unfortunately, life ain't like an episode of the West Wing.

[maryb2004]

I always read but never comment but this made me come in to say AMEN!

I now think: Democrats' willingness to be sane and fiscally responsible just enables the Republicans. I am not willing to play that game. So don't count on me to think that universal health insurance is something we just can't afford any more.

[Gary Farber]

"I don't understand why anyone is so much as tempted to think that "regulation" is good or bad, as a whole: to me, that's like being for or against "things" or "people".

Either because they've been fooled by bad ideology and bad propaganda, or they're ideologues blinded by their ideology. Or they're paid propagandists for someone or some entity that benefits.

[Hob]

LJ, could you explain your reason for drawing attention to that particular comment? All I see is someone expressing the same anger we all feel, but doing it based on a very inaccurate reading of what the alleged Congressman said. I mean, it's just not true that "He's ready to give a $700 billion gift to Wall St., and the only thing he wants in return is... to make the execs feels bad". He (or she) tossed in the "insult provisions" bit at the end as a bitter joke, but the rest of the piece is about refusing to support any bill that doesn't include "reforms of the industry" with some possible examples given: "corporate government reforms, including CEO compensation," "allowing modification of mortgages in bankruptcy," "strip[ping] out all the gives to industry in the predatory mortgage lending bill that the House passed last November." Any opinion on that, or do you just think the author is blowing smoke?

[ThatLeftTurnInABQ]

a couple of more points, courtesy of Yves Smith's commentary:

Jon Hatzius, the Goldman analyst who was an early housing/financial firm bear and has forecast that credit-related losses to the economy will reach $2 trillion

Let that sink in for a moment.

As stunningly huge as this proposed bailout is, and assuming that it passes and we attempt to recapitalize the insolvent Wall St. firms by simply giving them the money and effectively getting nothing back in return, it may still fail simply because it isn't big enough.

Others elsewhere in the blogosphere have already pointed out that this giveaway is not restricted to US firms. Foreign companies which do business in the US would be able to apply for relief under the same program.

This means that we are not merely attempting to recapitalize the US banking system alone, but also anybody else who can sneak in while the door to the nightclub is being held open.

This weary Titan staggers under the too vast orb of it's fate, indeed.

..idea that the goal is to avoid a sharp contraction in lending. The US needs to wean itself of unsustainable overconsumption, and since consumption has come to depend on growth in indebtedness, a reversal, however painful, is necessary. Our excesses have been so great that there is no way out of this that does not lead to a general fall in living standards (note that the officialdom in the UK is willing to say that, but since perpetual prosperity is a God-given right in America, admitting we will be getting poorer is verboten). Thus, a sharp contraction in lending seems inevitable; the trick is to prevent it from crossing the tipping point into a vicious, accelerating downward spiral.

Let that sink in for a moment.

The rationale (at least for public consumption) for this bailout is that the credit markets are frozen and Americans cannot get access to more liquidity. In other words, we cannot take out newer and bigger loans, on top of the ones we already struggle to pay back now.

Hearing the problem framed this way makes me want to scream, because in the somewhat longer term, we can't and shouldn't get more liquidity. We have debts to pay down, and you don't do that by borrowing yet more - that is payday loans masquerading as macro-economic and fiscal policy.

This is like legislating that the local liquor store has to remain open so the alchoholics will have somewhere to buy more booze. We need a 12-step program for debt, not the equivalent of taxpayer subsidized kegs on tap.

[Ben Alpers]

I think we'd be much better off today if Clinton had spent his political capital on establishing a real system of national health insurance rather than spending it on passing NAFTA and WTO, and getting to an oh-so-fleeting balanced budget.

Balanced budgets are better than total fiscal irresponsibility, but balancing the budget is not an absolute good and there are more important things to get done.

Personally, I hope that Obama does not absolutely prioritize the more sober version of Washington consensus economics....though I think that's exactly what he's likely to do.

Given the choice between a pragmatic party of big business and a kleptocratic party of big business, I'll vote for the pragmatic party of big business. But this country needs something better.

[liberal japonicus]

LJ, could you explain your reason for drawing attention to that particular comment?

Well, as readers of TiO are painfully aware, I've been talking about anger driving dem and liberal responses, so that comment caught my eye. There is also a danger that there is going to be a civil war over what is the 'proper' response, which is why that comment is notable. Is the commentor just blowing smoke? I don't know, but there seems to be this desire to capture the moral high ground that always bedevils liberals. However, when Chris Dodd uses the word "reciprocity" as an important part of the bill, I shudder.

Unfortunately, with all of this, it is difficult to discern all the forces in play. When I read that the bill is being held up because Dems want to include economic stimulus to the middle class, I wonder is this MSM spin? Or is this simply the Dems getting rolled again?

I don't know if that explains my comment any better, but it's not that I think either person is right or either person is wrong, but the juxtaposition seemed significant.

[Adam]

McCain was noncommittal on the administration's proposal, but criticized Obama.

That sentence pretty much sums up this entire election.

[David]

To my elected representative,

Please STOP the lunacy that is the proposed $700 billion bailout of the financial industry. Make no mistake, this is not a bailout of the citizens you were elected to represent. This is a bailout of the corporations from whom you've accepted money and other support, using money you are taking from the citizens you were elected to represent...and from their children...and from their children.

The citizens you were elected to represent are substantially protected from major changes in the financial industry via FDIC, SIPC, and excess SIPC insurance on their bank and brokerage accounts. Only those citizens who freely chose to invest in financial companies will suffer investment losses, just as those did who freely chose to invest in technology companies before the dot com bust. That's the way it should be.

The financial companies in trouble are the ones who freely chose to make bad decisions about what they invested in, and about how they managed risk and cash flows. They deserve to fail so that a new generation of financial companies which are better managed can flourish, making it much less likely that the current situation will ever repeat. The financial companies in trouble do not deserve to be gifted, or even "loaned," taxpayer money so that they can continue their past mistakes. If they are able to avoid failing by changing quickly into a next-generation financial company WITHOUT a taxpayer-funded bailout, then they have proven they deserve to survive. Whether new or re-born, we need better managed next-generation financial companies in our economy.

You are free to use the arguments made here to publicly justify your vote against the proposed $700 billion bailout.

I am asking you to vote AGAINST the proposed $700 billion bailout, in any form. I will record which of my representatives vote FOR the bailout, and will vote AGAINST them and their parties in the November election. I am also urging my friends, colleagues, and community to do the same.

Warm regards,
David

[mds]

Correct me if I wrong in my reading of the bill, but the idea of a $700 million price tag that keeps getting attached to this seems like a misnomer. With the $700 million as only a balance sheet limit, it would only seem to make sense that there will be a lot of cycling in and out loans for pennies on the dollar before the Fed even approaches that limit, meaning we could conceivably be on the hook for a lot more actual expenditures. Would the purpose of this limit be just to make sure we don't make any one massive purchase of toxic debt that could bankrupt us, or is it just a cloak for a more massive program of loan laundering?

[cleek]

There is also a danger that there is going to be a civil war over what is the 'proper' response, which is why that comment is notable.

there will be nothing from the masses until the effects of this start to affect them in direct and painful ways. seeing the DJIA flail around 5 or 6 percent isn't direct enough. it'll take something like massive unemployment or a 20% drop in everyone's 401k before the masses get involved for real.

until then, we're just the grumbling wind beneath a sky full of golden parachutes.

[efgoldman]

1) sorry for the double post. I certainly didn't mean it.

2) Greenwald is worth a look on this issue:
http://www.salon.com/opinion/greenwald/2008/09/20/bailout/index.html

[Slartibartfast]

Correct me if I wrong in my reading of the bill, but the idea of a $700 million price tag

Uh, that's million with a 'b'.

[Jay Arcey]

Word!

I probably count as an Ent. While I vote reliably Democratic and consider myself a progressive, I work in the law (and so perhaps over-appreciate how little one individual can affect policy) and am old enough to have been repeatedly appalled by stupid public policies (and so have become somewhat inured to them). Plus I've got the usual busy-life excuse. I don't write letters to politicians or newspapers and rarely comment on blogs.

And I spent this morning writing letters to my Congressional delegation and regional newspapers denouncing this load of garbage, and contacting friends and colleagues asking them to do the same. And now I'm commenting on a blog.

How this plays out will have everything to do with who I support politically, and where and how I vest my involvement in the future. And since I have to accept that lack of adequate political involvement by people like me (educated, well-meaning, progressive but otherwise preoccupied) is one of the factors enabling this mess, I guarantee I will be looking for and exploiting ways I can help get us out - not simply writing a blank check, thanks - and help keep this, and things like this, from happening again.

[ThatLeftTurnInABQ]

Correct me if I wrong in my reading of the bill, but the idea of a $700 billion price tag that keeps getting attached to this seems like a misnomer. With the $700 billion as only a balance sheet limit

If you think of this bailout package as being like the shower scene from Psycho, then the 700 billion limit is the width of the drain.

The wider the drain, the less time the blood spends circling around and around before it goes down the drainpipe.

[Nell]

Paulson seems to me to be one of the better members of this administration.

Well, he's not. He's saying the sky will fall if he isn't handed unconstitutional absolute power over $700 billion dollars right now. He's using the same fearmongering tactics as Cheney and Bush to stampede Congress in the service of amassing power that will be untransparent, unaccountable, and near-permanent.

He also has failed to do anything until right now. How conveeeeenient.

No, he's no better than the criminals who hired him.

[Nell]

I would like to reinforce ThatLeftTurn's recommendation of Nadezhda's posts, particularly the one on the politics of opposing the blank check.

Her crucial insight is that the provisions Democrats have to push for have to be presented, and be, essential to the effectiveness of any proposal -- not "reciprocity" or political trades.

Aside from the massive political and constitutional, naked class-war, socialize-risk/privatize profit aspect of the Paulson handover proposal, there's the point that Jim Henley makes (following Jim Joyner):

There is no way whatsoever to credibly cast the proposed bailout as a "never again" measure. ... There’s no institutional mechanism; there’s no logic to this bailout that could not apply to a future one. It not only culminates the previous era of Moral Hazard, it inaugurates the next one. It guarantees more of the same behavior that led to the current crisis. The only way it would not eventually lead to another, even bigger bailout like the one that got rolling with Bear Stearns in March is if - here comes the happy part - the government is simply too broke next time to pull it off.

[Molloy]

Not that we need more bad news but this is an interesting if rather grim insight.

[Gary Farber]

Robert Reich.

Bernie Sanders.

[hilzoy]

Nell: as I said, "one of the better members of this administration" is a pretty low bar. Think of Alberto Gonzales, or Donald Rumsfeld.

[Incertus]

The angry mob with pitchforks and torches at John Cole's blog is a sight to behold for pure entertainment value and some commenters there are also posting links worth following.

As a member in good standing of that angry mob, let me say that I'll be cutting torches from the trees for the next few days, and I'm training for the rush up the hill to set the master's house on fire.

Forget the economics for a moment. Here's the reason why this is a bad idea. The Bush administration has managed the unique trick of being both criminal and massively incompetent, and what's more, they've only got four months left in office--and people are seriously considering giving them $700 billion with no preconditions or restrictions? If we're going to get a depression, I'd rather do it without further enriching friends of Bush.

[Gary Farber]

"Correct me if I wrong in my reading of the bill, but the idea of a $700 million"

Billion.

"price tag that keeps getting attached to this seems like a misnomer. With the $700 million"

Billion.

[liberal japonicus]

There is no way whatsoever to credibly cast the proposed bailout as a "never again" measure. ... There’s no institutional mechanism; there’s no logic to this bailout that could not apply to a future one.

Hmmm, sounds like the 2000 SCOTUS decision. Interesting pair of bookends, eh?

[FlyOnTneWall]

Look, there's no question that the $700 billion bailout is, regrettably, necessary. That makes the inevitable additions to the bill a rather high-stakes game of chicken. I think it's worth playing, mind you, but I'm appalled by the petulance being displayed by some on the left. Dean Baker, for example, seems to actually believe that it'd be worth letting the international economy melt-down rather than pass the plan in its present form. That's just silly. I understand that, having played the role of Cassandra for a decade, he's not particularly sympathetic. But the question at hand is how we move forward from here.

First, let's dispose of the concept of "moral hazard," at least as its been employed in the present crisis. For the decision-makers at BearStearns and AIG, the bailout was, in fact, a catastrophe. The problem wasn't that they sat at their desks and thought to themselves, "Well, even if our models turn out to be faulty, at least the federal government will intervene. It may fire us from our jobs, devalue our extensive stock holdings, and turn is out on the street - but it's not like we're facing bankruptcy here." The problem was that they never contemplated the possibility of error in the first place. Their firms will be used as cautionary tales, no more or less than Lehman, which was allowed to founder. Look at it this way: moral hazards can be real, but they have declining marginal utility. So, for example, the prospect of losing ten dollars is less likely to inhibit me than the prospect of losing a million. The prospect of losing ten million, however, has no additional deterrent effect - I don't even have one million. Either way, I'd go bankrupt, and the sums are bigger than I care to contemplate. That's roughly what's happened here. When you're talking about degrees of catastrophic failure, you're talking about outcomes that are very different, but which have roughly the same deterrent effect. So the prospective bailouts don't alter the calculation.

So what can we do? Well, there are a lot of worthwhile proposals on the table, including Hilzoy's endorsement of the stocks. But what makes the most sense, to me, is that the legislatures stipulate that instead of mindlessly seeking to maximize its returns, the Treasury should reduce the outstanding value of the loans that are purchased to match the current value of the home, as estimated by two appraisers, or to what it draws in a sale on the open market. It's not just the financial markets that are illiquid; the housing market is, too. Reducing the loan balances would serve to give homeowners in or near default new options. They might be able to make the new, lower payments, and hang on to the home. Alternatively, they would be able to sell the home and use the proceeds to pay off the balance of the loan. And, in a nice benefit for taxpayers, in many cases that would mean a better return on the asset. It's insane, I know, but foreclosure is rarely the most profitable option for banks - just the simplest and the one that costs the least in overhead. But banks lose a fortune on each foreclosure; they'd do much better to restructure loans or to allow for the property to be sold and then simply call it quits. But the banks and the loan pool administrators don't have the infrastructure to treat loans on an individual basis. So they go ahead and foreclose, and lose money in the process. Insanity. The federal government, on the other hand, is actually pretty good at managing complex nationwide programs. Bureaucracy is what it does - and I mean that in a positive sense. It could run such a program, and turn underperforming assets around, in the process aiding millions of homeowners and bolstering the economy. What's not to love?

[Gary Farber]

I linked to Jim over here, btw, Nell. (Also here.)

[Gary Farber]

"Look, there's no question that the $700 billion bailout is, regrettably, necessary."

Really? Why are so many economists saying otherwise?

[liberal japonicus]

FotW,
Can I read you as saying that some intervention is necessary, or are you saying that it has to be in the form of a bailout? There are a number of other proposals, so I can't ask you to comment on all of them, but if you could link to and comment on one or two, explaining why the bailout as it has been presented is superior, I'd appreciate it

[flicker]

Nice post, Hilzoy. This whole thing has disturbed me so much that I finally got off my duff and wrote my congressman, which (alas) is a rarity for me.

[now_what]

Really? Why are so many economists saying otherwise?

FlyOnTheWall said so. Who can argue with handwaving?

I'm appalled by the petulance being displayed by some on the left.

Do NOT, and I repeat NOT, feed the trolls 700 billion dollars. It just encourages them.

[ThatLeftTurnInABQ]

Look, there's no question that the $700 billion bailout is, regrettably, necessary.

Not in it's proposed form - I don't accept that logic at all, because Paulson's TARP does nothing to solve the underlying problem of a US middle class which is close to being insolvent (too much debt, not enough income) and housing prices which still haven't reverted to historic norms in terms of price/rent and price/income.

Either this plan fails to recapitalize the banks, or it fails to push down housing prices, or some combination of the two, depending on whether the Treasury underpays or overpays for the purchased MBS.

What about this as an alternative plan (thinking off the top of my head here, so please poke holes):

Much of the systemic risk we face come from the potential for an accelerated deleveraging due to capital requirements, once a market clearing price is established for the MBS these firms are holding and they actually mark their assets to market. That is the deflationary spiral of doom scenario which has everyone spooked. So we do this:

step 1) Congress legislates that companies which meet some regulatory* and equity share threshold (it could be less than 100%) in terms of US Treasury Dept. control will temporarily be exempted by law from their current capital requirements - that is so as to defuse the deleveraging "bomb" by preventing sale of assets from being triggered in a mechanical fashion.

step 2) Congress then provides funds for the Treasury Dept to purchase equity shares in companies which need rescuing, so as to meet the requirements in step 1. This accomplishes the goal of diluting the existing shareholders. Management at these companies will need to held accountable for their performance or lack thereof.

step 3) Congress additionally provides funds which are to be used once these companies have been taken over by the Treasury for the purposes of partially subsidising a cramdown of the mortgages held by homeowners which are on the books at these firms. This will be very hard to do, requiring an army of accountants, but I think it can be done with enough labor - which would certainly help out the employment picture.

Basically this is partial compensation for the loss of asset value imposed by the mortgage cramdown. Bad loans which cannot be renegotiated in this fashion are sold to anyone who will take them at whatever the market clearing price is, or written off as a loss.

step 4) Treasury then sells off assets of these firms as needed to bring them back into compliance with the capital requirements which were suspended in step 1. If anything is left, the company survives, otherwise it goes into bankruptcy. Those which survive are then sold by the Treasury to recoup as much of the taxpayer money invested in step 2 as possible.

*In parallel with this, Congress writes new regulations and if necessary creates a new regulatory body to supervise the surviving IB's and hedge funds so this disaster does not happen again.

The net result will be that we spend a lot of taxpayer money and what we get in return is a smaller and healthier set of finanical firms, MBS which are liquid and marked to market again, and some degree of homeowner relief via mortgage cramdowns.

I don't know how much of Wall St. can be cleaned up in that fashion for $700 billion, but it sounds to me like a better use of the money than what Paulson's TARP plan calls for.

[liberal japonicus]

TLT,
I'm in way over my head here, but isn't the presence of foreign companies in the line a problem? From this interesting TPM post, I see that Barclay's and UBS listed. Or are American units of foreign companies essentially the same thing as American companies?

[John Thullen]

Great post and great comments.

Let's not dismiss FlyOnTheWall's commentary so readily.

I agree with him, her, it, for this reason:

All of us are unwittlingly implicated and victimized by this financial debacle.

Most of us own a part of it, whether we know it or not or like it or not.

A gigantic spider has been weaving the web since Ronald Reagan was elected in 1980 and systematically and methodically capturing we flies and wrapping us in its web and keeping us numb with free market, deregulatory, patriotic bullshit venom and fresh for the eating.

The web is where we all live now. What, you wanna blow it up?

You wanna see where the chips land? They will land on us, not the scum who conceptualized this crap these past 35 years.

No, now you get to pay rent for living in the web, because that's what trickle down means.

Just think. We could have let Social Security privitization happen and you could be free to put ALL of your investable money into this worthless paper, instead of those "worthless" Treasury bills and notes George Bush waved round in front of the file cabinet all those arguments ago.

You know, those IOUs no one can get enough of right now because the funky liar's paper floated by the vaunted private sector is so, what ...... toxic, worthless, illiquid.

[ThatLeftTurnInABQ]

lj,

That question (how to deal with foreign companies and/or their subsidiaries in this context) is "over my pay grade".

I don't know - it is a very thorny problem.

The Phil Gramm - UBS connection that Josh Marshall points out is creepy, but hard to tell if it just looks bad, or really is bad. These folks (not just Gramm) are so in bed with each other at so many different levels that it hurts my head sometimes trying to figure out who the real crooks are.

[libarbarian]

The Republicans are the party of fiscal responsibility.

[russell]

I'm appalled by the petulance being displayed by some on the left.

My first reaction to this was "Kiss my sorry white @ss".

That seemed a little harsh so I'll try again.

What you see is not petulance. It is outrage. And it is well earned.

Republicans have demonstrated, over and over again, but especially in the last eight years, that they have no respect for the proper function and responsibilities of government.

They don't like government, they think it does nothing but get in the way, and they want it neutered to the greatest degree possible.

The result is what you see.

The reason we have a financial crisis is that a bunch of Wall Street smartasses thought they could misrepresent the value of the paper they were selling and get away with it.

The reason they thought they could get away with it is because for the last few decades the financial industry in this country has been increasingly released from the regulatory regimes introduced after the depression.

Shorter me: the value they claimed was in the paper was not there, and they got caught with their pants down.

A simplistic analysis? Yes, it is. Inaccurate? I don't think so.

And now they want $2,000 from every man, woman, and child in the USA to bail their sorry asses out, and they want it with no conditions or oversight.

I say f8ck them and the horse they rode in on. They can lose their damned shirts and go to hell. In my perfect world, they'd be breaking rocks and living on bread and water, so they should thank their lucky stars I'm not king and STFU.

And trust me when I say this is not personal. It ain't show friends, dude, it's show business. I'm sure they can all relate to that.

They want $2K from me to bail them out? If I was late a week on a credit card payment they'd triple my rate. If I missed a couple of mortgage payments they'd kick my ass out into the street. That is no joke, stuff like that happens every damned day of the week.

Screw them. They can have my money when I see their blood, and you better believe I'm serious.

Petulance, my ass. You have to be f8cking kidding me.

Thanks -

[russell]

The web is where we all live now. What, you wanna blow it up?

No man, I do not. What I want is the spider on a leash, and I want to be holding the other end.

It's the least they can do for my $2K.

Thanks -

[hilzoy]

I do not dismiss Fly's comments. I think the question is: how close are we to genuine crisis? Will any sign that a deal won't go through get us there?

By "crisis" I understand something like: not only do things like mortgages and car loans freeze up, the kinds of credit necessary for the continued functioning of the economy -- literally -- freeze up. The kinds of short-term loans that people need for basic, day-to-day functioning. I imagine it being, for the economy as a whole, what happens to an engine without oil.

If not passing this would produce that, then we should pass it. If not, not. Everything depends on your assessment of risk. And assessing it right is above my pay grade.

[John Thullen]

Me too, Russell, me too.

You go.

Man, I'm gonna go listen to some Aretha Franklin.

[Gary Farber]

Alternatives.

[Nell]

Chain, chain, chaaaaiiiinnn...

[Incertus]

If not passing this would produce that, then we should pass it. If not, not. Everything depends on your assessment of risk.

Seems to me that it's in everyone's best interests if we don't pass anything quickly. Okay, that's not quite accurate--the people at the top who got us into this mess will benefit if we panic and throw a blank check at the Bush administration. But no one with any sense wants a crash, so the best thing to do is just slow down, take a breath, and try to figure out a plan.

The one question that I've asked since last week that no one has been able to answer is this--what if no one will loan us the money to bail out the system? Let's face it--we're not a good risk right now, and everyone knows it.

[thoreau]

Well, in all fairness, by the time this is done we really might not have any money left for national healthcare. $700 billion here, $700 billion there, pretty soon it's real money.

But, yes, if I ever again hear a Republican say "Oh, we can't afford that!" in regards to any sort of social spending, I'll beat the crap out of him. And I say that as somebody who is skeptical of a lot of social spending. Whatever I may think of any social spending, I don't want to hear another word out of the mouths of Republicans on, well, anything, ever.

[ThatLeftTurnInABQ]

what if no one will loan us the money to bail out the system?

If we can't raise it from taxes, and we can't borrow it, then we'll have to print it. Not that this would be inflationary or anything. Nor would it have any effect on interest rates - I'm sure the whiz kids have it all figured out. Besides, I'm sure the Chinese will be happy to loan us the money via the front door (Treasury) to bail out the banks which they are invested in via the back door.

Maybe we could cut out some of the paperwork and overhead if we just all made out a $7,000 check and sent it to Beijing. I'm sure they would be willing to work out a payroll deduction plan for those of us who can't fork it over as a lump sum.

But no one with any sense wants a crash, so the best thing to do is just slow down, take a breath, and try to figure out a plan.

word on that.

One thing that hasn't made a lick of sense to me since this TARP plan was first announced, is why it tacks off in such a different direction from the AIG bailout.

The consensus I read on the econ/finance blogs is that AIG was very much more dangerous a collapse than that of Lehman from the standpoint of being the possible trigger for a systemic failure, because they were counterparties on such a large volume of credit default swap contracts. In other words, of all the firms on Wall St., AIG was one of the worst in terms of systemic risk.

So if a bridge loan and an orderly liquidation was good enough to manage one of the most dangerous firms in this crisis, why is a bald faced giveaway with no strings attached all of a sudden needed now?

I can't think of any rational reason for it that is even remotely connected with the public interest. I can think of a consipracy theory, which is that this has everything to do with Goldman Sachs being more equal than the others - the sudden sense of panic and "do it, do it now, don't stop to even think for a moment" is because GS is looking at bad numbers internally, and they can pull way more strings than the other IB's.

Note this story which recently broke that both Goldman Sachs and Morgan Stanley have given up the investment bank business model and are going to convert into commercial bank holding companies. This story is getting really complicated really fast.

[ThatLeftTurnInABQ]

It also looks like the TARP plan is already mutating (metastasising?):

Bloomberg: U.S. Treasury Widens Scope of Plan to Buy Bad Debt

The U.S. Treasury submitted revised guidance to Congress on its plan a day after first submitting it, as lawmakers and lobbyists push their own ideas. Officials now propose buying what they term troubled assets, without specifying the type, according to a document obtained by Bloomberg News and confirmed by a congressional aide.

The change suggests the inclusion of instruments such as car and student loans, credit-card debt and any other troubled asset. That may force an eventual increase in the size of the package

...

In another change today, the Treasury said it would limit its $50 billion plan for insuring money-market funds to those held by investors as of Sept. 19, excluding any subsequent contributions.

Bankers React

The American Bankers' Association, which had expressed concern about the plan last week, praised the move, saying it would eliminate an incentive for savers to shift out of bank accounts into money-market funds. The Treasury put no limit on the money-market fund insurance, while the Federal Deposit Insurance Corp. protects bank deposits up to $100,000.

``If all money market mutual funds had been included with the government guarantee moving forward, this proposal would have threatened to take money out of local FDIC-insured banks,'' Edward Yingling, president of the ABA in Washington, said in a statement.

OK this is a bad symptom of a meta-level problem. Our financial system has in a sense grown organically over a period of years and decades, and it is very difficult to change the rules in one place without creating a ripple effect elsewhere. But the haste with which these changes are being made means that little thought appears to be going in to what these second order effects may be, until after they pop up as problems or somebody notices just in time.

See here and the update here for an example of how complicated it gets when you just start making up new rules in an ad hoc manner. And the thing is, due to the exploitation of arbitrage, our financial system doesn't have any systemic slack left in it - every part is connected with every other part in some fashion or another. From a systems theory standpoint that is how you make something really rigid, brittle, and maladaptive with respect to sudden changes. Not the kind of system that it is a good idea to just randomly poke in different ways.

The law of unintended consequences is waiting, and in our rush to do something we may trigger the very systemic instability that we are trying to avoid. This is starting to feel like a set of scenes from Jurassic Park.

...

In its latest guidance on the bad-debt fund, the Treasury said firms that are headquartered outside the U.S. will now be eligible.

jp,

Does that answer your question from earlier? Sounds like everybody gets to line up for ice cream and a pony. Funny how the GOP fear and loathing of foreigners doesn't apply to banking bailouts.

[zinnia]

Just found this blog through a search for details of Obama’s Senate record. Thanks hilzoy--I will share your post from 2-4-08 with all those undecideds who believe McCain's lies about Obama's lack of experience.
This bailout is a foreshadowing of the consequences of McCain's proposed healthcare plan. He wants to put American people at the mercy of the private healthcare insurance industry.
“McCain’s plan changes the incentives for purchasing in the employer market as compared to the individual market. This change will lead to destabilized employer pools and fewer employers offering insurance” (EPI Policy Memorandum #126Under)
Under McCain’s free market plan, the insured would eventually be forced to buy there own insurance. Imagine what the piranhas of that industry would do left unregulated. Perhaps he has an underlying motive of covert population control and a survival of the fittest agenda.

[Graham Bell]

This is a colossal gamble; maybe the biggest gamble ever.

Hope it works.

If it doesn't work, and the United States descends into chaos .... would you Americans kindly consider fleeing to Australia rather than elsewhere? The climate is generally mild, apart from droughts, floods, bushfires [wildfires], storms and cyclones [hurricanes]; blizzards are very rare and confined to a few shires [counties/parishes]. We speak a dialect of English here; we do have have a few strange laws and customs but they're not intolerable. And we do welcome refugees who seek to make a new start for themselves.

Good luck.

[Mike Schilling]

I will either dissolve in laughter or bite their heads off. I don't know which.

Why not both?

[Tony P.]

Hilzoy comments: I think the question is: how close are we to genuine crisis? Will any sign that a deal won't go through get us there?

How close were we to a WMD attack from Saddam? Was giving Dick and Dubya a blank check the only way to avert the threat?

Look: a financial catastrophe, unlike a physical catastrophe, is reversible. If your doctor amputates the wrong leg, that's a physical catastrophe -- and you still need the diseased leg amputated. If your doctor accidentally bills you for a heart transplant when all he did was cut off your leg, that's a financial catastrophe -- but you can get your money back eventually, albeit with a lot of fuss and bother that should never have been necessary.

So, even if the looming catastrophe is as certain as Saddam's WMD were improbable, it is more in the nature of an impending billing error than in the nature of an impending nukular explosion. There is no excuse for a panicky, blank-check response.

To be fair, my argument cuts both ways. A stupid, unfair, rip-off of a bail-out plan would also be a merely financial catastrophe. A President Obama could set about unwinding it, as of next January.

Or conceivably actual mobs, with actual torches and pitchforks, could take on the job. Better to avoid that kind of fuss and bother, by taking the time to make a sensible bail-out plan in the first place.

--TP

[John Spragge]

Allow me to point out that when Wile E Coyote grabs onto a rock to stop from falling into the canyon, he always ends up under said rock when they reach the bottom.

In other words, it seems to me that either this panic stricken plan will make the problem go away by painting the seal of the US Treasury on a bale of toxic securities (good, until you have to pay it back) or the smell of those securities will seep right past the Treasury seal (bad, way bad. seriously bad. Walmart and Coca Cola going belly up bad.)

[John Spragge]

And Hilzoy... forgive me if someone else has suggested this, but if this mess goes through, I think every American who gets stuck with the bill has the right to ask for footage of the kitchen counter-tops of every chief officer of every affected bank (google Graeme Frost). On a special blog feed. 24/7.

Oh, and one other thing. Drug tests. You can't get a job at Walmart or a sub-poverty level welfare cheque without a drug test, so I think the people who get stuck with the bill can reasonably expect to see the people responsible for this fiasco (and the main beneficiaries of an umpteen hundred billion dollar bailout) made to pee in front of a witness, just like normal people have to. Then test for any and all metabolites, traces, and other illegal substances. And put the results on a special blog, with a live feed of any applicable stocks or pillories.

[Charles Hicks]

This whole bailout is the largest "taking" this world has ever witnessed. Now add to that the ability for MS and GS to participate as a "bank" and the foriegn banks to have the same access to our tax dollars..... it is criminal. Nobody in their right mind can believe this is $700B. It is more like $2Trillion and will still not solve the problem. What happen to the free market system. A very sad day for America!

[Graham Bell]

Charles Hicks:

No. That's not the Very Sad Day for America.

The Very Sad Days for America have already happened.

The first when Caligula's Horse got "elected" by the hanging chads of Florida. Where were the impartial vigilant United Nations Observers when that was allowed to be committed?

The second was EITHER when a tiny bunch of renegade war veterans swiftboated your Vice Presidential candidate and thereby allowed The World's Greatest Strategist [??] to win a second term OR the eighth day after Hurricane Katrina ... take your pick.

Self-inflicted Very Sad Days.

Okay, two strikes. What are you yourself going to do to try to prevent a third Very Sad Day for America?

[FlyOnTneWall]

Hilzoy writes:

By "crisis" I understand something like: not only do things like mortgages and car loans freeze up, the kinds of credit necessary for the continued functioning of the economy -- literally -- freeze up. The kinds of short-term loans that people need for basic, day-to-day functioning. I imagine it being, for the economy as a whole, what happens to an engine without oil.

If there's any lesson to be learnt from the present crisis, it's that the ability to represent outcomes in mathematical form does not, in fact, lend such predictions mathematical certitude. That is, for the past few decades (since the econometric revolution became fully ascendant), economists have tended to represent themselves as more closely akin to scientists than to social scientists, disdaining qualitative work as insufficiently rigorous and exalting quantitative approaches. Much of what the discipline has produced in that time has been valuable. And economists from Krugman to Sachs to Levitt have captured the public imagination by using the tools developed by their profession in the realm of public policy, offering the long-sought grail of predictability in policy prescriptions. But the central promise proffered by the discipline, that mathematical models validated against the past can be used to predict the future, has proven fatally flawed. So let us acknowledge, openly and forthrightly, what is now plain as day - that economists, like other social scientists, are very good at understanding the past, can often apply those lessons to the present that the past produces, and tend to be good at prognosticating the future only to the extent that it resembles the past.

Where am I going with this? Hilzoy suggests that we intervene only if the alternative is catastrophe. I'm suggesting that this is inherently unknowable. We've never been at this impasse before; we have no way to predict, with any degree of certitude, what happens next. Is the alternative to the federal acquisition of bad assets a "crisis," as Hilzoy defines it? I would suggest that there is a decent possibility that, in fact, it is. Others on this board have suggested that it is not the only possible outcome, that it is not the most likely of outcomes, or that it will be the outcome irrespective of the proposed intervention. The first two arguments are unpersuasive to me - it's akin to someone telling me that the bomb in my backyard may not detonate, or even that it is more likely than not to be a dud. I'd still rather pay to defuse it, even if it costs me a fortune. (This is not, contra Tony P, an "impending billing error." If financial institutions across the world actually collapse, the result will be Depression.) The third, advanced by Krugman, DeLong and others, is more interesting. They suggest that since the ultimate aim of the Fed is to preserve the solvency of financial institutions, it's possible that simply buying the assets at market prices won't suffice to keep them solvent. So, they write, either the Fed is actually going to use this program to pump cash into the institutions in a gigantic give-away, or the whole plan is ill-conceived. Well, perhaps so. Clearly, the authorities are making this up as they go along. But the truth is, none of us have that crystal ball of predictive certainty. And there's a decent chance this will work. I'm willing to take that chance.

Now, as to my critics on this board. I'm not endorsing the Paulson Plan as it stands, just pointing out that the Congress has (effectively) no choice but to pass its central element. I understand the temptation to indulge in high moral dudgeon - the ineptitude, greed, and insincerity of free market ideologues is now on full display. So let's pause for a moment of schadenfreude. Feel good?

Now, with that out of the way, I'm hoping that one or more of the posters who launched into me for daring to suggest that government is sometimes better at providing solutions than the free market will care to engage my central suggestion - that in addition to whatever petty humiliations and prospective limitations we place upon the titans of finance, we also take affirmative action to relieve the underlying economic crisis which has brought us to this point. I don't know of any financial analysts who believe that foreclosure is more cost effective than meaningful restructuring (that is, writing down the balance to the present value of the home) or short-selling (selling the house, giving the proceeds to the bank, and writing off the difference). In either case, on average, the bank will get more of its money back. These ideas terrify those in the financial sector for two reasons: they lack the infrastructure to implement them, and they lack the tools to predict their impact accurately. Well, the government isn't similarly disadvantaged. It doesn't have to produce accurate valuations for these assets -it can wait to tally things up after things are over. And it has a wealth of experience in administering the kind of bureaucracy this sort of operation would require. There's an analogous suggestion being mooted in the House Judiciary committee - empowering bankruptcy judges to do the same sorts of things. But the dockets in those courts are already overwhelmed by filings; the process is drawn-out and expensive, and it permanently ruins the credit of those who file. It'd be far more efficient to restructure the loans on the front end than to force people into the court system to accomplish the same thing. That's not to say the bankruptcy reforms are a bad idea - they're necessary for those loans that will continue to be held by private corporations. But if it's worth doing that way, it's certainly worth requiring the Fed to do the same with the hundreds of billions of dollars of loans that it's now acquiring.

Anyone care to engage with the substance of the suggestion?

[hilzoy]

Tony P: "How close were we to a WMD attack from Saddam? Was giving Dick and Dubya a blank check the only way to avert the threat?"

This is, of course, the problem with crying wolf. It does not mean that there is no wolf this time. I do not for a moment trust Dick Cheney's word on this. But there are a number of other people, outside the administration, who are terrified.

"Look: a financial catastrophe, unlike a physical catastrophe, is reversible."

It's reversible in this sense: after it happens, and a whole lot of people are thrown out of work, lose their homes and their savings, move into their cars with their kids, lose their health insurance and possibly die, etc., the economy can shudder back into motion.

For any one person who has lost everything, it might or might not be reversible. It will certainly take time to, say, get a new place to live, find another job, etc.

With respect, because I like Tony P, this reminds me of the time back in the 80s, when I lived in MA, and William Weld, who was then running for governor, proposed eliminating I forget which major program. Someone asked him whether he had seriously considered the risk that a whole lot of people would become homeless, which was, iirc, a pretty serious possibility, given the program in question. He said: well, if that happens, we'll just put it back in place again.

But being thrown out onto the street with your family is not something you can just undo, I thought then. Same now.

[FlyOnTneWall]

I appear to have been outpaced by events. The morning papers are now reporting that the House plan would "require the Treasury to use its status as the new owner of billions of dollars in mortgage-backed assets to reduce foreclosures by forcing banks to rewrite loans for distressed homeowners and forgive a portion of their debt." Even Paulson is now on the record supporting at least the general outlines of that idea.

We'll have to wait until the actual legislation is publicly available to see whether the plan, in its present form, goes far enough. But at least the Democrats are thinking about this constructively. The second of the three main planks of their emerging platform seems equally wise - requiring the GAO to set up shop over at Treasury, and to keep an eye on what's happening and report it to Congress. Great idea.

It's the third element of this that makes me nervous. Executive compensation is a disaster. There's no longer any doubt about this. It siphons off a non-trivial amount of corporate profits that might otherwise devolve to shareholders, be reinvested, or otherwise benefit the broader economy. It creates perverse incentives that have had catastrophic consequences. I'm all for an overhaul of executive compensation. But if we need new rules, why limit those rules to the firms seeking a bailout? If they're a good idea, they should be imposed across the board. If they're a bad idea, they shouldn't be imposed at all. But this halfway measure is pure political theater.

There's a time and a place for political theater; I have no objection to exposing the hypocrisy of the GOP on this issue, nor to reminding working Americans which party is actually on their side. But if the plan, as proposed, passes, it will create a new set of perverse incentives. If the problem it proposes to rectify is that corporate executives often place their own enrichment above the welfare of the company or the interests of the shareholders they purport to represent, why on earth would we want to drive a new wedge between the interests of executives and those of the public? The Democratic plan is based upon the presumption that executives will forego their pay in order to take part in the bailout. Sure, that's what they should do. But what if they don't? What if they'd rather risk bankruptcy than take a pay cut, even if that puts the broader economy at risk? Moreover, imposing these restrictions only on the most crippled firms is simply likely to accelerate their decline. Since solvent firms not participating in the bailout won't have to abide by the restrictions, they can woo talent away from any firms that do agree. It's not improbable that a few months down the road, despite the expenditure of hundreds of billions, the competitive disadvantage being imposed on these firms would result in their ruin, and we'd be back where we started.

To recap: Restructuring loans is a good idea. Opening a GAO branch office at Treasury is a good idea. Restructuring executive compensation is a good idea. But restructuring compensation only at firms that participate in the bailout? A very bad idea indeed.

[liberal japonicus]

FotW
Thanks for your comment. I'm not an econ guy, so please take this with the appropriate NaCl

They suggest that since the ultimate aim of the Fed is to preserve the solvency of financial institutions, it's possible that simply buying the assets at market prices won't suffice to keep them solvent. So, they write, either the Fed is actually going to use this program to pump cash into the institutions in a gigantic give-away, or the whole plan is ill-conceived. Well, perhaps so. Clearly, the authorities are making this up as they go along.

But the suggestions they make aren't simply negations of buying assets at market prices, they inject various ways to insulate the government from getting sold all the lemons. Rather than simply bailing out the various companies, they give the government a stake in those businesses.

Now, as to my critics on this board. I'm not endorsing the Paulson Plan as it stands, just pointing out that the Congress has (effectively) no choice but to pass its central element. I understand the temptation to indulge in high moral dudgeon - the ineptitude, greed, and insincerity of free market ideologues is now on full display. So let's pause for a moment of schadenfreude. Feel good?

Actually, no. Negotiation can only take place if one of the participants can walk away. You are saying, well, you (the gov) can't walk away, so you really can't dictate any conditions. This inverts who is asking who. If these companies are willing to threaten a global depression if they don't get their way, then they need to be told in no uncertain terms something like 'we know where you live'. You think this is spite, but I think it is putting some limits that should have been put on these companies long ago.

I asked earlier "Can I read you as saying that some intervention is necessary, or are you saying that it has to be in the form of a bailout? " I read you as saying, well, we don't really know what is best, so we best go for the bailout. If I am misinterpreting you, I hope you can explain to a non-econ guy why a debt for equity swap is not possible (elmendorf/Buitler) or why a bill must necessarily leave out regulatory reform (cf demands for a 'clean' bill) or why the government shouldn't step up and order these companies to stop paying dividends for a period of time, thereby eliminating that as a signal of strength or weakness, or put rather punitive conditions on the bailout so that only those companies that truly need it request it, rather than everyone lining up to dump their toxic assets on the US government.

Again, I'm not the best guy for putting these thoughts forward, but what seems to be the accusation that it is simply spite that is driving everyone on the board but you to reject this seems a bit implausible, though, given the level of anger, I don't rule it out. But I'm really looking for some explanations for why the other proposals just won't fly. Thanks.

[liberal japonicus]

Whoops, we crossposted, FotW. Thanks for the link, I'm off to figure out what it means. Any pointers to good explanations are appreciated.

[Donald Johnson]

"I understand the temptation to indulge in high moral dudgeon - the ineptitude, greed, and insincerity of free market ideologues is now on full display. So let's pause for a moment of schadenfreude. Feel good?"

Speaking of temptation, try to resist the temptation to be condescending. You wouldn't have so many people jumping down your throat if hadn't started off throwing around words like "petulance" and had stuck to substance.

And speaking of that, I have nothing to contribute, so I'll go back to lurking.

[Doctor Science]

You say "petulance" and "high moral dungeon", I say "deterrance."

Stanley Hauerwas is a great theologian, scholar, ethicist, and proponent of non-violence. In Performing the Faith: Bonhoeffer and the Practice of Nonviolence he argues against the "capital punishment has a deterrant effect" position, by saying (paraphrased), "if we really wanted to see effective deterrance, we'd have public executions on Wall Street for insider trading, and it would probably work."

I'm sure Hauerwas is being ironic and doesn't *really* believe in capital punishment for white-collar crime, but I think there's a lot to be said for direct, shaming punishment of wealthy malefactors. It's the Stan Lee principle for avoiding moral hazard: "With great power comes great responsibility, and also serious personal consequences when you f*ck up."

Vengence and schadenfreude are all very well, but what I want to see is some *deterrance*.

[zinnia]

A country that can not manage it's own economy has no business engaging in nation building. Why would Iraq or any other country be interested in following our brand of democracy if this is where it leads?

[KCinDC]

Doctor Science, the scum running things nowadays got where they are partly because they have no capacity for shame. Shame isn't nearly as effective as a deterrent nowadays. Would the Bush administration have done half the things it has if the people in it cared what other people thought of them? (See Kung Fu Monkey on shame.)

[jwo]

TLTABQ: "But the haste with which these changes are being made means that little thought appears to be going in to what these second order effects may be, until after they pop up as problems or somebody notices just in time."

Isn't this pretty much how the Bush Administration has done everything? I have been deeply angry about the power and money grab that is this Admin., but the anger is now at almost unbearable levels. We are a nation of idiots if we re-elect a Republican now, especially if it is because he is not a black man! And we are a nation of idiots if we let them steal an election again without hitting the streets. Our passivity for the "good of the country" has been of little benefit to date.

[russell]

So let's pause for a moment of schadenfreude. Feel good?

I have no particular problem with the specific proposals you've outlined for addressing the financial problems we face. Like others here, I'm not an economist, and am perfectly happy to admit that the details, by and large, go over my head. I'll look forward to discussion by the brighter lights here to flesh out my understanding of the fine points. But the suggestions you make seem reasonable, and I appreciate them.

But when you use terms like "petulance" and "schadenfreude", and ask us if we "feel good" after indulging our little fit of pique, you seriously misjudge the depth and strength of the anger that lots of folks feel. There is nothing whatsoever trivial about it.

Contrary to my somewhat combative persona here, in real life I'm an extremely easygoing guy. Comically so, even. I can find a way to get along with pretty much anyone, and I don't look for fights. But I can't have a meat-world discussion of anything having to do with public policy anymore, because it just makes me too angry. I just end up wanting to yell at someone. That's kind of rude, so I just STFU and walk away. ObWi is my outlet, otherwise I'd probably have to kick the furniture.

And I'm a pretty lucky guy. My wife and I are far from underwater on the house, we can cover our mortgage from one of our incomes if need be, we don't have outrageous credit card debt, we own our cars outright. I have a good, solid job and my wife has a good consultancy business in retail marketing and private and commercial space planning. We're fine.

If I were actually losing my house, or my job, or if I was relying on my savings for income, I'd be getting close to Naugatuck Bomber territory right about now.

What we see now is the failure of government to safeguard the interests of the public, because it has been corrupted by decades of co-opting by the financial industry. The demotic term for that is "getting screwed".

People are tired of getting screwed.

I won't belabor this any further, but believe me when I tell you that what you see in the reactions of folks on the left and elsewhere is neither truculence nor schadenfreude.

It is anger, and it is well earned. If the folks who are trying to find a solution right now are wise, they will give that anger the respect it deserves.

I would, personally, appreciate it if you were to do the same.

Thanks -

[jwo]

I agree that shame is not likely to work, especially as long as they still feel so insulated from the effects of their actions. Hit them in the pocketbook. Money is the only thing that matters to them, for money represents power, sex, and all the good stuff and sets them above the rabble. In a total economic collapse, I wonder if that money would still insulate? If money has no worth, and we became a barter economy, what would these fools have worth bartering for?

[Gary Farber]

"You say 'petulance' and 'high moral dungeon,' I say 'deterrance.'"

"Deterrence" would be better. :-)

Also, "dudgeon," not "dungeon," which makes no sense at all.

[ThatLeftTurnInABQ]

FlyOnTneWall,

I don't see anywhere that you've addressed the objection which I've raised multiple times now (and made a concrete counterproposal regarding) that the TARP plan as proposed by Paulson does not dilute existing shareholder equity (and give the Treasury a chance to recoup some costs by selling that equity when the crisis is over).

If you've already addressed that then I apologise for missing it, but I don't see it. Could you please address this specific point. Why are you in favor of a plan which leaves equity untouched (in notable contrast to the way the AIG loan was collateralized against equity).

I think I have a reasonable grasp of the systemic failure risks here (I’ve been following many of the elements of what has become this story for over 2 years now and have known for most of that period with some certainty that something very much like the present situation was highly likely to occur at some point in the near to mid-term future). I take those both those risks and the consequences which they have the potential to impose on ordinary people very seriously (hilzoy is right, a lot of those consequences will be irreversible, IMHO). If I thought that the TARP plan was our only chance to avert them then I would be in agreement with you that spending the money, distasteful though it may be, is the right thing to do.

But it seems to me that the primary shareholders and management of the Wall St. firms most at risk do not in fact regard these risks nearly as seriously, either that or they are deliberately playing a game of “chicken” with the government and the people of the US in order to extort money from us.

The reason I think this is that this plan is not the only possible route to recapitalizing these firms. A sufficient surplus of private capital is available from other sources, both from individual investors and institutional investors such as SWFs to do so, if the terms are attractive. That capital can and almost certainly will flow into these firms as soon as they do two things: (1) open their books to scrutiny, and (2) accept a dilution of present equity shares at a fair market price. If they are willing to be effectively bought out at a fair price, we can defuse this crisis the old fashioned way.

The need for a government handout (which is what this is*) comes because these firms are unwilling to swallow this bitter pill. It isn’t that they can’t, they just don’t want to. The systemic risk is not just a fixed element in the landscape, or the product of decisions made in the past which now cannot be unmade, it is also a product of bad decisions being made right now in the present. Bad in both senses of the word: improvident and immoral, the latter because these firms are using both their lobbying power with the US govt (in the case of Goldman Sachs this includes having their former CEO be the architect of the plan) and their custody of a system at systemic risk as negotiating leverage to extort money from taxpayers.

*regarding the handout aspect – many of the MBS sold to the Treasury under the proposed TARP plan will be those which are based on junior tranches. Judging from your comments already, I assume you have enough knowledge of what that means to understand that these securities are effectively worthless if the default rates on these mortgages run significantly above their historic norms. The evidence that this is what will actually happen is very strong right now. If you think differently and have evidence to the contrary, please share.

[Sam Jaffe]

Hilzoy is wrong about one thing: there are definitely economists who support the bailout. The problem is that they are all employed by Goldman Sachs and Morgan Stanley.

I'm against the bailout, but Obama should see it as the golden opportunity that it is. Explication here:

http://www.gatesofemporia.com

[bedtimeforbonzo]

Hilzoy: "McCain was noncommittal on the administration's proposal, but criticized Obama."

In one of his ubiquitous town hall meetings this morning in Scranton, televised live on MSNBC, I would not call McCain noncommittal. He voiced real concern in giving the go-ahead to a $700 billion bailout on the say-so of one man, Paulson.

That said, while criticizing Obama for being noncommital on the Paulson plan, McCain did not offer an alternative, as far as I could tell. Classic McCain: You're wrong and I'm right even though I won' tell you why.

---

Nell on Paulson: "He's saying the sky will fall if he isn't handed unconstitutional absolute power over $700 billion dollars right now."

This is the problem I have with Paulson -- and Schumer and his fellow Congressmen who told us how the air was sucked out of the room when Paulson told them how dire the situation was.

That Bush gave the bailout such a quick stamp of approval seems to be all I need to demand Congress proceed with caution.

If they have the nerve to ask us for the $700 billion, then they damn well ought to tell us just how bad the situation is. Let us know just how f---ed up the financial situation is and who are the culprits.

I haven't had time to read Hilzoy's links -- or read this thread as carefully as I would like -- and have a hard time reading this financial stuff without my eyes glazing over, but it's incumbent the Bush administration and Congress to put forth an explanation as to why this bailout means life-and-death for our economy.

And if he hasn't already -- I've been busy with work and football -- Barack Obama needs to get out in front of this subject, and any and all issues that will make our economy better or worse.

[Tony P.]

Hilzoy says (and TLT echoes) the point that financial damage is not really 'reversible'. That's true, of course, because time only flows one way: if you end up living in your car for a year you can't get that year back. On the other hand, if you go for a year with a net worth of a mere million dollars when, in a just world, you would have been worth two ... well, that's different, IMHO.

Those two kinds of "irreversible" pain are related in this crisis. Why might you have to live in your car for a year? Because you could not pay your mortgage. Why would the other guy's portfolio lose a million dollars? Because you could not pay your mortgage.

There is absolutely no reason why anybody should have to live in his car for a year. There is no shortage of actual houses. The only thing there's a shortage of is mortgage payments. The TARP plan seems to be an effort to keep up the pretense that the second guy's portfolio really is worth two million dollars. That's the irreversible pain TARP seems exclusively concerned to prevent.

And what's the point of preventing that kind of pain? Why, to "get banks lending again". Presumably, lending to people who are still able to pay their mortgages. Those people are obviously not carrying enough debt. Yet.

--TP

[ThatLeftTurnInABQ]

I'm glad to see that I'm not the only one asking that we take an equity share in the firms which are to be bailed out. Sen. Chris Dodd is too:

Sen. Dodd's plan would not allow the Treasury Department to purchase any assets "unless the Secretary receives contingent shares in the financial institution from which such assets are to be purchased equal in value to the purchase price of the assets to be purchased."

My friends, that is a bailout we can invest in.

[Jon H]

Financial institutions often maintain significant art collections.

I'm just sayin'.

[FlyOnTneWall]

TLTIA:

Fair enough.

Let me take a stab at the objections you raise. I am indeed opposed to plans that would grant the government equity stakes in these private firms - not because I am uninterested in minimizing taxpayer risks, eager to dole out unearned subsidies, or unaware of the potential for appreciation. No, my opposition stems from the fact that giving government an equity stake in private enterprise is rarely a wise move. Consider, if you will, the implications. If the government's ability to recoup its investment is tied to the market valuation of these firms, then there emerges a clear incentive for the government to pursue policies that will lead to the enrichment of these firms, and hence the appreciation of its stake. Further efforts at reform would present a difficult dilemma: should the government act to protect the public, even if doing so would devalue its stake in these firms, or should it act to protect its holdings at the expense of the public? It will be difficult enough to force reforms through Congress, and perhaps over Bush's veto, without Republicans pointing out (correctly) that these reforms will cost the taxpayers billions in equity. We've gone quite far enough down this road already. I'd push for the complete nationalization of Fannie and Freddie, and for an early divestiture of AIG. When federal revenues get tied to the success or failure of individual enterprises, ordinary Americans almost always lose out, whether as taxpayers on the one hand or as consumers on the other.

Which is not to say that I support the creation of a situation in which a taxpayer bailout leads to a windfall for these companies. I simply oppose the simplistic solution being proffered by some economists - elegant in theory, disastrous in practice. There are better solutions available. The key, I believe, is to ensure that the government doesn't become invested, literally or emotionally, in the success or failure of any group of institutions at the expense of others. And, I might add, we ought to be recapturing the windfall profits at all of the firms that don't benefit directly from a bailout, but which will see their stock prices soar as a result of the intervention. That, after all, is what happened at AIG - our intervention there rescued unknown numbers of other firms that were exposed to counterparty risk. But whereas AIG will eventually be put up on the auction block and sold off to cover the bailout, the firms that benefited the most got bailed out for nothing. I'm afraid that demanding equity stakes or other compensation from firms participating in the cash-for-assets swap would lead to a similarly perverse outcome - that those who benefit the most from the continued solvency of these giants may be other actors, who get bailed out for nothing.

So I think we need policies that are broader in their scope, and which preserve, as much as is still possible, the ability of the government to act impartially as a regulator. The best place to start would be the tax code. Simply adjusting the top marginal rate upwards would be a good first step. Next, change the tax code to treat private equity and hedge fund gains of professional managers as income (35%) and not as capital gains (15%). And, for good measure, let's start thinking about a new set of fees imposed upon the banking sector, to cover the costs of the vastly enhanced regulatory oversight that it so clearly requires.

If I may, I'd like to (politely) disagree with your assessment of the current impasse. You suggest that if these firms were simply willing to open their books and mark their assets down to fair market value, they would see a rapid inflow of equity that would enable them to recapitalize. Well, that's what happened earlier this year, when sovereign wealth funds stepped into the gap and snapped up stakes in several prestigious firms. There's a reason that these firms are willing to contemplate the unthinkable - Goldman and Morgan reincorporating as bank holding companies, diversified banks accepting government intervention. The problem is that they hold assets of enormous value on their balance sheets, and no one really knows how much they're worth. All previous estimates have proven to be so grossly flawed that the assets have come to be viewed as toxic. And since they're not trading freely in this illiquid market, we have no 'market value' to which to mark them. Ordinarily, the price falls until a buyer appears. But with the credit markets in their current dysfunctional state, no potential buyer would be able to arrange the necessary financing. It's an impasse. Buyers won't take new stakes in the banks as long as they hold these assets of indeterminate value; without recapitalizing the banks, the credit system remains frozen; and with a frozen credit system, no one can purchase the assets. And the longer the assets sit there, freezing the credit system, the less they're worth, heightening the need for new capital. A vicious circle.

There are no buyers in this marketplace. No one has the cash. Every potential suitor is already overleveraged. And so we've turned to the buyer of last resort: the Fed.

If the plan works correctly, it should look something like this. The Fed makes an offer to the banks pegged substantially below its best estimate of the value of the assets underlying the loans. The banks grit their teeth and accept the offer, giving the assets to the government at less than their worth in order to clean up their balance sheets and resume their profitable business. The Fed, acting under Congressional mandate, moves aggressively to restructure troubled loans, writing down a portion of the balance. Ideally, this will return the loans to conforming status, allowing homeowners either to resume making payments or to sell the home and repay the new balance - thus actually making the portfolio more valuable than it is at present. At worst, the Fed uses some of the difference between what it paid for the loans and what they are worth to cover the costs of the restructuring. Then, over the next several years, as the credit markets resume their orderly functioning and it becomes possible to assign market values to these assets, the Fed sells them back into the private marketplace, covering its initial costs and then some.

(An aside: I don't know how you know what these assets consist of - the rules for which assets even qualify are still being negotiated. These loans aren't worthless - they're simply worth less than they were, or than anyone expected them to be. And they're backed by real assets. So as long as the price being paid is low enough, there's real potential here.)

Think that's far-fetched? I'd point out that one of the most contentious debates unfolding on Capitol Hill is how to handle the eventual profits from the transaction - whether they should be earmarked for the deficit or whether a portion (20%?) should be set aside for affordable housing and the like (initiatives once funded by Fannie/Freddie surcharges). Congress knows that there may be a substantial upside to the intervention, because when you're holding all the cards, you can sometimes drive very effective bargains.

If the program works well, it'll be a win-win - stabilizing the markets without costing the taxpayers. And yes, returning financial firms to profitability. Of course, these things are inherently unpredictable. The Fed's effort to lowball the price of these assets may turn out to be an overestimate of their worth - that's happened repeatedly in the last few months. The economy could collapse, rendering even a good estimate worthless. Or the firms could fail to recapitalize even with these assets moved off of their balance sheets, making this an expensive exercise in futility. Or it could be something else that we can't even anticipate. So what the taxpayers are shouldering here is risk - the costs or benefits of the initiative are unknown. By removing this risk from the banking sector, yes, we'll be bailing it out. But we'll also be assuming the upside potential of these assets at fire-sale prices.

So yes, we need strong oversight; strict guidelines about what can be purchased, from whom, and at what price; and regulatory initiatives to insure this doesn't happen again. But at the end of the day, the windfall profits of Wall Street executives are the least of my concerns. If our economy revives, irrespective of whether the federal government plays a direct role in that revival, people who took unsound risks are going to benefit. That's inevitable. But it's not a reason to hope for economic decline.

[(The original) Francis]

FoTW: If the Fed buys the assets at a discount from what the bank is reporting it to be worth, then we worsen the capitalization problem.

In order to recapitalize the banks, the Fed must overpay. That's why Dodd wants for the taxpayer to have an equity stake.

[LizardBreath]

If the government's ability to recoup its investment is tied to the market valuation of these firms, then there emerges a clear incentive for the government to pursue policies that will lead to the enrichment of these firms, and hence the appreciation of its stake.

Wait a minute. If the government has equity in banking firms, it might shape its policies to enrich them at the expense of the public. Fair enough. So to avoid this, we should hand those same banking firms $700B, no strings attaches, of public money. Huh?

[FlyOnTneWall]

(TO)F:

You write:

In order to recapitalize the banks, the Fed must overpay. That's why Dodd wants for the taxpayer to have an equity stake.

Perhaps so. But the Fed isn't trying to recapitalize the banks. It's moving to take assets of indeterminate value off their hands, by acquiring them, so that others can then step in to recapitalize them. And yes, the larger the loss these institutions are forced to absorb (and mark my words, they will take a loss on every asset they sell) the more capital they'll have to raise. (Although it's not quite that simple in the predominant case of off-balance-sheet assets.) So the Fed will be walking a fine line here, driving a hard bargain, but not so hard as to push these institutions over the brink into outright insolvency. But we've had no indication from policy makers that they intend to overpay for these assets in an under-the-table transfer of wealth to these institutions. I certainly support strong oversight to ensure that such a transfer doesn't take place. By all means, build it into the authorizing legislation. But it strikes me as an unlikely outcome.

What has Dodd exercised isn't that we're recapitalizing the banks without receiving equity in return, it's that we're acquiring their downside risk without their upside benefit. That is, if the plan works as I described above, it will leave these institutions free to accept infusions of equity from third parties, and to return to profitability. In exchange for helping them out, Dodd wants a piece of the action. And, as I wrote above, that's understandable. But even if the plan benefits some singularly unworthy folks, I still think that taking an equity stake (however well deserved) leads to more problems than it's worth.

LizardBreath:

We're not handing "those same banking firms $700B, no strings attached, of public money." If we wanted to do that, we'd write them a check for $700 billion, and say - Here! It's for you, no strings attached!

What Paulson has proposed is that we offer them a deal. They give us their troubled assets, and we give them cash. Will this serve to enrich these firms? Not at first. Without doubt, the Fed will offer these firms less than these firms have said their assets are worth. They will have to accept a substantial loss on each sale. But yes, over the longer term, these firms are likely to recapitalize, recover, and return to profitability. And, if things go well, the Treasury will use its virtually unlimited reserves to hold on to these loans until the market recovers, and then sell them back at a profit.

In other words, the elegance of the proposal is that the firms are left to go their own way, while the Treasury will be left with an interest in the recovery of the market in general, and not in the recovery of any particular firm.

[bedtimeforbonzo]

I need to echo LizarBreath's "Huh?"

At this point, this bailout is starting to sound like the equivalent of a dog chasing its tail.

[ThatLeftTurnInABQ]

FlyOnTneWall,

Thank you for a response.

It looks to me like a maze of contradictory ideas. Don't take that as an attack, I freely admit to at times being guilty of the same defect.

You are (rightly IMHO) opposed to the govt. having an equity stake in firms for fear that in the long run it will create incentives which distort policy making yet you are willing to support an emergency intervention right now which is by definition a gross distortion of policy making. This makes no sense to me.

You suggest that if these firms were simply willing to open their books and mark their assets down to fair market value, they would see a rapid inflow of equity that would enable them to recapitalize. Well, that's what happened earlier this year, when sovereign wealth funds stepped into the gap and snapped up stakes in several prestigious firms.

Yes, and it turned out that the investors involved overpaid during that phase, because of inaccurate information regarding the assets being held by the firms in question. Their books weren’t open enough (I’m charitably assuming that actual fraud was not involved) and the SWFs were too careless in evaluating what they were buying into. That is an argument for greater due diligence, not an absence of available funding under the right conditions (including due diligence). But next time the SWFs will be far more critical in the scrutiny they give to statements made by the firms seeking a capital injection, as well they should.

Why does this lesson not also apply to us, the taxpayers?

If the plan works correctly, it should look something like this. The Fed makes an offer to the banks pegged substantially below its best estimate of the value of the assets underlying the loans.

I believe that Paulson has already let slip that the intent of the TARP plan is the reverse, to recapitalize the banks by overpaying for these assets.

The problem is that they hold assets of enormous value on their balance sheets, and no one really knows how much they're worth. All previous estimates have proven to be so grossly flawed that the assets have come to be viewed as toxic. And since they're not trading freely in this illiquid market, we have no 'market value' to which to mark them. Ordinarily, the price falls until a buyer appears. But with the credit markets in their current dysfunctional state, no potential buyer would be able to arrange the necessary financing. It's an impasse. Buyers won't take new stakes in the banks as long as they hold these assets of indeterminate value; without recapitalizing the banks, the credit system remains frozen; and with a frozen credit system, no one can purchase the assets. And the longer the assets sit there, freezing the credit system, the less they're worth, heightening the need for new capital. A vicious circle.

I’m sorry, but I think this is bad analysis. I don’t buy this explanation that the market for the assets which the IB’s need to sell in order recapitalize is frozen because the securities have suddenly become impossible to price and hence illiquid. If that were the case, then nobody, neither on the Treasury side nor on the IB side, would have any idea what the proposed sale of these assets to the govt. would do to the balance sheet on either side. In which case, how do we know that offloading these assets will in any way help these banks, rather than making them weaker?

An alternative explanation is that the market has frozen because both the sellers and potential buyers have a pretty good idea what these assets are worth, and the sellers are not motivated to sell at that price. The market isn’t illiquid; instead we have a seller’s strike.

How could we test between these two different hypotheses? The salient characteristic of yours is that an absence of information is causing the problem – the illiquidity is coming from the absence of a price discovery mechanism and fear of the unknown. That means there should be a strong negative correlation between disclosed information bearing on the value of these assets and their liquidity.

I find that hard to believe, because the present “frozen” state of the market has hardened into immobility during precisely the same time that a lengthy discovery process has been going on shining light on the details of these MBS assets and fleshing out their risk profile, which was a blank slate when they were originated. There is now much more public information available regarding how the specific pools of mortgages which various MBS are based on are likely to perform than there was a year ago. That should mean that these securities are now more liquid, not less liquid, if missing information is the problem. But in fact the opposite has happened – the more we find out about these securities, the more frozen they become.

Now you could argue that the information loss has occurred because the housing markets are acting in a more unpredictable manner, but that idea does not stand up to scrutiny either. It was during the boom phase of the housing bubble that prices were so far outside the envelope of historic norms as to be essentially unpredictable. Instead what we are seeing now is a reversion to the mean. I can use the long term trendlines in price/rent and price/income to make a more robust prediction today as to what housing prices will be in a given market 12 months from now, that I could 2-3 years ago. And since the refinancing option has been taken away from most homeowners, I can also make a more robust prediction regarding which homeowners will be unable to keep up with their payments as a function of current income, than was the case 2-3 years ago (the answer isn't pretty), because loan default rates are now more purely a function of debt to income ratio than they were at the height of the bubble. In other words, the performance of these loan pools in now more transparent, not less transparent, than when they were orginated.

I submit that the illiquid state of these toxic MBS has come about not because the sellers and potential buyers do not know what these MBS are worth, but because they now know all too well (or at least better than they did before the current phase of this crisis) how little they are worth, and the sellers don’t want to sell at that price until somebody puts a gun to their heads and forces them to do it.

[blizzardofoz]

"There is no shortage of actual houses. The only thing there's a shortage of is mortgage payments."

Why aren't more people saying this? Instead, even skeptical bloggers are eager to concede the "necessity" of a bailout. And yet it should be obvious that a bailout is only necessary insofar as the top .1% actually having to swallow their "poison pill" is unthinkable. We are being lied to, and we are about to be the victims of the biggest swindle in civilization's history.

During the Repub convention we were all shocked as we saw our political discourse fall from the gutter to the sewer. A lot of us wondered how any country could survive this level of corruption from its leaders and ignorance from its citizens. Well, here's the answer. We have become barbarians, and we're going down hard, and faster than any of us imagined.

/apocalyptic rant

[ThatLeftTurnInABQ]

That means there should be a strong negative positive correlation between disclosed information bearing on the value of these assets and their liquidity.

Fixt.

[bedtimeforbonzo]

Fly: "But we've had no indication from policy makers that they intend to overpay for these assets in an under-the-table transfer of wealth to these institutions."

Other than the "overpay" part and the "under-the-table" part -- or for that matter a "transfer of wealth" -- does any of this sound fishy?

As described in the paragraph above, it sounds like the Fed would be enacting a scam to get all of us out of one big scam gone bad.

Or I may be wrong.

[bedtimeforbonzo]

"There is no shortage of actual houses. The only thing there's a shortage of is mortgage payments."

Perhaps taxpayers need a bailout so they could make the aforementioned payments -- if we're giving handouts, let's give 'em to everybody.

[Tsam]

Hilzoy,

When I read your post, describing all the head biting you were likely to be doing, my wife kindly offered to pass you some salt.

(I'm still trying to catch up with the thread. Stayed up late last night to write my Congressfolk.)

[(The original) Francis]

FoTW: The problem with your approach is that the existing equity and debt holders of the institutions don't take their haircut. You are proposing a massive transfer of wealth from taxpayers to people who hold debt/equity interests in banking institutions.

The Dodd proposal is essentially an alternative to bankruptcy, with the taxpayer providing the necessary bridge financing. Once all the SIVs are brought onto balance sheets and toxic derivatives transferred to the US Govt, the US can then sell its shares on the open market. In fact, I'd require that course of action; once an institution can obtain a clean bill of health according to accounting standards to be developed to address the derivatives issue, the US must sell its interests in that entity.

[FlyOnTneWall]

All I can do at this point is direct you to the Dodd Bill. It's actually a fairly sound piece of legislation. It turns out he's not concerned with windfall profits so much as with overpaying for assets. The shares would only vest if the assets turn out to be worth less than the Fed pays. In other words, the clause operates to remove any incentive these firms might have to hold out for favorable prices - if they don't sell the assets at a loss upfront, they'll lose 125% of the difference in equity dilution down the road. That's clever - it protects taxpayers, in case the assets sour. And because of its complicated mechanism, the government's recovery of value isn't really linked to the share price of the institutions. I rather like it.

The rest of the bill looks pretty good, too. Take a look at the actual proposal; let me know what you think.

[Tony P.]

Perhaps taxpayers need a bailout so they could make the aforementioned payments -- if we're giving handouts, let's give 'em to everybody.

You gotta be kidding, bedtimeforbonzo. Sure, if Paulson's plan was to give individual Americans money to pay their mortgages with, the "liquidity" problem would instantly disappear. All those mortgage-backed securities would be worth what the investors thought they were worth. The investment bankers' balance sheets would look jim-dandy. Nobody would need to "recapitalize".

Problem is, even Americans are not stupid enough to buy the notion that they (as taxpayers) can afford to pay the mortgages that they (as borrowers) cannot afford to pay. It's too simple, too obvious.

No, the grown-up solution is to make it all sound very complex, so that only financial wizzes can understand the problem. Financial wizzes are smarter than the average American. Financial wizzes are smart enough to outwit themselves.

--TP

[Looper]

As I recall, the Bush tax cuts for the rich cost us about $1.6 trillion. It seems to me the cornerstone of the bailout plan should be reversing those cuts and increasing the tax rate for the very rich. It's the high-fliers who profited from the Wall Street casino, and they should bear the brunt of the bailout.

[bedtimeforbonzo]

Looper: That's what I found outrageous about what I heard from the televised part of McCain's town hall meeting today. Once again, he said raising taxes will do more harm than good. Fine. So I suppose Republicans figure we can finance this $700 billion bailout of Wall Street AND lower taxes. And this is what McCain calls Straight Talk?

Bullshit.

Call it for what it is: corporate welfare.

[KCinDC]

I think the McCain plan is to oppose whatever bill appears, regardless of its provisions, and paint it as Bush and the Democrats bailing out Wall Street at the expense of Main Street (I just heard Gingrich selling that story on NPR).

It remains to be seen whether McCain's people and the media listening to them will be able to keep a straight face during this depiction of McCain as the populist hero bravely facing down special interests whose lobbyists populate his campaign.

[liberal japonicus]

There are no buyers in this marketplace. No one has the cash. Every potential suitor is already overleveraged. And so we've turned to the buyer of last resort: the Fed.

There are buyers, we just might not like who they are.

[vida]

"So I suppose Republicans figure we can finance this $700 billion bailout of Wall Street AND lower taxes."

Amazingly, they don't seem to have the slightest concern for future generations. Whether its saddling them with $10 trillion of debt, or global warming and other environmental degradation, somehow they just don't care. The only sense I can make of it is that they are counting on the "Great Bailout from the Sky" aka Second Coming, so none of it matters? Somehow we have to elect adults again.

[FlyOnTneWall]

lj:

Those are good examples. Remember, Lehman couldn't find a buyer, so it had to file for bankruptcy. That allowed it to ditch its non-performing assets. On a stand-alone basis, its operating units are extremely attractive, and were quickly snapped up, as you point out.

So, actually, I think you've illustrated my point. As long as they're encumbered by these assets on (or off) their balance sheets, Wall Street firms are going to be unable to raise fresh capital. Remove the assets from the equation, and they'll get snapped right up.

[Graham Bell]

Blizzardofoz and Bedtimeforbonzo:

You've both hit the nail right on the head.

Here in Australia [where we have our own problems caused by corporate welfare and by neglect of duty] almost all we get to hear about are the comings-and-goings in Wall Street or The Fed or The White House.

Our news[??] media here protects us from distressing stories of decent American families having to run away from what were formerly their own houses, of hard-working employees being retrenched from efficient firms, of swindlers being rewarded for cheating the public.

Okay then. What would be so wrong with filling all those empty unsaleable houses with those evicted, forced to relinquish their equity or just plain rendered homeless by the "sub-prime crisis".

Don't try to tell me that doing so wouldn't have at least a better chance of saving the American economy [and the the United States as a sovereign nation] than chucking between $7 billion and $3 trillion at the same bunch of boofheads who got you into this calamity into the first place.

There is a clear fork in the road. Surely you don't want to go down the one that leads inevitably to chaos, ruin, famine and "conquest by cheque-book", do you?

By all means raise that huge amount of money .... but spend it wisely and where it will do the most good, not on rescuing greedy fools and gullible screen-jockeys [they can look for real jobs instead!]

[liberal japonicus]

So, actually, I think you've illustrated my point. As long as they're encumbered by these assets on (or off) their balance sheets, Wall Street firms are going to be unable to raise fresh capital. Remove the assets from the equation, and they'll get snapped right up.

As much as I am pleased that the country I live in is getting the benefit, if the US taxpayer ends up holding the bag, and foreign countries can snap up all the good bits, I don't think that is a good thing.

[Karen Hurtz]

If you listened to Hank Paulson on the Sunday political sitcoms, you undoubtedly heard him not explaining why “we” need to spend hundreds of billions of dollars in mortgage-backed junk securities.
.
He may as well have said “We don’t want the smoking gun to be a mushroom cloud”, because it’s the same fear-based scam they ran on Congress to buy a war back in 2003.
.
Granted, there’s a serious mess in the financial markets, but what moron would give billions to the criminals that caused the mess in the first place. And what - or who - are they trying to save anyway?
.
While you heard Paulson talking about “mainstream companies”, American workers pensions, and even farmers, what he was decidedly quiet about was sovereign wealth funds and foreign banks in China, Japan, Europe, the Middle East and Russia.
.
To get an idea of just who’s getting bailed out one need only take a glance at the list of foreign billionaire stockholders at Bear Stearns, which received a $29 billion guarantee from the Treasury Department.
.
Or consider the fact that a majority of the stock in AIG, ($85B bailout) is held by foreign investors. Worse yet, look at the $200B nationalization bailout of Fannie Mae and Freddie Mac. Their top bond holder is none other than the Chinese government.
.
These are not minor omissions.
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Even more troublesome is the fact that on July 15, 3008 Mr Paulson testified as follows:
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“Let me stress that there are no immediate plans to access either the proposed liquidity or the proposed capital backstop.”
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Yet here we are, less than six weeks later and he has already issued more than $300B in guarantees and nationalized the two largest mortgage companies in the nation.
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In light of the massive discrepancy between his words and his actions, it certainly seems appropriate for taxpayers to ask about Mr. Paulson grasp of the situation.
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Whether he was being dishonest or simply was unaware of the scale of the problem, it raises grave concerns about his ability to unilaterally handle the situation.
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And one only becomes more suspicious when just two years ago Mr. Paulson himself received $18.7M in bonuses from the same Wall Street he is now bailing out.
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The sentiment is also represented in his currently proposed legislation, which intentionally puts the stability of financial markets above the protection of citizens, stating “the Secretary shall take into consideration means for–
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(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer.”
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So if the stability of financial institutions comes before the protection of citizens, and the stability of financial institutions requires the protection of sovereign wealth funds and foreign banks, it seems clear that citizens of the United States of America have lost control of their government.
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If any control of government is going to be regained, Congress must immediately reject this course of action and attack the underlying problem by assisting citizens in securing stable home loans.
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Absorbing reckless financial institutions and funding their foreclosure activities will only create more devastated neighborhoods that cause greater declines in housing values, which in turn will create more trapped citizens that see foreclosure as their only alternative.
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