Slowly the terror and panic subsides. The outrageous claims of certain doom come from members of several groups, the largest being…
- those who seek to raid the government’s coffers,
- regulators, who malfeasance had a large role in creating the problem,
- statists, excited at the prospect of expanding the government’s power.
A quick look at the Paulson/Bernanke proposal shows what a radical departure it is from American theory and practice. As described by the New York Times:
The Bush administration on Saturday formally proposed to Congress what could become the largest financial bailout in United States history, requesting unfettered authority for the Treasury Department to buy up to $700 billion in mortgage-related assets. The proposal, not quite three pages long, was stunning for its stark simplicity. It would raise the national debt ceiling to $11.3 trillion. And it would place no restrictions on the administration other than requiring semiannual reports to Congress, granting the Treasury secretary unprecedented power to buy and resell mortgage debt.
A $700 billion expenditure on distressed mortgage-related assets would be roughly what the country has spent so far in direct costs on the Iraq war … Divided across the population, it would amount to more than $2,000 for every man, woman and child in the United States.
… Some lawmakers were more critical or even adamantly opposed to the plan. “The free market for all intents and purposes is dead in America,” Senator Jim Bunning, Republican of Kentucky, declared on Friday.
The debate about the bailout does not follow partisan or ideological lines. A leftist statist like Paul Krugman has opposed the program (“No deal“).
The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system – that is, convince creditors of troubled institutions that everything’s OK – simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem – which seems doubtful – or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.
And there’s no quid pro quo here – nothing that gives taxpayers a stake in the upside, nothing that ensures that the money is used to stabilize the system rather than reward the undeserving.
I hope I’m wrong about this. But let me say it again: Treasury needs to explain why this is supposed to work – not try to panic Congress into giving it a blank check. Otherwise, no deal.
For a more detailed analysis of this terrible proposal see “A Bad Bank Rescue” by Sebastian Mallaby, op-ed in the Washington Post, 21 September 2008 — Excerpt:
With truly extraordinary speed, opinion has swung behind the radical idea that the government should commit hundreds of billions in taxpayer money to purchasing dud loans from banks that aren’t actually insolvent. As recently as a week ago, no public official had even mentioned this option. Now the Treasury, the Fed and congressional leaders are promising its enactment within days. The scheme has gone from invisibility to inevitability in the blink of an eye. This is extremely dangerous.
The plan is being marketed under false pretenses. Supporters have invoked the shining success of the Resolution Trust Corporation as justification and precedent. But the RTC, which was created in 1989 to clean up the wreckage of the savings-and-loan crisis, bears little resemblance to what is being contemplated now. The RTC collected and eventually sold off loans made by thrifts that had gone bust. The administration proposes to buy up bad loans before the lenders go bust. This difference raises several questions.
The first is whether the bailout is necessary. In 1989, there was no choice. The federal government insured the thrifts, so when they failed, the feds were left holding their loans; the RTC’s job was simply to get rid of them. But in buying bad loans before banks fail, the Bush administration would be signing up for a financial war of choice. It would spend billions of dollars on the theory that preemption will avert the mass destruction of banks. There are cheaper ways to stabilize the system.
In the 1980s, the government did not need a strategy to decide which bad loans to take over; it dealt with anything that fell into its lap as a result of a thrift bankruptcy. But under the current proposal, the government would go out and shop for bad loans. These come in all shapes and sizes, so the government would have to judge what type of loans it wants. They are illiquid, so it’s hard to know how to value them. Bad loans are weighing down the financial system precisely because private-sector experts can’t determine their worth. The government would have no better handle on the problem.
In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals.
,,, Within hours of the Treasury announcement Friday, economists had proposed preferable alternatives. Their core insight is that it is better to boost the banking system by increasing its capital than by reducing its loans. Given a fatter capital cushion, banks would have time to dispose of the bad loans in an orderly fashion. Taxpayers would be spared the experience of wandering into a bad-loan bazaar and being ripped off by every merchant.
Raghuram Rajan and Luigi Zingales “(“Why Paulson is wrong“) of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers.
… Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks’ bad loans but by buying equity stakes in the banks themselves. Whereas it’s horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.
… Congress and the administration may not like the sound of these ideas. Taking bad loans off the shoulders of the banks seems like a merciful rescue; ordering banks to raise capital or buying equity stakes in them sounds like big-government meddling. But we are in the midst of a crisis, and it shouldn’t matter how things sound. The Treasury plan outlined on Friday involves vast risks to taxpayers, huge complexity and no guarantee of success. There are better ways forward.
Afterword
If you are new to this site, please glance at the archives below. You may find answers to your questions in these.
Please share your comments by posting below. Please make them brief (250 words max), civil, and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar. Of esp interest these days:
- about America – how can we reform it?
- about the Financial crisis – what’s happening? how will this end?.
- about The End of the Post-WWII Geopolitical Regime.
- links to Damage Reports from home and abroad
A few of the most important posts warning about this crisis
This crisis has long been forecast by many, including in articles on this site. Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results. Here are some of those posts.
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A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
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The post-WWII geopolitical regime is dying. Chapter One, 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
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We have been warned. Death of the post-WWII geopolitical regime, Chapter II, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
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Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
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Geopolitical implications of the current economic downturn, 24 January 2008, – How will this recession end? With re-balancing of the global economy, so that the US goods and services are again competitive. No more trade deficit, and we can pay out debts.
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- What will America look like after this recession?, 18 March 208 — The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
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The most important story in this week’s newspapers , 22 May 2008 — How solvent is the US government? They report the facts to us every year.
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The World’s biggest mess, 22 August 2008 — A brillant ex pat looks at America from across the ocean.
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“The changing balance of global financial power”, by Brad Setser, 22 August 2008
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“The Coming US Consumption Bust”, by Nouriel Roubini, 6 September 2008
Excellent analysis. I have been searching for something like that since the great jubilation of Friday, when the bailout plan was announced and everybody was happy. From a more philosophical point of view I would like to add that this policy is entirely in line with what we have witnessed for the last eight years: Bad planning, bad execution of the bad planning, an awful lot of spending (after all the Dollar will last forever) and most importantly a reward of failure. If everything goes awry Bernanke and Paulson can be assured they will get their Medal of Freedom at a ceremony inside the White Hut in Washington.
I have grown tired of this blithering by this blog and others about “theft” of taxpayer money, how bad an idea this economic rescue is etc, etc.
Here is how I see it:
We as a nation (including this blog’s author and many others) have grown comfortable with a status quo which has evolved for many years. Any overt move from this status quo toward more gov’t. involvement is viewed by some as a move toward “socialism.” Any overt move toward less gov’t involvement is viewed as “letting the fox in the hen house”
or some other dumb analogy since we don’t give a specific name to it.
The bottom line is this: Our nation is and has always been a grand compromise between the idealist and the pragmatist, the inept and the competent, the unconcerned and the diligent, the common and the elite, etc, etc. But like all political systems it has never been a compromise between the powerful and the weak.
What we are seeing in this current crisis is simply the powerful dictating action over the weak. Only while many may say that the powerful dictating this action are in D.C. or Manhattan the truth is more subtle. The powerful dictating this action are those who have chosen to own their lives and the unpowerful are those who’ve chosen to rent their lives.
The simple fact is no one who has an equity share in anything wants a “market” solution to this crisis because that will mean they will help bear randomly the consequences of the decisions of all those who rode the “get rich on someone else’s money” wave for the past decade or more. They would rather have a predictable if terrible solution.
The view of this move as “socialist” and a “theft of taxpayer money” ignores the fact that we already have a tax system that permits one to pay almost at will if one has the funds or time to dedicate to it, a subsidy system that benefits those who it favors or those willing to take advantage of it, a lobbying system that generates welfare for corporations and special interests, entitlement programs that threaten to sink our government and a general attitude toward our Federal gov’t as a giant tit to suck on. So I ask: after all these years of the Fed. Gov’t. socializing all these things what is wrong with it spending a few hundred billion to preserve the equity of those who’ve worked hard to build equity and wealth? It’s nothing compared to the future unfunded obligations of Medicare. Yes it will also help some tit suckers but the tit suckers tit suck anyway. I as a person who has sacrificed and diligently accumulated some wealth don’t want to sacrifice it because a huge chunk of our very well off country have no idea what wealth is, and don’t care to aquire it. They just buy the corporate consumption message and head on down to the local mall or the local realestate office with their corporate credit line and buy the latest keep up with the Jones’s gizmo and let the rest of us worry about it later.
This didn’t start with Mr. Paulson or Mr. Bernanke. This started years ago when a large chunk of Americans started to believe in prosperity through lottery instead of prosperity through dilligence.
I say take my taxpayer money through the front door just don’t take my house or my businesses or my investments through the back door and give them to the tit suckers. That would really piss me off. I’d rather just add a little more socialism and hope we’ve finally come to the point where there’s no more easy money for the tit suckers to slurp up.
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Fabius Maximus replies: I am surprized at how easily you trade your Republic away for a promise of security. Ben Franklin would not be, however. This comment would have made an excellent illustrtation in Chet Richard’s book “If We Can Keep It.”
Your diagnosis of this problem is difficult to extract from this, but it appears in your mind to result not from irrsponsibility of our government and corporate leaders — as the evidence clearly shows — but from borrowing by people in the 2nd, 3rd, and 4th income quintiles. Perhaps this is the money passage:
“The powerful dictating this action are those who have chosen to own their lives and the unpowerful are those who’ve chosen to rent their lives.”
So it is the powerless people’s fault! And the only solution is to further concentrate wealth and power, along with a massive transfer of funds from the taxpayers to the wealthy.
“what is wrong with it spending a few hundred billion to preserve the equity of those who’ve worked hard”
Only the extremely naive believe that the cost will be a few hundred billion. That was the cost of the S&L crisis, and this is already a magnitude larger — and still in the early stages.
As yet there has not been the slightest substantive explanation of the nature of the crisis by any official, except vague intimations by Bush that the mortgages are ‘entangled’ in other things (i.e. trillions of CDS’s – only one of many similar leveraged derivatives), and reports that Paulson’s briefing to I can’t remember which group (congressional committee leaders?) a few days ago said many very disturbing things about the consequences of doing nothing, however these things were apparently said in confidence and could not be reported by the press.
IF there is a huge crisis – which certainly seems to be the case – then FIRST they should at least lay out in clear and relatively transparent fashion what the nature of that crisis is before solutions are shuttled through using panic to enforce so-called ‘bipartisanship’, aka rolling over.
I’ve not had a chance to read the Bush administration proposal but the NY Times states that the plan submitted to Congress is 2-1/2 pages long, including legalese and that there is no provision on how to pay for the required $700 billion.
This isn’t a plan, it’s another “Gulf of Tonkin” resolution similar to the Authorization for the Use of Military Power that, if passed, will cut Congress (and by extension, the people) out any future fiscal policy deliberations and will concentrate an extraordinary amount of power and money in the hands of a very small group of appointed officials who will be acting without supervision.
I have to wonder if a Depression isn’t preferable to the implications of this proposal.
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Fabius Maximus replies: (1) I have inserted a link in your comment to the proposal. For an analysis of its key provisions see “America appoints a Magister Populi to deal with the financial crisis.”
(2) Of course it does not describe how we will pay for it. No legislation does, anymore than a shopping-drunk teenage girl thinks about it so long as she has her mom’s VISA card.
(3) The Gulf of Tonkin crisis and the Saddam’s nukes crisis are exactly the right parallels, as I said in “Say good-bye to the old America. Welcome to our new socialist paradise!” — Opening:
“America is changing while we debate the minutia of the presidential candidates’ syntax and style. No conspiracies, nothing hidden. A Tonkin Gulf resolution for our generation. The Executive branch reshapes our economy in plain sight. With just a nod from Congress (no tiresome bother with debate and voting). Not only is our economy being restructured, but powerful precedents are set which will be used again. And again.”
If we were to analyze this in terms of the Thirty-Six Stratagems of Ancient China this would appear to be an instance of Loot a burning house:
When a country is beset by internal conflicts, when disease and famine ravage the population, when corruption and crime are rampant, then it will be unable to deal with an outside threat. This is the time to attack.
However, this is a stratagem to be used when commanding superiority, which begs the question of whether the Bush administration so commands.
As one commentator says of stratagems when commanding superiority:
These stratagems are the most straightforward and therefore the most easily seen through. To succeed with them, you often need to b e in a stronger position to start with, and even then they may backfire. In general, they rest on an assumption of superior force- the resources to besiege others, the time and sustenance to relax while waiting for the enemy to tire, the manpower to pretend to attack in one direction while really attacking in another.
For reasons often discussed in the blog, it is questionable whether either the Bush Administration or the United States have such commanding force.
Fabius Maximus? An interesting hero–why him?
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Fabius Maximus replies: The “about” page provides the answer.
“Fabius Maximus (280 – 203 BC) saved Rome from Hannibal by recognizing Rome’s weakness and therefore the need to conserve its strength. He turned from the easy path of macho ‘boldness’ to the long, difficult task of rebuilding Rome’s power and greatness. His life holds profound lessons for 21st Century Americans.”
The voices are coming fast and furious, mostly because Paulson’s plan was too simple: people CAN understand it. The problems in the financial sector are liquidity, solvency, and trust.
Paulson’s plan doesnt’ help liquidity. The fed has already been willing to loan with this toxic crap as collateral. Paulson’s plan, if honest (buy at fair-market value) doesn’t help solvency.
Paulson’s plan helps solvency if explicitly dishonest, buying up the assets for far more than they are worth: a huge transfer of wealth to those who caused the problem.
And Paulson’s plan includes no regulatory changes to enhance transparency and trustworthyness of bank-like institutions.
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Fabius Maximus replies: I agree with all but the last line. The government’s actions during the past year have been expressly to “enhance trustworthyness” by preventing transparency of financial statements. Truth is their enemy. That is a powerful indicator of a defective institutional structure, and primary reason why resolving this will be so difficult.
Duncan Kinder : those commentaries are just meant to be GUIDELINES, not commandments etched in stone. (No fixed rules for the usage of strategems.) My guess is that the present administration is desperate & have decided that it’ll go down with Russia & the rest if necessary if it cannot control the dynamics of the situation… Let’s hope that ain’t what they’ve got in mind, for I remembered Oldskeptic’s revelations & they’re not exactly cheery ones.
Ye Gods, save our souls from these knuckleheads!
Update: a new hidden wrinkle in the plan is exposed
“A Quiet Windfall For U.S. Banks“, Washington Post, 10 November 2008 — “With Attention on Bailout Debate, Treasury Made Change to Tax Policy.” Excerpt: