The Bailout of All Bailouts just got voted down, 228 to 205. There’s the expected partisan finger-pointing but House leaders will schedule another vote as soon as they can convince twelve of the nay-sayers, from either party, to approve.
Wild card: Angry voters who go to the polls in five weeks. Conservatives don’t want government to take over the free market. Liberals don’t want Wall Street fat-cats to get a free ride. And the more the public focuses on the bill, the angrier they become. (Polls show about a third of Americans in favor, a third opposed, and a third undecided; the percent in favor is growing slightly, but the percent against is growing even faster.)
Wild card on the other side: The Dow is dropping precipitously. Roughly half of all American families have some retirement money in the stock market. And even if they don’t own shares of stock, an increasing number are feeling the pinch of an economy gradually grinding to a halt. (This week’s employment report will not be very encouraging.)
Don’t expect easier sailing in the Senate. Fewer than a third of the Senate is up for reelection on November 4, but they’re all hearing from angry constituents.
Prediction: A scaled-down bill will be enacted by the end of the week. It will provide the Treasury with a first installment of $150 billion. Treasury can use it to back Wall Street’s bad debts with lend no-interest loans of up to two years, until the housing market rebounds. Or to invest in Wall Street houses directly, in exchange for stocks and stock warrants. There will be strict oversight. Congressional leaders will promise further installments, but with conditions calling for limits on salaries and relief to distressed homeowners.
September 2008
14 posts
With the biggest gun at their heads imaginable — an economic meltdown just five weeks before many of them are up for reelection — members of Congress have just about agreed to the terms of the mother of all bailouts. They’ve also agreed to press two conditions — limits on executive salaries, and some sort of public ownership proportional to the risks taxpayers are taking on.
But the devil is in the details. From what I’ve heard, the kinds of limits being discussed could easily be cosmetic, such as limits on golden parachutes or limits on net increases in direct salaries during the duration of the bailout. Public equity could also vaporize into conditional warrants, giving taxpayers (and the Treasury) the option to cash in on certain classes of stock or applying only where firms get direct government aid rather than where they fob off their bad debts on the public.
There will be some skirmishing over whether homeowners in danger of losing their homes should be given some breaks, but here too it’s important to watch the details. Wall Street doesn’t want any provision that allows distressed homeowners to wiggle out of their mortgage obligations, even though Wall Street is wiggling out of its own bad debts.
Congress knows the public is furious. That’s why it’s insisting on the above-mentioned provisions. But Congress and the Administration, and Wall Street, also know that the public — and the media — can easily be hoodwinked into believing that certain limits and protections have been built into the deal when, on closer inspection, they haven’t. Wall Street is masterful at creating the appearances of value when there’s no value there, and many of our representatives in Congress are well-versed in the art of creating the appearances of public gains when the gains are mostly private. So the media has to dig hard and look at the details of this deal.
Meanwhile, when no one was looking, American automakers are on the way to getting their own sweetheart deal from Congress — billions, ostensibly to convert to more fuel-efficient cars. On a much smaller scale, this bailout is almost as outrageuos as Wall Street’s. Detroit has known for years that it would eventually have to create fuel-efficient cars, but it kept producing SUVs and trucks because that was where the profits were. Japanese automakers in the US did the right thing, took the risk, made the investments in fuel-efficient technologies. But they’re not getting bailed out.
In just a few weeks, capitalism has been turned upside down. The underlying question here, as with trickle-down tax policy, is whether any of this ultimately helps Main Street.
But will it work? Here’s Paulson’s and Bernanke’s logic, made explicit at the Senate hearing today: There’s only a certain amount of bad debt on Wall Street’s books, left over from the wild and woolly days of lax mortgage lending. Once removed from the Streets’ books, credit will flow again. And once credit flows again, even Main Street can breath a sigh of relief.
P&B failed to mention that bad debts are growing even among people recently considered good credit risks. At end of August, 6.6 percent of mortgages were at least 30 days past due. That’s up from 5.8 percent at end of June. We’re also seeing a growing amount of credit card and auto payments past due.
The culprit isn’t just those sub-prime loans. With jobs and wages are dropping across America, many people who had been able to pay their bills no longer can.
It’s no coincidence that states where mortgage delinquencies are highest are also states with the highest rates of job losses. According to the Bureau of Labor Statistics, the official rate of unemployment in California last month was 7.7 percent. That’s up from 5.5 percent a year ago. In Florida, unemployment has climbed to 6.5 percent, from 4.1 percent a year ago. No surprise that bad debts are mounting fastest in California and Florida – and elsewhere around the country where jobs are evaporating fastest.
Note that these are just the official rates. Some 600,000 fewer jobs are listed on the nation’s payrolls than were there last year. Millions more Americans are too discouraged even to look for work. And as employers squeeze their payrolls, even people with jobs are putting in fewer hours.
Bailing out Wall Street’s bad debts when millions more Americans can’t pay their bills is like bailing out a rowboat springing more leaks while the ocean is rising. Many of the average taxpayers being asked to take on Wall Street’s bad loans are the same people whose incomes are dropping, which means they’re struggling to pay their debts and potentially creating even more bad loans.
Congress should drive the hardest deal it can with Wall Street. But Congress also needs to pay direct attention to Main Street. It should extend unemployment insurance, freeze mortgage rates, and pass a stimulus package that generates more jobs.
Bottom line: Unless Americans on Main Street have more money in their pockets, Wall Street’s bad debts will continue to rise — which means the Bailout of All Bailouts grows even larger, which means taxpayers take on even more risk and cost.
The frame has been set, the dye cast. Treasury Secretary Hank Paulson, presumably representing the Bush administration but indirectly representing Wall Street, and Fed Chief Ben Bernanke, want a blank check from Congress for $700 billion or possibly a trillion dollars or more to take bad debt off Wall Street’s balance sheets. Never before in the history of American capitalism has so much been asked of so many for (at least in the first instance) so few.
Put yourself in the shoes of a member of Congress, including our two presidential candidates. The Treasury Secretary and Fed Chair have told you this is necessary to save the economy. If you don’t agree, you risk a meltdown of the entire global financial system. Your own constituents’ savings could go down with it. An election is six weeks away. Besides, in the last two days of trading, since rumors spread that the Treasury and the Fed were planning something of this sort, stock prices revived.
Now – quick — what do you do? You have no choice but to say yes.
But you might also set some conditions on Wall Street.
The public doesn’t like a blank check. They think this whole bailout idea is nuts. They see fat cats on Wall Street who have raked in zillions for years, now extorting in effect $2,000 to $5,000 from every American family to make up for their own nonfeasance, malfeasance, greed, and just plain stupidity. Wall Street’s request for a blank check comes at the same time most of the public is worried about their jobs and declining wages, and having enough money to pay for gas and food and health insurance, meet their car payments and mortgage payments, and save for their retirement and childrens’ college education. And so the public is asking: Why should Wall Street get bailed out by me when I’m getting screwed?
So if you are a member of Congress, you just might be in a position to demand from Wall Street certain conditions in return for the blank check.
My five nominees:
1. The government (i.e. taxpayers) gets an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.
2. Wall Street executives and directors of Wall Street firms relinquish their current stock options and this year’s other forms of compensation, and agree to future compensation linked to a rolling five-year average of firm profitability. Why should taxpayers feather their already amply-feathered nests?
3. All Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers. Why should taxpayers finance Wall Street’s outsized political power – especially when that power is being exercised to get favorable terms from taxpayers?
4. Wall Street firms agree to comply with new regulations over disclosure, capital requirements, conflicts of interest, and market manipulation. The regulations will emerge in ninety days from a bi-partisan working group, to be convened immediately. After all, inadequate regulation and lack of oversight got us into this mess.
5. Wall Street agrees to give bankruptcy judges the authority to modify the terms of primary mortgages, so homeowners have a fighting chance to keep their homes. Why should distressed homeowners lose their homes when Wall Streeters receive taxpayer money that helps them keep their fancy ones?
Wall Streeters may not like these conditions. Well, you should tell them that the public doesn’t like the idea of bailing out Wall Street. So if Wall Street doesn’t accept these conditions, it doesn’t get the blank check.
Talk today about the Bailouts of All Bailouts eased market fears and generated a giant rally on the Street, but how realistic is it?
On Capitol Hill, Senator Charles Schumer suggested that government inject funds into financial companies in exchange for equity stakes and pledges to rewrite mortgages and make them more affordable. At the other end of Pennsylvania Avenue, Hank Paulson reportedly is considering an agency like the Resolution Trust Corporation, established during the savings and loan crisis of the late 1980s, to take bad debts off the balance sheets of financial institutions.
Problems are: (1) It’s not likely to do all that much good because no one knows how much bad debt there is out there. Even if the government bought a lot of it, investors and lenders still couldn’t be sure how much remained. After all, big banks have already written down hundreds of billions of bad debts, and that hasn’t restored confidence in the Street. As the economy slows, bad debts will grow. Again, the problem isn’t a liquidity or solvency crisis; it’s a crisis of trust.
(2) However much bad debt there may be, that amount is surely far greater than the $394 billion of real estate, mortgages, and other assets that the old RTC bought from hundreds of failed savings-and-loans — thereafter selling them off form whatever it could get for them. The Bailout of All Bailouts would therefore put taxpayers at far greater risk than they are even today, and require an unprecedented role for government in reselling assets. Another major step toward socialized capitalism.
A better idea would be for the Fed and Treasury to organize a giant workout of Wall Street — essentially, a reorganization under bankruptcy, for whatever firms wanted to join in. Equity would be eliminated, along with most preferred stock, creditors would be paid off to the extent possible. And then the participants would start over with clean balance sheets that reflected new, agreed-upon rules for full disclosure, along with minimum capitalization. Everyone would know where they stood. Bad debts would be eliminated. Taxpayers wouldn’t get left holding the bag. And there would be no “moral hazard” incentive for future financial wizards to take giant risks with other taxpayers’ money.
Congress, the Fed, and the Administration shouldn’t be giving more help to Wall Street. Policymakers should focus instead on people who really need a safety net right now — workers who have lost or are about to lose their jobs, who need extended unemployment insurance and health insurance for themselves and their families; homeowners who have lost or are likely to lose their homes, who need additional help meeting mortgage payments and reorganizing their debts; and people who have lost or are in danger of losing their savings or pensions, who need better insurance against possible loss.
The only way Wall Street’s meltdown doesn’t spill over to Main Street is if policymakers begin to pay adequate attention to the people whose wallets really keep the economy going, and who merit more help than the Wall Street tycoons whose carelessness and negligence have put it in such jeopardy.
If you think the Bailout of All Bailouts (whose details will be worked out over the coming week) won’t saddle American taxpayers with billions, if not trillions, of risky obligations, you don’t know politics — especially in an election year when members of Congress are eager to get home to campaign; when the incumbent lame-duck president (who was he?) has all but vanished, leaving his hapless Treasury Secretary, a former investment banker, to take the lead and the heat; when voters are in high anxiety over the economy and Wall Street is melting down; when the executives of every financial powerhouse in America have staked lots of money on campaigns in both parties and have indundated Washington with lobbyists.
In other words, watch your wallets. The tab here could be very high. If everything goes extremely well, markets move upward, and the risky loans become far less risky, it’s possible that taxpayers (that is, the Treasury) might actually make money. But if the bottom falls out, American taxpayers could be on the hook for trillions of dollars. What then? The federal debt soars. What then? Interest rates go out of sight. What then? Foreigners lend us less money. What then? We’re cooked.
Some Democrats will try to make the best of the emerging Bailout of All Bailouts Bill, seeking to tack a stimulus package on it. In my view, they’d be better advised to hold out for a different approach.
Paulson is right that it makes sense to allow the big banks to wipe their balance sheets clean of as many bad loans as they can identify, and put them into a special agency that then sells them for as much as possible. The agency would bundle or unbundle the risky loans, slice and dice them as needed, with the goal of getting the most for them on world markets by creating a market for them.
But there’s no reason taxpayers need to be involved in this.
Whether you call it a reorganization under bankruptcy or just a hellova fire sale, the process should resemble chapter 11 under bankruptcy. Any big financial institution that wants to clear its books can opt in. But the price for opting in is this: Investors in these institutions lose the value of their equity. Executives lose the value of their options, and their pay (and the pay of their directors) is sharply limited. All the money from the fire sale goes to making creditors as whole as possible.
Meanwhile, policymakers work on a new set of regulations to ensure transparency on Wall Street — governing disclosures, minimum capital requirements, avoidance of conflicts of interest, and better ensurance against stock manipulation — so that, once the bad debts are off the books, the new numbers can be trusted.
I repeat: This isn’t a crisis of solvency or liquidity; it’s a crisis of trust.
Hank Paulson didn’t blink, so Lehman Brothers went down the tubes. The end of socialized capitalism? Don’t bet on it. The Treasury and the Fed are scrambling to enlarge the government’s authority to exchange securities of unknown value for guaranteed securities in an effort to stave off the biggest financial meltdown since the 1930s.
Ironically, a free-market-loving Republican administration is presiding over the most ambitious intrusion of government into the market in almost anyone’s memory. But to what end? Bailouts, subsidies, and government insurance won’t help Wall Street because the Street’s fundamental problem isn’t lack of capital. It’s lack of trust.
The sub-prime mortgage mess triggered it, but the problem lies much deeper. Financial markets trade in promises — that assets have a certain value, that numbers on a balance sheet are accurate, that a loan carries a limited risk. If investors stop trusting the promises, Wall Street can’t function.
But it’s turned out that many promises like these weren’t worth the paper they were written on.
That’s because, when the market was roaring a few years back, many financial players had no idea what they were buying or selling. Worse, they didn’t care. Derivatives on derivatives, SIVs, credit default swaps (watch this one!), and of course securities backed by home loans. There seemed no limit to the leverage, the off-balance sheet liabilities, and what credit rating agencies would approve by issuers who paid them to.
Two years ago I asked a hedge fund manager to describe the assets in his fund. He laughed and said he had no idea.
This meant almost no limit to what was promised. Regulators — Alan Greenspan in particular — looked the other way.
It worked great as long as everyone kept trusting and the market kept roaring. But all it took was a few broken promises for the whole system to break down.
What to do? Not to socialize capitalism with bailouts and subsidies that put taxpayers at risk. If what’s lacking is trust rather than capital, the most important steps policymakers can take are to rebuild trust. And the best way to rebuild trust is through regulations that require financial players to stand behind their promises and tell the truth, along with strict oversight to make sure they do.
We tell poor nations they have to make their financial markets transparent before capital will flow to them. Now it’s our turn. Lacking adequate regulation or oversight, our financial markets have become a snare and a delusion. Government only has two choices now: Either continue to bail them out, or regulate them in order to keep them honest. I vote for the latter.
As I write this, Hurricane Ike is heading to the Gulf coast.
Even if you don’t believe in global warming, a lot of insurance companies do. Ever since eight costly hurricanes struck Florida and the Gulf Coast in 2004 and 2005, large national insurers have been dropping customers whose homes are located on or near coastlines, and refusing new ones.
It’s not only flooding that has insurers worried. It’s wind damage, mud slides, and coastal erosion. We’re talking tens of billions of dollars of potential damage. Right now there’s only a patchwork of state insurance funds which may not be up to the task, coupled with federal flood insurance that already went $17 billion into the hole after Katrina.
If you believe in global warming – and just about every expert does – hurricanes are going to become even more violent and the oceans will rise even faster over the next decade or two, even if we figure out some way to control climate change over the longer term.
To make matters worse, developers are planning even more homes and commercial properties in vulnerable areas. You see, 77 million boomers will be retiring over the next fifteen to twenty years, and many want to go to coastal areas where the weather is milder and the beaches beautiful – Florida, the Carolinas, coastal Virginia, Cape Cod.
So who’s going to insure against all the likely damage? There’s mounting pressure on Washington to come to the rescue with federally-subsidized insurance. Once again, this means the rest of us taxpayers will be left holding the bag.
Here’s a better idea. Get private insurers back into the business of insuring homeowners against flooding, wind damage, and erosion. Do this by having the federal government offer to sell the companies reinsurance against catastrophic loss. This wouldn’t be a handout. Insurance companies would have to buy the reinsurance. But because the federal government can spread the risk far more broadly than can any individual company, the price of reinsurance is likely to be low enough to make it profitable for individual insurance companies to get back in the market. Essentially, the government would back up insurance companies in much the same way it does for possible losses associated with terrorism.
But there’s no reason to extend this back-up to future development in vulnerable coastal areas. Federal reinsurance shouldn’t be available for policies on new homes or commercial properties there. We now know too much about global warming to encourage this.
Sorry boomers. You’ll have to retire to safer ground.
Accounting gimmicks first came to light at Fannie and Freddie in 2003, at which time Fannie’s and Freddie’s former CEOs were sacked. Why, then, did they continue for another five years, even under new CEOs, even after policymakers first learned of them? Three reasons: (1) Top executives and shareholders continued to profit from them so there was no incentive to stop them, (2) everyone involved kept expecting home values to continue to rise — or, when they fell, rise again soon enough — to make up for the accounting shortfalls, and (3) Fannie and Freddie continued to be in bed with Congress and the administration. Democrats and Republicans alike have been complicit in this outrage.
A reprise of what I wrote August 25: Any day now — perhaps any hour — the plug will be pulled on Fannie Mae and Freddie Mac, and a massive government bailout will ensue. Together, they’ll become the largest government-owned entities in American history, and, once again, taxpayers will pay the bill, which could come to $25 billion or more.
One question is how did we ever get to this? The Savings and Loan Bailout of the late 1980s should have taught us that when government guarantees the downside of risks and private investors reap the upside gains, there’s hell to pay. The risks Fannie and Freddie took on weren’t officially guaranteed by the government — that is, by you and me — but investors assumed they were. And so did Fannie’s and Freddie’s executives, who reaped a bonanza with bonuses in the tens of millions each year.
Apologists will say that Fannie and Freddie exist to make housing loans to low-income Americans, so it was inevitable that the two giants would get caught in the quagmire of the housing burst. But the fact is, Fannie and Freddie — and the executives who ran them and still run them — have been out to maximize profits. Period. Just the same as every other mortgage and investment bank. High-risk sub-prime loans offered a higher rate of return, so Fannie and Freddie went into them big time. And because of the implicit government guarantee, Fannie and Freddie could take on even more risks and make even more money. Until now.
It’s another case of socialized capitalism, folks. The largest, yet. Along with making lots of money for investors and their executives, Fannie and Freddie corrupted our political process. They blocked any attempt to reign in the risks. Their lobbyists were and are the most sophisticated and among the most ubiquitous in Washington.
What to do now? Hope that, like the S&L fiasco, taxpayers can get back a fair portion of our dollars. But unlike the S&L fiasco, this time we should make sure we bury socialized capitalism for good.
Today’s jobs report confirms not only how badly the economy is doing, but how badly working families are doing — and why it’s not possible to revive the economy unless and until working families have more purchasing power.
84,000 jobs were lost in August — the 8th month of job declines. Since January, more than 600,000 jobs have been lost. Remember that at least 125,000 new jobs need to be added to the economy each month merely in order to keep up with an expanding population. So the loss of 600,000 jobs actually means a larger portion of the population without work than today’s household survey (6.1 percent unemployment) reveals.
In the short term, the economy needs a powerful fiscal stimulus. Longer term, it needs policies (such as I mentioned yesterday) that will continue to put more money into the pockets of average working families.
The Labor Department today reported that business productivity surged to a revised 4.3 percent annual rate in the second quarter of the year. That’s impressive. It’s nearly double the 2.2 gain previously reported. It’s also well ahead of forecasts. So why did stocks tumble and the Dow Jones Industrial Average fall more than 300 points?
Because it’s finally dawning on investors that Americans don’t have the purchasing power to keep the economy going. A separate report today from the Department shows a steadily weakening labor market. The number of U.S. workers filing new claims for jobless benefits jumped by 15,000 last week, to a seasonally-adjusted 444,000. That’s much higher than anticipated. We’ll know tomorrow whether employers continued to shed jobs in August, as they’ve done in the prior seven months.
Remember, productivity measures hourly output per worker. When firms lay off their workers or cut the number of hours they work, the firms often get more output per hour from them. This is often because employees are pushed harder to generate more output in fewer hours — understanding that if they don’t, they’ll be the next ones on the chopping block. Or because each who remains is overseeing more machinery than before. (This may result in lower-quality products and services, but the productivity figures don’t measure quality of output.)
Higher productivity keeps inflation in check. When companies can produce more stuff with fewer workers, their unit costs drop. And they face even less pressure to raise wages — even in the face of rising costs of living — because average employees have virtually no bargaining power. This also helps boost corporate profits.
But this also means less purchasing power by consumers whose paychecks are getting even smaller and jobs even less stable, and who have reached the end of their lines of credit because the housing bubble has burst. The result? Employers can’t sell as much as before, so they reduce their payrolls by cutting hours and laying off more workers.
Retailers are the canaries in this mine. Their sales are sharply down. (Today Nordstrom and other retailers posted big disappointments for August sales.)
Unless or until America’s broad middle class has more money in its pockets — because we get a more progressive tax system, because unions become more powerful and push prevailing wages upward, because employers finally understand what Henry Ford understood a century ago (unless workers have enough money to buy the products they’re making, the products won’t sell) — this downturn is likely to last a long time.
Having been through the process of “vetting” prospective cabinet members, I can tell you it’s time-consuming, detailed, and thorough. I’d like to think the vetting of a vice presidential nominee would be more so – especially one whose odds of becoming president, should she be elected, are somewhat higher than that of the normal vice president.
Sixteen years ago, Bill Clinton’s “vetting” team asked me and other prospective cabinet members for (1) our tax returns, going back at least five years, (2) our bank records, (3) a detailed listing of our assets, (4) the names and places of everywhere we had lived, and the names and phone numbers of neighbors whom they could call about us, (5) a description of every job we had ever had, every client we had ever served, and the names of employers and clients with whom they could check, (6) the names of our family members, their ages, their occupations (if any), (7) a description of any civil or criminal investigations or prosecutions in which we had been involved (8) and – perhaps most importantly – “anything we should ask you about, the answer to which might cause you or the administration any embarrassment.”
It didn’t stop there. Investigators checked our answers, interviewed our friends and neighbors and former employers, asked for more records if uncertain. Agents from the Federal Bureau of Investigation did their own background checks. Staff members of the relevant congressional committees, representing both parties, looked over the files and added questions of their own.
It didn’t even stop there. I recall two large, three-ring black binders containing passages from books and articles I had written that might prove troubling to some of the Senators. My vetting team suggested I be prepared to answer questions about them.
The process took well over a month, not including the Senate confirmation hearing. I don’t recall doing anything during that interval except responding to questions from the vetting team, the FBI, and oversight committee staffers, both Republican and Democrat.
Do you believe Sarah Palin was put through anything remotely like this before John McCain decided she would be his vice presidential candidate, and possible President of the United States?
At the Democratic convention last week, I kept bumping into two different kinds of corporate professionals. Most have headed over to the Republican convention this week. One type says its job is “public affairs;” the other, “government affairs.” They sound similar but the jobs are quite different.
The “public affairs” types are at the conventions to bring attention to their companies’ commitments to social responsibility. Many of them have hand-outs and fancy brochures touting all the good things their firms do. The “government affairs” types are at the conventions to build their companies’ political influence. They’re the ones in the sky boxes with cocktails and hors d’oeuvres.
The two types often work for the same big companies but they seem to operate at cross purposes. For example, I met a public affairs person who talked about the great strides his company was making in green technologies. But the government affairs people from the same company have been actively lobbying against environmental laws and regulations.
Another public affairs person was touting her companies’ dedication to its communities – gifts to local schools and playgrounds, for example. But in the sky boxes were lobbyists from the same firm that have been demanding tax abatements from those same communities, as a condition for keeping jobs there. And those tax abatements have meant less revenues for local schools and playgrounds.
Other public affairs people told me how much their firms value their employees, giving them more flexible work schedules and extra days off. But the same firms have been lobbying against paid family leave.
I’m not suggesting hypocrisy. I mean, it’s entirely possible these companies have voluntarily taken on corporate social responsibilities and don’t want the government to force them to do any of it. Or maybe the left hand of corporate public affairs doesn’t know what the right hand of government affairs is up to.
But I can’t help thinking that if these companies took social responsibility seriously, they’d put a brake on their lobbying and influence-peddling. Maybe they’d even avoid spending so much on political conventions.
