Waiting For The Bailout Bill

by hilzoy

While I wait for more details about the bailout bill, a few general points.

First: some people write as though we're being asked to trust the Bush administration about the existence of a crisis. This isn't true. It's not like the runup to the war in Iraq, where a lot of the crucial information was classified and we had to take the government's word for it. In this case, a lot of information is out in the open, and lots of people, many of them not otherwise sympathetic to the administration, are very scared. Barry Eichengreen notes that "we are not going to see 25 per cent unemployment rates like those of the Great Depression", but he thinks over 10% of the workforce could well end up unemployed. That's a world of hurt; and it's not counting the trillions in vanished assets, etc.

Second: if I were Henry Paulson, I would have spent at least the last year working out the best possible solution to the problems we now face. But I am not Henry Paulson; I'm a citizen wondering how I should ask my representatives to vote. I therefore have to face a very different question, namely: which of the alternatives that can be enacted in the time available to us would help most? The best alternative we can get might not be the best alternative there is. But it matters more to figure out which of the options we actually have is best than to figure out which we would enact if we were benevolent tyrants and could do whatever we wanted.

Third: we also need to bear in mind that whatever plan we end up with, it will be executed by the Treasury and Fed we now have. This matters because it's not obvious how (for instance) Paulson would implement a plan he fundamentally disagreed with. I assume that there are some differences (e.g., reporting requirements) that he would implement without question, and others (e.g. nationalizing the banking and mortgage industries) that he might have a harder time with. (The problem need not be that he would not be trying in good faith to implement what Congress passed. Anything Congress passes will leave some room for people to exercise their judgment, and people who think that Congress' entire approach is fundamentally misguided will be unlikely to do the best possible job of implementing it.)

Fourth: I have precisely no interest in bailing out investment bankers and hedge fund managers, per se. It's not that I have anything against them; I just don't think that spending a ton of money to rescue very wealthy people from the consequences of stupid choices that have put us all at risk is a worthwhile goal for government. By the same token, though, I am not interested in punishing them per se either. I am interested in making sure that ordinary people have as much protection as possible from the economic troubles that lie ahead. If getting them this protection requires that I let the head of WaMu waft off into the sunset in his golden parachute, then so be it. I care much, much less about what happens to him than about what happens to small business owners, construction workers, families whose home values are dropping just when their paychecks are cut, kids whose parents lose their jobs, and seniors whose retirement plans go up in smoke.

Fifth: That said, I think there are very good reasons to include serious cuts on executive compensation in any deal that gets made. Matt Yglesias has noted one of them:

"If we limited executive pay for bailed out institutions — say by forcing executives to work on government pay scale — then firms’ managers would have a strong incentive to avoid taking taxpayer money unless it was genuinely necessary. Banks that would mere prefer to get bailed out because it would enhance their profits won’t do it if taking the bailout means a big cut in executive pay. But institutions that would actually collapse absent a bailout will take the deal because they have no choice."

Relatedly, imposing limits on the compensation of executives whose firms are bailed out would help to lessen the problem of moral hazard. The firms that are bailed out might not have to face the full consequences of their employees' stupid decisions, but if their executives did, that might be enough.

But there's another reason to include serious limits on executive compensation in any bailout we pass. It's always a good idea to try to ensure that people are behind what the government does. But there are some times when it's absolutely crucial. Going to war is one; this is another. One thing our representatives should do is to explain, as clearly as possible, why letting the financial system collapse would be in no one's interest. But another is putting serious limits on executive compensation in place. People simply will not support this package as long as they get to read headlines about executives at firms that we have had to bail out getting seven- or eight-figure bonuses; nor can I think of any reason why we should be expected to.

Finally, while we're considering the possibility that we might be facing an economic depression, it might be a good idea to recall the last one. Mark Thoma has posted some audio links to interviews with people who lived through it; this one and this one are particularly good. I've put a few graphs and pictures below the fold.

Industrial Production:

Stock Market:

At a job bureau (more photos at same link):

Hooverville:

Family:

Here's a good timeline on the Great Depression from PBS, and a good economic history by Brad DeLong.

Food for thought.

Comments

[Hob]

Hilzoy, about executive pay limits, it seems to me that there's a more basic point you left out. We're giving a zillion dollars to company X, ostensibly to make the difference between corporate life and death; now company X hands over half a zillion dollars to executive Y. That's half a zillion of our emergency dollars that aren't going toward the emergency.

[JayS]

Bailout bill text here.
106 page PDF.

[Oyster Tea]

Why can't the government simply pump this amount of money into failing mortgages, taking a proportionate equity interest in each mortgage? Instead of buying unknown valued "mortgage backed securities", just make the mortgages whole? This would solve the problem at its root, rather than at its crown, wouldn't it?

I am obviously no economist, but haven't heard anything wrong with this idea.

People could stay in their homes and the bad securities would become good securities. Wouldn't that work?

[Neil the Ethical Werewolf]

I like the distinction between the hidden non-crisis in Iraq, and the crisis that's in plain view here.

And I think that people ought to be a lot more optimistic about the consequences of the bailout for the Treasury. We've made profit off of government bailouts before -- the Chrysler bailout made us $350 million. If you look at the terms of the AIG deal, they look really good for the taxpayer. We now own 80% of the company, and we get interest rates on our $85 billion between 8.5% and 11.5% depending on how much actually gets borrowed. That's a great deal for the taxpayer, as long as AIG actually gets saved.

Calling this a $700B bailout seems way too pessimistic to me. It looks more like a $700B act of predatory lending where we're the loan shark, and big banks with no other options end up getting owned, or pwned, or something like that. I look forward to President Obama calling up Warren Buffett and asking when to sell all this bank stock that has gone up after the crisis. Buying at the bottom is fun!

[hilzoy]

Oyster Tea: I don't know whether it could be done -- I suspect it could, somehow -- but one thing that makes this all a lot more complicated than it would be otherwise is that the mortgages have been sliced and diced into tiny pieces and sold to the holders of MBS. So there is no one mortgage-holder from whom one could buy the mortgage.

[hilzoy]

And Hob: yeah, I was imagining that someone was making an argument that curtailing exec. compensation would in some way be counterproductive, and saying: if anyone is going to tot up the pros and cons, political backing for something of this magnitude has to be one of the pros.

[KCinDC]

I hope you're right, Neil. I'm not quite so optimistic about the relative power and ruthlessness of the good guys among the Democratic leadership on one side versus the Bush administration, most other Republicans, the bad-guy Democrats, and Wall Street on the other.

[KCinDC]

Also, why is everyone accepting $700 billion as an exact number carved in stone, when apparently the Treasury Department just made it up out of thin air?

[redwood]

hilzoy: ...families whose home values are dropping...

if you knew the self-righteous hostility and belligerence us renters in metropolitan cores have received through the latest two decades, you might at least wonder why again renters must pay for the cost of property owners's mortgages.

which in the end will only continue to price us (and the homeless) out of the market.

[hilzoy]

KCinDC: I actually think there's more to be said for making a figure up than meets the eye. (Really!)

One of the things I'd imagine one wants to do, in designing something like this, is to prevent anyone from trying to game the system, and also to prevent e.g. runs on hedge funds, mutual funds, etc., by making it clear that you have *just a ton* of money, and that there is no realistic possibility of betting that the Treasury will run out and winning.

For that purpose, figuring out what ballpark figure you think will do the trick, and then making it a whole lot bigger might have a lot to recommend it, as a strategy. The reasoning would be like that used to come up with the number of troops you use to fight a war, when you're aiming to go in with truly overwhelming force: you really do not need a precise estimate of how many you will actually need, so much as an estimate of how many it will take to make it the case that no one who isn't literally insane will take you on. And for those purposes, coming up with something that is just a really big number might be exactly the right way to go.

[Adam]

The problem with limiting exec pay is analogous to attempting to get Paulson to implement a plan he doesn't like; telling people to work harder and take a pay cut just doesn't work well in practice.

The heads-must-roll mentality is laudable and all, but it's just not realistic to claim that needing assistance is analogous to moral culpability right now; it's tantamount to the conservative argument that we shouldn't prevent foreclosures because people should have known better that to buy houses they couldn't afford.

If there were a good yardstick for freezing compensation, that might work. And if executives do take a pay cut, they should get recognized for it somewhere down the line -- not monetarily, but there should be a list of some sort.

[Carleton Wu]

I look forward to President Obama calling up Warren Buffett and asking when to sell all this bank stock that has gone up after the crisis. Buying at the bottom is fun!

Not if the GOP gets their way- they're strenuously opposed to the taxpayers getting equity- that's socialism! Much more important to avoid socialism than to get a good deal.
Thus, they back the idea of insurance. Insurance for assets that are of questionable value. It's like selling someone flood insurance when the river is already rising... either we charge so much that the bailout won't help banks' balance sheets, or we charge a little bit and get taken to the cleaners.

Kruman's had a lot to say on the subject- if we buy or insure the assets, we're only helping if we're doing so at above-market rates (ie losing money)- basically giving the banks money to correct their balance sheets.
[exception- if the assets are improperly-priced right now, it would make sense to buy them for more than they're currently worth, thus the US becomes the market-maker & the prices rise on their own. Downside of that plan is that if Paulson et al are wrong & the assets aren't improperly priced, we eat a huge, huge loss].

[Adam]

you might at least wonder why again renters must pay for the cost of property owners's mortgages.

well, one reason might be that if they get kicked out of their homes, they'll become renters, and you'll end up paying for it anyway. if they renegotiate their loans with the bank, it won't affect you one way or the other.

[gwangung]

The problem with limiting exec pay is analogous to attempting to get Paulson to implement a plan he doesn't like; telling people to work harder and take a pay cut just doesn't work well in practice.

See Indian CEO.

Conservatives should consider that the "heads must roll" sentiment is getting pretty damn close to being literal, not metaphorical.

[Tony P.]

Oyster Tea: I'm not sure Hilzoy's comment about mortgages having been sliced and diced is actually a valid objection to your idea. All the funky paper out there seemed like a good deal to investors, based on the assumption that the underlying mortgages would get paid. The investors don't care about the price of the houses, only about the cash flow from the mortgages. If the feds could guarantee the mortgage payments, investors would be happy, the paper would be "liquid", and Wall Street honchos would be ecstatic. Whatever "equity participation" Uncle Sam extracted from homeowners would be no skin off Wall Street's nose.

So, bailing out homeowners would be a no-strings bailout for investment bankers: no curbs on pay, or bonuses, or profits. That's still not the main objection though.

The main objection is this: if Americans (as homeowners) can't afford to make their mortgage payments, then Americans (as taxpayers) probably can't either.

--TP

[mikkel]

Um looking at Calculated Risk, the parts about executive pay or even buying the assets have become negligible.

It says that they are suspending Mark-to-Market and can allow a reserve ratio of zero. This means that it will be impossible to tell how much a banks assets are really worth AND possibly (at least give authority to make this) that they don't have to have any real money backing up their assets. If you think what we've seen is bad, we ain't seen nothing yet.

If this is highly abused then it will effectively allow banks to get complete garbage, no body would necessarily know and then have taxpayers be on the hook when they collapse because they didn't have enough reserves to back even a small decline. The mere chance of that happening might kill bank stocks over the long run and the dollar in the intermediate run, since it'll be hard to gauge how many losses there will actually be.

[Neil the Ethical Werewolf]

Fortunately, Carleton, Hank Paulson realizes that the House GOP insurance proposal is bullshit. I loved this section from the Politico article on the White House meeting:

It was McCain who had urged Bush to call the White House meeting but Democrats made sure Obama had a prominent part. And much as they complained later of being blindsided, the whole event turned out to be something of an ambush on their part—aimed at McCain and House Republicans

“Speaking professionally,” said one Republican aide, “They did a very good job.”

When Bush yielded early to Pelosi and Senate Majority Leader Harry Reid (D- Nev.) to speak, they yielded to Obama to speak for the assembled Democrats. And it was Obama who raised the subject of the conservative alternative and pressed Paulson on what he thought of the idea.

House Republicans felt trapped—squeezed by Treasury, House Democrats and a bipartisan coalition in the Senate. And while McCain spoke surprisingly little after asking for the meeting, he conceded that it appeared there were not the votes for the core Paulson plan without major changes.

It's a beautiful picture -- Democratic teamwork with Reid and Pelosi passing to Obama, and then Obama forcing Paulson to tell the House GOP that their plan wouldn't work. I also wonder if this helped Obama get into McCain's head before their debate.

[Carleton Wu]

Fortunately, Carleton, Hank Paulson realizes that the House GOP insurance proposal is bullshit.

I think that this is true, and it's unlikely to be implemented. But the GOP will use it as a club- if a bailout passes without the GOP, they'll run against the spend-happy Dems and the unpopular Bush WH. So we need to get them on board with some kind of plan, and they're apparently willing to play political hardball at the risk of the US financial system.

I dont know what concessions they'll wring out- it looks like the Dems have already caved on giving bankruptcy judges the power to adjust mortgage terms. Once again, the Dems have to play the grown-ups while the GOP throws a tantrum- but as hilzoy has said, we cannot afford to play the adults and let them reap the political benefits.

[Adam]

The main objection is this: if Americans (as homeowners) can't afford to make their mortgage payments, then Americans (as taxpayers) probably can't either.

The response to that objection, I think, is that we also can't afford for them to get kicked out of their houses, lose their credit ratings, enter the renter's market, and stick the bank and investors with the paper loss while the house loses actual value because no one's living in it and maintaining it.

So asking whether or not someone can "afford" a mortgage is a loaded question -- if they get kicked out of the house and no one buys it, it doesn't matter what the house was worth.

The real question is how many of those people can't afford 15-year fluctuating-rate mortages but could pay 30-year fixed-rate mortgages. If someone is living in a house that's worth $500K on paper but they can only "afford" a house that's worth $300K, it's not in our interests to kick them out -- the only financially sensible move is to have them pay $300K and try to make up the rest via a renegotiation of the mortgage terms.

[lightning]

TP --

Problem is not with mortgages not being paid. That's a minor part of the problem. The real problem is with "derivatives", which are basically wagers on future performance, usually of other derivatives. (Crazy? Yes. Terms I would use would be "masturbatory" or "incestuous".)

The entire financial system just found out that a lot of the money they thought they had, doesn't really exist.

Ideally, since everybody owes everybody else money, financial institutions should be able to get together and swap worthless assets until everybody comes out even. Unfortunately, this would take decades, to be optimistic. We can't put the world finance system on hold.

I do question the need to get the bailout done *right now this minute*. Seems we need a real plan (other than Paulson's "give me money and don't ask questions") and a couple of weeks isn't going to make much difference.

As to executive pay caps, screw that. I want to see those [deleted] sleeping on steam grates, to see their kids' flipping burgers if they want to go to the local community college, to hear the lamentations of their women ... (sorry, got carried away there :-)

[bemused]

You might find this recording of a sort of teach-in at the Princeton econ dept. enlightening:

http://krugman.blogs.nytimes.com/2008/09/26/crisis-at-princeton/

[gwangung]

I do question the need to get the bailout done *right now this minute*. Seems we need a real plan (other than Paulson's "give me money and don't ask questions") and a couple of weeks isn't going to make much difference.

The sense I'm getting is that something did have to be done right now; credit (as in everyday line of credit, credit card, etc.) is about to seize up right now.

Which is not to say that this current plan is the best we could do...

[Adam]

The real problem is with "derivatives", which are basically wagers on future performance, usually of other derivatives.

That's an incorrect definition of "derivative." Every security is a "wager on future performance." "Unfunded derivatives" would be closer, but still a long way from the neighborhood of accurate.

[Nell]

The "deal" as presented stinks.

Paulson is still in charge of all the decisions. This after having already done the AIG deal with his former firm's executive as the only Wall Streeter in the room.

$350 billion is way too much to give away before any Presidential/Congressional brake can be put on. Disclosure is up to Paulson.

See Calculated Risk for chapter and verse.

That NY Times story (first link) is a classic Saturday story -- too revealing for the better-read editions of the paper.

[Adam]

Paulson is still in charge of all the decisions. This after having already done the AIG deal with his former firm's executive as the only Wall Streeter in the room.

That story has nothing to do with Paulson and almost as little to do with Goldman. All that sentence says is that Goldman was connected to AIG, which is not exactly a startling revelation considering that Goldman was only one of the two major investment banks left when that meeting took place. That story is about AIG.

[Nell]

Krugman says House staff tell him there are significant changes from the draft released today.

Don't know when those will be public. Ought to be any minute now if Dems are going to hold to their announced reform (which has been tossed overboard in practice at least two or three times I'm aware of) of making legislative text available at least 24 hours in advance of a vote...

[liberal japonicus]

Perhaps I was the only one, but with the title, this whole thing reminds of

ESTRAGON: People are bloody ignorant apes... Charming spot. Inspiring prospects. Let's go.
VLADIMIR: We can't.
ESTRAGON: Why not?
VLADIMIR: We're waiting for Godot.

[Adam]

"Dan, still no sign of Sarah Palin here at the pending 2008 Vice Presidential Debate, but we've just gotten word from the McCain campaign that she'll be accompanied by her new chief strategist, Mr. Godot."

[russell]

If there were a good yardstick for freezing compensation, that might work.

If you drove your company off the cliff, you don't get a bonus.

That seems pretty damned reasonable to me.

Thanks -

[Ponder Stibbons]

Casey Mulligan argues that the non-financial sector will not be greatly affected if we let Wall Street drown:

The non-financial sector today looks nothing like it did in 1930.
The weak correlation between asset prices and non-financial sector performance and the strong profitability of today’s non-financial capital are two good reasons to scoff at the idea that the non-financial sector will collapse because of the recent events on Wall Street, and even better reasons to scoff at the Bernanke-Paulson-Bush idea that a massive bailout of financial firms is the key to avoiding a non-financial collapse. Wall Street’s woes are and will be largely limited to Wall Street. The Bush administration should not use the power of the IRS to force the rest of us to board Wall Street’s sinking ship.
Of course, six percent of the workforce is bigger than zero, so a Wall Street mess has indirect effects on the non-financial sector as it absorbs former Wall Street employees and finds alternatives to the financial services Wall Street once provided. But, as long as the government does not get in the way, the marketplace will quickly react to provide the non-financial sector with financial services, even if the main players in that marketplace are no longer named Lehman, Merrill, or Goldman.

[Observer]

The only heartfelt lessons in life are those that hurt.

I have no problem with voters understanding for the first time since their grandparents / great-grandparents why voting for substance is important.

I say this fully recognizant of the fallout. I believe voters since the Nixonian era have been infantile.

The "broken dishes" theory. Yes, sometimes things have to just get that bad. I don't think pacifiers for all is the answer.

[Nell]

Adam: Goldman was connected to AIG, which is not exactly a startling revelation considering that Goldman was only one of the two major investment banks left when that meeting took place.

The story is about AIG and the decision to take it over, but also about Goldman, and their participation in the decision:

Although it was not widely known, Goldman, a Wall Street stalwart that had seemed immune to its rivals’ woes, was A.I.G.’s largest trading partner... as this intricate skein [of clients and counterparties] expanded over the years, it meant that the participants were linked to one another by contracts that existed for the most part inside the financial world’s version of a black box.

AIG's trading partners came out just fine. The stockholders, not so much.

I am completely disgusted with a bailout deal in which Henry Paulson makes all the important decisions when he may well be out of a job in four months and going out to seek work among the very firms he's passing billions to. It's a built-in conflict of interest, and very few people are raising it. The Times article hints at the conflict rather broadly in the course of educating readers about how the CDS bubble was created by AIG's London unit.

By the way, for compensation wonks:

compensation expenses took a large percentage of the [AIG financial] unit’s revenue. In lean years it was 33 percent; in fatter ones 46 percent.

[Tony P.]

The real question is how many of those people can't afford 15-year fluctuating-rate mortages but could pay 30-year fixed-rate mortgages. If someone is living in a house that's worth $500K on paper but they can only "afford" a house that's worth $300K, it's not in our interests to kick them out -- the only financially sensible move is to have them pay $300K and try to make up the rest via a renegotiation of the mortgage terms.

Adam, I'm only thinking out loud here, but consider two distinct scenarios:

1) Treasury guarantees (and if need be, subsidizes) the payments due on the $500K mortgage.

2) Treasury buys that mortgage for $300K, and allows the homeowner to keep paying based on the new, lower principal.

Take the second scenario first: Wall Street takes a haircut; homeowner gets lower payments; taxpayers come out even.

Now, assume perfect implementation of the first scenario: "means tested" subsidies to homeowners. That is, only "deserving" homowners get a taxpayer subsidy to make up the difference between the $300K mortgage they can afford and the $500K mortgage they signed up for. Assume that, in exchange for the subsidy, Treasury takes an "equity stake" in the house. What's the score on this one?

Well, Wall Street comes out even: all the "paper", no matter how sliced or diced or derivative, was based on the $500K payment stream. Homeowners give up equity to taxpayers. Taxpayers give up cash to homeowners.

The devil lies in the detail that "Wall Street", "homeowners", and "taxpayers" are overlapping subsets of "Americans". We can certainly picture an individual American who pays taxes, needs help on his mortgage, and counts on his Wall Street "paper" for his retirement. Ouch, my head hurts.

And I'm still leaving out the foreign investors who are themselves a subset of "Wall Street". All I can say about them is that if they will sit still for a haircut, we Americans will be better off than if they don't.

--TP

[bedtimeforbonzo]

CNBC's Jim Cramer contends that things will get worse -- and we will probably fall into a deeper recession -- even if we get a big bailout. Scary.

If so, there will be a lot of political fallout with a public that already doesn't like the idea of a bailout -- and will no doubt think it is supposed to be some sort of cure-all.

Bush/McCain/Paulson/Obama/Dodd/Pelsoi/Reid have all done a bad job of conveying to the country that the proposed billion-dollar bailout is Just A First Step.

A sign, to me, that this country truly has a leadership void.

[bedtimeforbonzo]

TP commented:

"Oyster Tea: I'm not sure Hilzoy's comment about mortgages having been sliced and diced is actually a valid objection to your idea. All the funky paper out there seemed like a good deal to investors, based on the assumption that the underlying mortgages would get paid. The investors don't care about the price of the houses, only about the cash flow from the mortgages."

I agree with both Oyster Tea (a cool handle, by the way) and TP.

I'm tired hearing that countless entities hold a piece of my mortgage.

All I know is, when I write that $1,400 check to Wells Fargo every month all of those other parties must somehow get their share.

So as Oyster Tea suggests: "Why can't the government simply pump this amount of money into failing mortgages, taking a proportionate equity interest in each mortgage?"

I imagine just as I write out that check every month to Wells Fargo but everybody else gets a piece of the action, so, too would they under Oyster Tea's plan.

But there is one big problem with Oyster Tea's suggestion:

It is consumer-driven. It offers consumer protection.

Paulson and the rest of them would no doubt prefer that Goldman Sachs, Morgan Stanley and the rest of Wall Street see tangible benefits -- see money they can count in too "stacks" (street lingo for increments of $1,000) -- and see the price of stocks go up and benefit shareholders.

Mortgage holders are pawns in all of this; they have very little say. Actually, do we have any say?

[bedtimeforbonzo]

Oyster Tea: "Why can't the government simply pump this amount of money into failing mortgages, taking a proportionate equity interest in each mortgage?"

Another thing: This seems like it would be a far more significant economic stimulus than those checks George W. Bush sent us not that long ago.

As it was, I paid June's $1,400 mortgage with the $1,500 "stimulus check" the government sent me -- it actually helped me get through the summer. Good to know that Goldman Sachs and the rest of the investment firms will now be getting theirs. The rich get richer.

[sootytern]

Here is my proposed solution to the executive compensation problem. On the 21st of January 2009, after the current incompetents are out on their ears, let's enact a new tax bill with the following provisions:

Over 10,000,000 = tax rate 75%
5M to 10M = tax rate 62.5%
1M to 5M = tax rate 50%
500K to 1M = tax rate 37.5

[sootytern]

In addition, hedge fund managers I believe are paid with capital gains not ordinary income and their pay should be declared as ordinary income or make cap gains taxes the same as ordinary income.

[bedtimeforbonzo]

Why hard-working Americans are outraged by the billion-dollar bailout AND despise the obsenity that has become executive pay:

Courtesy of The Dallas Morning News website:

"Washington Mutual's new CEO Alan Fishman -- who had been on the job a measly 17 days -- was paid nearly $20 million in the last month.

"That includes a $7.5 million bonus when he was hired Sept. 8. And it includes a mind-blowing $11.6 million cash severance now that the company has gone under. That's on top of his base salary -- a cool $1 million a year. Plus, he was eligible for annual bonuses worth up to 365 percent of his base pay.

"All this while the company was posting billions in losses. (Yesterday, it became the biggest bank failure in U.S. history, as it was seized by the federal government and then sold off, in part, to JP Morgan Chase.)"

Yeah, these firms need my tax dollars.

Frankly, the more I read stuff like this, the more I wish Wall Street would not receive one damn penny of taxpayer money.

[russell]

I am completely disgusted with a bailout deal in which Henry Paulson makes all the important decisions when he may well be out of a job in four months and going out to seek work among the very firms he's passing billions to.

I heard that. Right the F on, Nell.

The longer this drama plays out, the more I am reminded of David Brooks comments in his op-ed in the NYT last week.

We’re entering an era of the educated establishment, in which government acts to create a stable — and often oligarchic — framework for capitalist endeavor.

All I have to say to that is DO NOT WANT.

Look, if we need to do something to make sure the credit markets don't melt down, then let's do that. They are essential to the functioning of the rest of the economy.

But I have no idea why we should be responsible to guarantee attractive returns on investment for folks who thought they'd take a flier on mortgage backed securities.

And I don't see that these two things are impossible to separate out.

The financial sector is not an end in itself. It exists to support other sectors of the economy, by accumulating capital, making it available for investment, and identifying the most fruitful places to invest.

They generate no real value in and of themselves. They exist to grease the wheels of other, directly value-producing enterprises.

They are stewards for OTHER PEOPLE'S MONEY, and are expected to make wise use of that money. If they're smart folks and find good opportunities for maximizing the return on the money they've been entrusted with, they deserve a reward. If they piss it away on pipe dreams, they do not.

The fact that we are in this situation is, I hope, sufficient evidence that they have not been good, or wise, or effective, stewards of other people's money.

So no donut for them.

I'm not interested in seeing them impoverished and driven from town. If laws were broken, they should be punished. If folks acted recklessly in carrying out their fiduciary responsibilities, they shouldn't be allowed to work in the industry anymore. But there's no real value to be had here in punishment for punishment's sake.

But multi-billion dollar bonus distributions for the management of failed companies, as for instance we saw last week with Lehman Brothers, are absolutely, batshit, barking insane.

If I were a shareholder in Barclays, I'd be looking for someone's head on a platter.

And devoting a third to almost half of revenues to executive compensation, as in Nell's example from AIG, is obscene. Period.

IT'S NOT THEIR MONEY.

I'll say it again so it's clear.

IT'S NOT THEIR MONEY.

If they make a lot of money for other folks, they deserve a reward. If they piss away that money, they do not.

If you need billions of dollars in bailout money, you're in the "pissed it away" column.

Thanks -

[John Thullen]

Adam:

"Telling people to work harder and take a pay cut just doesn't work well in practice."

Finally!

It worked great in the 1980 LBO boom; it worked great in the send jobs abroad boom; it worked great in the outsourcing boom; it worked great in the work-for-Wal-Mart-find-healthcare-on-Medicaid boom ...

What I love about conservatives is their propensity to lecture us about human nature and the incentives and disincentives thereof.

Their view of human nature leaves out one thing: themselves.

Cut their pay and their benefits and they become lazy tramps (No thanks. It's not worth it.) Cut everyone else's pay and benefits and it's morally uplifting and contributes to thrift, going to bed early, and still being to tired to get laid.

Just blow it up. I'm sick to death of these people.

[bedtimeforbonzo]

What Russell said.

[russell]

Over 10,000,000 = tax rate 75%
5M to 10M = tax rate 62.5%
1M to 5M = tax rate 50%
500K to 1M = tax rate 37.5

Historically, these are modest. They are comparable to tax rates in the US from about 1932 until WWII.

From the early 50's through 1963 the top rate of 91% kicked in a $400,000.

Top rate in the 70's was 70%, kicking in at at $200K.

Then, 50% kicking in at less that $200K until 1987.

During all of that time, people made money. People with good ideas started successful businesses, attracted capital, employed lots of other people, got rich, bought homes and cars, sent their kids to college.

Somehow.

The world did not come to an end.

THanks -

[bedtimeforbonzo]

I wonder: If this market is so bad, why did Warren Buffet buy a piece of Goldman Sachs -- I believe the amount was $5 million.

I don't think the esteemed Mr. Buffet would take such action if he thought Wall Street was on the verge of a collapse.

Then again, he may have figured -- with taxpayer money about to prop up Wall Street -- why not take advantage of the situation.

[bedtimeforbonzo]

Make that $5 Billion.

Courtesy of the website "Marketplace" --

"Fed Chair Ben Bernanke has been saying that investments with value are going for fire sale prices. Well, Warren Buffet heard that and jumped in to buy $5 billion of stock in Goldman Sachs."

[bedtimeforbonzo]

Here's the link:

http://marketplace.publicradio.org/display/web/2008/09/24/buffet_goldman_investment/

[John Thullen]

However, I'm for the bailout.

They are the spiders and we are the flies.

We're stuck in the web and we were anesthetized for too many years.

The web is made of very sticky commercial paper attached to everthing and everyone and every transaction.

Whether you know it or like it or not, we are attached to Henry Paulson at the financial hip.

We can wreak populist justice, but it's us who will be hung first.

Trickle down.

It's all trickled down, baby.

[sootytern]

Russell: Those figures are double the current rates. I also meant them to be a point of departure for a discussion.

My initial thought was that this is a better way of getting at executive compensation instead of something in the bailout bill itself. Everyone has been talking about the deficit and new taxes to help make the rich pay for their rape of the country. i wouldn't have a problem with 90% and continuing on down the ladder.

[bedtimeforbonzo]

I say let's put a "hold" on the bailout until the next President of the United States, John McCain or Barack Obama, says something coherent about it in their next debate.

[bedtimeforbonzo]

John Thullen commented: "Whether you know it or like it or not, we are attached to Henry Paulson at the financial hip."

I am not so sure Henry Paulson is still joined at the hip of Goldman Sachs.

[Jeff]

telling people to work harder and take a pay cut just doesn't work well in practice.

Why not? The CEOs do it to us all the time. If they want to take their company down the drain, I think [a] there will be a whole bunch of stockholders who disagree, and [b] plenty of young would-be execs who'd be happy to work for $400,000 a year.

This whole business of "we have to pay them millions to get the best" obviously isn't applicable to teachers, so why should it be applicable to those we need a whole lot less?

[John Thullen]

BTFB:

First, you're a great commentator.

But, if you wanna put a hold on the bailout until the election, wait until I put a $5 dollar bill under my mattress for the day after the election when I can buy the Dow Jones Industrial Average at 0.

Also, you sell cars, right? Commercial paper is your and your customers' lifeblood.

We are the creditors and the debtors. We pay the taxes to pay the interest on the Treasury notes in our IRAs.

Our money market funds and Ginnie Mae funds have our mortgages and the derivatives thereby as assets.

We are Jimmy Stewart and Lionel Barrymore and Uncle What's his Face in one wheelchair and it's a wonderful sight to behold as we yell at ourselves after we misplaced the money and demand of ourselves that we find it.

Zuzu's petals.

The government is going to print money. Milton Friedman should rise up from his grave and kiss the government's ass for doing so.

But he won't, cause he's a dead ideologist.

[John Thullen]

Actually, Milton Freidman is a dead ideologue.

I misheard him for a dead ventriloquist.

[Ugh]

We are all Friedmanologists now.

[david kilmer]

I think we should make sure he's well and truly dead.

While we're at it, someone ought to check on Hayek's grave.

[ThatLeftTurnInABQ]

Why can't the government simply pump this amount of money into failing mortgages, taking a proportionate equity interest in each mortgage? Instead of buying unknown valued "mortgage backed securities", just make the mortgages whole? This would solve the problem at its root, rather than at its crown, wouldn't it?

This isn't a good idea because any attempt to stabilize mortagages which are currently too high will have the effect of propping up artificially high valuations for those homes, essentially it would an attempt to reinflate the housing price bubble which began to deflate last year.

This won't work - prices are too high as measured by price/income and price/rent ratios (see calculatedrisk for details), and thus current price levels are fundamentally unsustainable. People won't be able to live the next 2-3 decades of their lives paying 50-60% of their income for housing rather than 25-30%. It would involve an immense sink not only of current money but also of the future labor of the next generation into propping up the value of an articifically inflated asset.

And the proposed bailout package is not nearly large enough even if this was a good idea. The US housing market at the peak of the bubble was overshooting historical price norms (based on income) by something like 5-8 trillion dollars in aggregate. We are now roughly halfway down from that peak, which means that stabilizing prices at current levels would cost about 2.5-3.5 trillion, or roughly four to five times the size of the current bailout bill.

A far better solution is to let housing prices return to their historic norms (so that people don't have to spend an unsustainable fraction of their income just to have shelter). People who cannot afford their mortgages now either need to have those mortgages crammed down to sustainable levels or move to smaller, more affordable homes.

I would err towards the fomer solution for the lower middle class and towards the latter solution for upper class people who traded up into McMansions they couldn't afford. I think shelter is a human right, but a 5,000 sq ft house with a 4 car garage, granite countertops, Viking range, and a giant jacuzzi tub perhaps not so much. To the extent that the government is trying to intervene to modify private contracts so that people can stay in their existing homes, let them start at the bottom of the socioeconomic pyramid and work upwards from there.

But the most important thing is to get prices back down to sustainable levels, and to address systemic collapse risk in the banking system independently of housing price levels.

On the latter point I think what is moving thru Congress is a bad bill, but I want to hear what Krugman and Roubini (and also CalculatedRisk and Yves Smith) have to say about it since the details appear to have changed a bit over the last 2 days. But I am fundamentally opposed to any bill which doesn't give the Treasury equity claims senior to both other equity shareholders and bondholders (per John Hussman's critique of the earlier version of this bill). If we are going to recapitalize the investment banks with taxpayer money, it should be by partially wiping out the existing stakeholders.That is the lesson which stands out clearly from past banking crises in other countries - stakeholders have to take a haircut or bailouts don't work.

[J. Michael Neal]

I wonder: If this market is so bad, why did Warren Buffet buy a piece of Goldman Sachs -- I believe the amount was $5 [b]illion.

Take another look at the terms he got. There's your explanation. It was an act of desperation on Goldman's part.

[ThatLeftTurnInABQ]

Actually, Milton Freidman is a dead ideologue.

He's just pining. Pining for the Fiords.

Beautiful plumage...

[ThatLeftTurnInABQ]

Take another look at the terms he got.

This is crucial - the devil is in the details. Buffett got terms which are close to highway robbery, with minimal downside risk because if Goldman Sachs goes down they he (Buffett) will be first in line to pick thru the rubble and get anything of value which is left after a collapse.

These are precisely the sort of terms that the US Treasury should be getting. Buffett may be big, but we are bigger, and if he can negotiate terms like that we should as well.

[russell]

These are precisely the sort of terms that the US Treasury should be getting. Buffett may be big, but we are bigger, and if he can negotiate terms like that we should as well.

F'ing A.

And with that, to bed.

THanks -

[bedtimeforbonzo]

Yeah, John, in my heart of hearts, I realize this bailout -- actually, I just saw on CNN during haftime of the Eagles-Bears game they are calling it a "buy-in" -- should benefit me and my downtrodden livelihood, at least in theory.

But it sure is frustrating knowing Wall Street will benefit, too. I suppose now is the time to pull out the old cliche that a rising tide lifts all boats.

I wonder if Congress would have worked this hard on the Bailout/Buy-in if it weren't a month before the election.

It's just very, very hard, as you and Russell and Nell and others have expressed, not to be cynical about this whole thing.

But I do see it firsthand: People with 680 credit scores -- a pretty good number -- aren't getting picked up by banks to finance a 2004 or 2005 vehicle. Banks would have fought over this person a year ago.

Another thing I see every day is the same banks are demanding money down -- $1,000/$1,500 -- for almost anyone who is borderline in their eyes. Which makes good business sense. But it was those same banks who got buyers used to no-money-down loans -- and, frankly, in the Bush economy, most folks just don't have $1,000 to spare.

A common answer I get is, "Well, I have $500. Can you wait two weeks for the other $500 when I get paid?"

What really unnerved me was seeing how unresponsive McCain and especially Obama, the man I will vote for, were about the economy in the first debate.

Either of these guys is going to inherit a big, big mess -- and neither of them seems ready to handle it.

(I better get back to the game and pet Hamilton, my 14-year-old Beagle. My wife just scolded me when I showed her on Petfinder the tri-colored English Setter I've had my eyes on -- it's pretty clear we have gone from a three-dog family, which was crazy, to a one-dog unit; Olga's the boss.)

[david kilmer]

Legs off, fins on, stick a little pipe through the back of its neck so it can breathe, bit of gold paint, make good ...

Mike Pence

[Tony P.]

A far better solution is to let housing prices return to their historic norms (so that people don't have to spend an unsustainable fraction of their income just to have shelter). People who cannot afford their mortgages now either need to have those mortgages crammed down to sustainable levels or move to smaller, more affordable homes.

TLTIABQ, you had me until that last bit. Where are those "smaller, more affordable homes" going to come from? The physical housing stock is probably 1)way overbuilt already, and 2)way slower to change than any financial arrangement you care to modify.

If everybody moving down one size in housing is the answer, what the hell is the question? Okay, I exaggerate to make a point: it's not "everybody" we're talking about; housing is still being built even now; people move, people marry, etc. But if anybody moves to a smaller, cheaper house, then that's either a new house (which we don't need) or an existing house somebody else had to move out of -- perhaps to the street, having been foreclosed. Meanwhile the old bigger, more expensive house will do what -- stand empty? Get torn down so as to be "off the books"? Or what?

I don't know what the total number of housing units in the US is. Adding up mansions, McMansions, tract houses, apartments, and log cabins in the country, do we get one unit per person? I bet it's close. We don't have a housing problem. Solving the financial problem requires reassigning ownership of that housing stock "on paper". That's going to take a lot of fuss and bother. But actually abandoning existing granite counters and Viking stoves that actual workers already got paid to make, build, and install, just to reshuffle ownership "on paper" seems like too much fuss and bother to me.

--TP

[ThatLeftTurnInABQ]

Tony P.,

What I meant is that if a queue is formed for mortgage cramdowns (which given the size limits on the existing legal and administrative infrastructure seems to me to be unavoidable) then the McMansion people should go to the back of the line. They were the ones most likely to possess a degree of financial sophistication and knowledge such that they knew what they were getting into and are responsible for dealing with their current situation as best they can now without drawing on public resources of one kind or another.

If you look at the charts and numbers posted on calculatedrisk at regular intervals, they show that we currently have excess inventory (i.e. more houses than people who can afford to purchase housing) and that new housing starts are way down but not to zero - in other words home builders are still building new homes, even now. Regional markets have a lot to do with this, as well as variable demand for different sizes and types of homes within a given market.

I think it is very likely that we are severely overstocked with McMansions right now - some of them can be converted to multi-family dwellings, others we may have no other choice than to simply leave them to fall down, or bulldoze them as has already happened in Spain (it was done under the pretense of revoking illegal building permits IIRC, but the supply destruction implications were clearly a motivating factor).

There should not be a surplus of housing at the smaller end of the scale, if anything that niche is probably holding price right now due to demand pressure as people trade down. If home builders can be redirected to build more small homes that will be a good thing because it will provide a boost to the construction economy at a time when it most needs it. If we get into Great Depression / New Deal territory, one of the things the govt. should do to create jobs is to support construction of affordable housing. Many of the homes built in the 1930s in my area are by today's standards very small (they average about 800-900 sq. ft.) but are solid well made homes which have lasted more than half a century.

I am also anticipating that average household size will rise, as multiple generations re-aggregate under a single roof - younger people moving back in with their parents, elderly family members living with working age children, extended families sharing housing, etc. There are already innumerable anecdotal stories of this sort circulating on the internet.

If you read Yves Smith's blog on a regular basis then it is very clear that if she is reading the tea leaves right, the US is due for a long postponed reduction in living standards and personal consumption per capita, until our debt levels are substantially reduced, and any attempt to postpone this reckoning will make it worse rather than better. I would rather see this take the form of more people per home, rather than the same ratio for some, and others sleeping in the parks and streets.

[hilzoy]

bedtime: "I wonder if Congress would have worked this hard on the Bailout/Buy-in if it weren't a month before the election."

Actually, I think that this would have been a lot easier to get through Congress if an election were not coming up. My impression is that people are furious. As am I; I'm trying to keep my eyes on the prize, though, and as far as I'm concerned the prize is people buying cars from you again. (Preferably hybrids!) I'm also trying to keep my fury directed where I think it should be: not just on the idiots who created these deals, but on the legislators who made it all possible by not doing their fracking jobs, and the idiotic economic philosophy that they used to justify their actions.

[Davis X. Machina]

but I want to hear what Krugman and Roubini (and also CalculatedRisk and Yves Smith) have to say about it

Krugman's verdict is in: Pass it now, fix it in January.

[Justin Slotman]

From the conference call notes at Yves' site (Treasury had a call with various financial types tonight) I think it looks fairly awful right now. No definition of the price we'll pay for the bad assets, for one.

[Nell]

What really unnerved me was seeing how unresponsive McCain and especially Obama, the man I will vote for, were about the economy in the first debate.

I'm not sure what you mean by this. If you're still under the misapprehension that Obama was not responsive to ordinary peoples' economic pain during the debate, then you should revisit the 'Crises Fiscal and Financial' thread, where I and others responded.

If you're talking about the candidates' elaboration of their proposals for the bailout, then you have to take into account the fact that during the debate negotiations were at a very delicate stage. Obama has been much, MUCH clearer during this week about what he wanted to see in the bailout proposal and beyond, and the points he identified have been largely (though I would say weakly and inadequately) reflected in the compromise negotiated by the Democrats.

If you're talking about the candidates' response to Jim Lehrer's "what would you cut" question, fair enough. I don't think that question captures 'responsiveness on the economy' well at all, but that's me.

[Joyful Alternative]

Unemployment exceeded 10% in 1982. Since then, we've finagled our counting in many ways, e.g., Reagan's moving a active-duty military from outside the equation to inclusion among the employed. Real unemployment, including people working PT because they can't find FT work, discouraged workers, and the like, is surely 10%, maybe 15%.

[Nell]

hilzoy: It is also, in my judgment, not a time for those of us who are not professional economists to imagine that we can sort things out without expert advice.

Tell it to Congress. They chose not to take testimony from any professional economists about these proposals.

Those principles Obama laid out last weekend? There are only gestures toward them. The negotiations won almost nothing substantive. This bill is the naked class war of the Paulson proposal with a few fig leaves.

No.

[Adam]

TLTIABQ is right on the money IMO. I would add that those large houses have other attached costs (maintenance, utilities, taxes, etc.) that are a drag on the residents' incomes even if they renegotiate the mortgages.

The bottom line is that if the house is affordable under different terms (30 v 15 years, etc.) and given the needs of the residents, renegotiate the terms.

If the person wants/needs to leave anyway then we have to start getting creative -- maybe by letting them put their mortgage payments into a fund to be used as a down payment on a new home but not kicking them out of their current home.

There are a lot of interesting options there but the key is that foreclosures need to be avoided at all costs until the market returns to some semblance of equilibrium. There probably needs to be a spectrum of options, but it'll be difficult to create adequate flexibility while avoiding loopholes. But I don't think we have much choice.

[samantha]

THIS WAS JUST CRAZY I HATE WEN THIS HAPPENS TO PEOPLE I HOPE IT NEVER HAPPENDS AGAIN!