THE PLANK SEPTEMBER 27, 2008
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David Cay Johnston, who won a Pulitzer
Prize for his innovative coverage of our tax system, retired this year
as a investigative reporter for The New York Times. He is the author of Free Lunch: How The Wealthiest Americans Enrich Themselves at Government Expenses (and Stick You with the Bill).
Maybe there is a cheaper way out of the credit mess than the plan put forth by Treasury Secretary Henry Paulson, the former chairman and CEO of Goldman Sachs. Any solution that costs less or has a better chance of success deserves serious review before Congress takes an action that will affect taxpayers for years to come.
The most stunning aspect of the Bush Administration's plan to borrow $700 billion to buy illiquid assets like bundles of subprime mortgages was the initial demand that neither Congress nor the courts could review how the money was used. That arrogance caught the attention of everyone who looked at the actual proposal, angering not just Congress, but Middle America.
The second most stunning was the lack of alternatives, the my-way-or-the-highway approach that has characterized the two terms of a president who won office promising he was a uniter and not a divider. The lack of options was also surprising since a basic tenet of management theory is exploring al options and this is, after all, the first time we have a president with an MBA, though not the first time we have a Treasury secretary who was head of an investment bank.
Taxpayers should be troubled that on Capitol Hill and at the White House the talk was about modifying the Paulson plan, not a different approach. They should be just as troubled that most news reporters and TV anchors initially assumed that there must be a crisis and only asked questions around the edges of the plan instead of taking it apart.
Now several options to the Paulson plan have begun to circulate.
One is based on how the Swedish government dealt with its own banking panic 16 years ago, a plan that put taxpayer money at risk, but that also gave taxpayers a chance to get their money back when the banks recovered. That plan, relative to the size of the Swedish economy, cost less than half as much as the $700 billion. And that $700 billion could just be a down payment on a bigger bailout if the Bush Administration plan goes awry.
One of the most intriguing proposals comes from Larry Kotlikoff, a Boston University economics professor who has conducted revealing studies of savings and retirement issues, and Perry Mehrling, an economics professor at Columbia University's Barnard College.
Kotlikoff is the author of an intriguing new book that challenges widely distributed advice on retirement savings called Spend 'Til the End: The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire. (Disclosure: we have the same literary agent, Alice Martell.)
Kotlikoff and Mehrling suggest that Uncle Sam get into the bond guarantee business--for a price (actually, prices). They say this would lubricate the system so credit continues to flow.
Here is why you should be interested: If they are right, it could sharply cut the costs to taxpayers and might even make money.
The professors note that "despite what we hear that 'no one knows' the value of toxic bonds, there is in fact a market for them, currently barely functioning at distressed prices."
Bondholders do not want to sell their weakest bonds for a fraction of their value for regulatory reasons (unmentioned by the professors) and because if Congress approves the Paulson plan the price of the bonds is likely to rise since Uncle Sam will have become a buyer of last resort. Indeed, the worst bonds, those that would sell for a small fraction of their face value, may sell for prices close to their face value if the Paulson plan becomes law.
So how to get bond sales moving?
"The Treasury would offer default insurance for the roughly five different classes or 'tranches' of bonds sold in the market, ranging from the safest AAA bonds, to the worst BBB bonds," the professors propose.
"Insurance premiums would be set based on the market value of the bonds just before the crisis hit, and would range from low" for top rated bonds to very high for the worst bonds. And they would let buyers pay in cash or in preferred stock, the kind of investment Warren Buffet just made in Goldman Sachs.
The professors suggest that instead of issuing preferred stock to the government some banks would pay cash for bond insurance, while others could be loaned money by the Treasury to pay their premiums.
If Uncle Sam loaning money to banks so banks can pay Uncle Sam an insurance premium seems convoluted, be advised that Kotlikoff, who brain is more akin to bubble-headed alien geniuses than mere mortals, loves complexity.
He is also half of a different economics team that figured out that our 401(k) system, which arose quite by accident, may cost many people more in taxes than if they had just paid their taxes up front ands then invested for their old age.
What matters here is that Kotlikoff and Mehrling have put forth an alternative, and one based on market principles. Before borrowing $700 billion, and thus shackling our government for years to come dealing with this debt monster, their idea ought to get a thorough review by Congress and by experts in finance.
Why hasn't Congress put a call for more alternatives and held hearings on options?
--David Cay Johnston
19 comments
If the banks are in trouble because many of the mortgages they hold
are likely to go into default, then, rather than give money to the
banks and/or take the mortgages off their hands, why not give money
to the homeowners who are having trouble paying their mortgages?
That way, the mortgages that the banks hold won't become worthless,
and the homeowners won't lose their homes.
Maybe congress and the administration intend to give some relief to
homeowners, but couldn't this be the main thrust of the bail
out? Bail out the people who pay the mortgages, and, by the magic of
Trickle Up Economics, you bail out the people who hold the mortgages.
- nathang
September 27, 2008 at 12:30pm
nathang said:
"Bail out the people who pay the mortgages, and, by the magic of
Trickle Up Economics, you bail out the people who hold the mortgages."
Bail out the *people who pay the mortgages*??? What are you, a Communist?!? Never, ever, *EVER* bail out the little guy. Never! Ever! They're the cause of all our problems, not the solution. No, if anything they should pay double, that way we'll get double our money back. Let charities take care of the poor. After all, the root cause of all poverty is poor people. Not being rich should be illegal.
- tomeg
September 27, 2008 at 2:17pm
What happens when (not if) the mortgages that underlie these securities start going bad, and the value of the securities fall precipitously. Wouldn't the federal government (read taxpayers) now be on the hook for massive claims from banks. (Remember, the rating agencies did a horrible job of determining the risk of these securities, so AAA rating means nothing -- let alone BBB). That's the whole problem here, no one knows the real value of these securities because (a) they don't really understand how they work; and (b) there is little confidence that the housing market has hit bottom yet.
Because of this, there is the massive collateral damage to the financial industry of trillions of dollars of bad assets floating around -- no one trusts each other and the credit markets have siezed up. Insurance may help in the short term here but at what long term risk to the taxpayers? Would the insurance be available only to the banks or corporations that need it so that others will do business with them? Would it be indiscriminate? How would we possibly develop risk profiles.
Of course, these concerns are also present with the Paulson plan, but at least the Paulson plan is grown up to know that there is no free lunch here. The taxpayers will pay at some point -- either by buying assets, paying off insurance claims, or if we do nothing now -- massive unemployment and other government programs.
I'm not going to disagree with holding hearings and educating ourselves on how we got here and where to go, but that doesn't mean we can wish this problem away.
- tgolomb
September 27, 2008 at 2:22pm
I confess to not being well informed on wall street, bailouts, and the like so I guess you can call me a low-info voter on that. So take what I'm about to say with a grain of salt.
Americans hate the bailout right? Well I guess it depends on who you talk to. It seems to me that if you are one of the Americans whose retirment funds are intertwined with the markets, then if the market fails, then ur retirement is essentially wiped out right? So if that's the case, I would think that retirees would be the ones who really want the bailout, to "keep the markets going?"
On the other hand, if you are not of retirment age, and you are middle class or lower, then you would probably see the bailout as a copt-out to Washington fatcats, and people who "got themselves into this mess". So you would I guess oppose the bailout.
I honestly think that the average voter is more fickle than we think. Yes they may hate the thought of a bailout, but I would place a bet (based on purely antecdotal(?)evidence) that they would hate it more if nothing is done, and more banks like WaMu go under. Because while the FDIC(?) says that the personal funds of WaMu customers are insured, how much money could the FDIC really match if there are more banks/financial institutions go belly-up. How soon after that would people be running to withdraw their funds from the respective banks (BTW, I already know of a few friends of mind who are already comtemplating taking their money from WaMu)
Anyway, I'm probably wrong about this since like McCain, I don't really understand the economy, but this is how it seems to me anyway.
- lamh31
September 27, 2008 at 2:47pm
Answer to your question (why hasn't the Congress considering more options?): because it was putten under a situation of blackmailing political terrorism (the sky will fall by monday morning if they don't approve something demential...) and because Congressmen no longer know how to think politically considering the long term consequences of options and the future that matters.
I'm couting on ordinary Joes here. By putting pressure on the Congress that counterbalances the gigantic pressure to approve this criminal bailout, they are the only ones that can still stop this criminal dementia.... They are the only ones that can still say: Americans are NOT for sale.
The American political culture is not dead yet, I HOPE, it hasn't definitively surrendered to an amorph and despicable atmosphere of unscrupulous financiers and avid consumers unable to stick to principle or too scared to even offer any kind of resistance...
- luispc
September 27, 2008 at 3:06pm
As everyone knows, capitalism is a system that depends ultimately, not on a neutral State (such as the one libertarians fiction) but on a system that protects property rights and contract laws, supporting them by coercion (for instance, by police, by courts that penalize contract breaks, etc.).
If such a system works under regulation and if those profiting from it are obliged to contribute to the common good through things such as progressive taxes, it's not a bad system. It's actually the best we know...
But if such a system works under no regulation and those profiting from it are not obliged to pay back the advantages they get from it (basing themselves on the fiction of a neutral state negatively bound by their "natural" negative liberty), it's an awful system.
Indeed, social and economic inequality on a grand scale is an inevitable result from it: an inequality that is perversely protected by the State since it protects the rights of those that get advantages from the system (I shall call these ones "the few", using Madison's expression) and enhances their ability to get even more advantages over others ("the many", probably those other ones that are too scrupulous or are simply not cut to make money..., but to compose music, teach classes, offer important and not so well payed public service etc., etc.)
In these last years the Bush Administration and the Republican Congress, inspired by a libertarian agenda (based on the fiction that rights such as property are "pre-juridical" and that a state that protects them is "neutral"...) has created a system in which those that are cut to get advantages from "the market" ("the few") are protected in a totally unbalanced way over "the many".
But until now such a totally unbalanced protection had been made in a strictly negative way by a "supposedly non-coercive state". A State (I shall call it "the Predator State", using James Kenneth Gralbraith's expression) that "believes", not only in all those libertarian fictions, but also in contradictory utilitarian fictions, according to which economic welfare "trickles down" if one arranges things for those ("the few") that were already getting over-protection.
So the fictions were already completely unbelievable and the unbalances were already totally unbearable. But what does "the Predator State" want to do now? "It" wants to transform the above said "totaly unbalanced protection", from a strictly negative one (that would respect "market principles") into a positive one. So those that were already getting over-protection start to get absurd protection: they get tax-payer's money!
And the means they choose are robbery ones: they want to get the tax payers' money by putting him against the wall under the threat of a time bomb. Something like this: either you give me the money by monday morning or the entire system in which you got to have some (very few) slices of bread (...and I got to have enormous creamy cakes...) paralyzes! The clock is ticking...
Of course, one day, the blackmailer and robber will come back to ask for more. Because the only way he knows to make money is by creating debt, by creating wealth out of nothing. And to you still want to feed the monster? In this way or in another?
Not to mention the systemic violence inherent in the perpetuation of a "spectral logic of capital" (to use Slavoj Zizek's terms) enhanced with 700 billion. And not to mention the disatrous long term moral and political consequences of all this. But I've already tried to explore these latest ones on other posts...
THERE IS STILL TIME TO STOP THIS MADNESS . And I'm counting on those ordinary Joes that are not for sale, have guts and a sense of what's right. I'm counting on them. "Ode to the common man"!
- luispc
September 27, 2008 at 4:33pm
nathang- what's with the Philip Larkin imitation?
- teplukhin2you
September 27, 2008 at 4:38pm
AGAIN (with less errors):
As everyone knows, Capitalism is a system that depends ultimately, not on a neutral State (such as the one Libertarians fiction) but on a State that protects property rights and contract laws, supporting them coercively (for instance, through police, through courts that penalize contract breaks, etc.).
If such a system works under regulation and if those profiting from it are obliged to contribute to the common good through things such as progressive taxes, it's not a bad system. It's actually the best we know...
But if such a system works under no regulation and those positioned to profit from it are not obliged to pay back the advantages they get from it (basing themselves on the fiction of a neutral state negatively bound by their "natural" negative liberty), it's an awful one.
Indeed, social and economic inequality on a grand scale is an inevitable result from it: an inequality that is perversely protected by the State. Since the State protects the rights of those that get advantages from the system (I shall call these ones "the few", using Madison's expression) and enhances their ability to get even more advantages over others ("the many", probably those other ones that are too scrupulous or simply not cut to make money..., but to compose music, teach classes, offer important and not so well payed public service etc., etc.)
In these last years the Bush Administration and the Republican Congress, inspired by a libertarian agenda (based on the fiction that rights such as property are "pre-juridical" and that a State that protects them is "neutral"...) has created a system in which those that are cut to get advantages from "the market" ("the few") are protected in a totally unbalanced way over "the many".
But until now such a totally unbalanced protection had been made in a strictly negative way by a "supposedly non-coercive state". A State (I shall call it "the Predator State", using James Kenneth Gralbraith's expression) that "believes", not only in all those libertarian fictions, but also in contradictory utilitarian fictions. Namely, in fictions according to which economic welfare "trickles down" if one arranges things for those ("the few") that were already getting over-protection.
So the fictions were already completely unbelievable and the unbalances were already totally unbearable. But what does "the Predator State" want to do now? "It" wants to transform the above said "totally unbalanced protection", from a strictly negative one (that would respect "market principles"), into a positive one. So those that were already getting over-protection start to get absurd protection: they get tax-payer's money!
And the means they choose are robbery ones: they want to get the tax payers' money by putting him under the threat of a time bomb. Something like this: either you give me the money by monday morning or the entire system in which you got to have some (very few) slices of bread (...and I got to have enormous creamy cakes...) paralyzes! The clock is ticking...
Of course, one day, the blackmailer and robber will come back to ask for more. Because the only way he knows to make money is by creating debt, by creating wealth out of nothing. So he will inevitably create more assets as worthless as the ones he wants the State to "buy" from him under a time bomb threat...
And do you still want to feed the monster? In this way or in another?
Not to mention the systemic violence inherent in the perpetuation of a "spectral logic of capital" (to use Slavoj Zizek's terms) enhanced with 700 billion. And not to mention the disatrous long term moral and political consequences of all this. But I've already tried to explore these latest ones on other posts...
THERE IS STILL TIME TO STOP THIS MADNESS . And I'm counting on those ordinary Joes that are not for sale, have guts and a sense of what's right. I'm counting on them. "Ode to the common man"!
- luispc
September 27, 2008 at 5:11pm
If I may interrupt the posts all dealing with mortgages, I'd like to say a few words for renters:
We're all getting pink slips, we're getting screwed every which way, and we think all is lost.
Okay, back to mortgages.
- fougasseu
September 27, 2008 at 5:11pm
how can you put a piece like this up here at this stage in the game? how do you not know about the credit default swaps (aka bond insurance) the 40 or 60 trillion dollar market that is also at the moment dis functional and getting worse due to the impending implosion of other credit products.?
insurance is not the answer. certainly, demanding the over leveraged to increase their leverage with zero potential upside at this point achieves what? how did you miss the piece in the WSJ about what happened to WAMU and their bond insurance costs over the last two months?
are we getting stupider by the day?
here's the saddest part of this at the moment. you have some 45 year old clown in the government being given credence as one with a 'better idea' than Paulson, a guy who has real financial market experience.
WTF?
This piece it a hairs breath away from being as frighteningly clueless as the Palin response to why
the plan is necessary on Couric the other day. Really insulting to america.
- 2736298
September 27, 2008 at 7:02pm
2736298 is exactly right. Which makes the House Republicans pathetic plan completely indicative of how we got into this mess in the first place.
- tgolomb
September 27, 2008 at 8:40pm
On the meaning of "radical evil" in Kant (as precised in Mark Lilla's very clear articulation of it in The Stillborn God, Knopf, 2007, p. 144-145):
«Radical evil is not rooted in passions or desires, though [it] certain may overwhelm our naturally good inclinations in particular situations. Radical evil is something else, a deeper corruption that causes us to distort the very nature of morality. Evil does not tempt us with sensual pleasures. Evil seduces us with the honeyed voice of reason, providing us with principled arguments for preferring our own happiness to the moral law. Kant gives as an example Eve's fateful decision in Eden to eat from the tree of knowledge of good and evil. Eve knew that what she was about to do was forbidden. But rather than accept her sin, which would have preserved the sanctity of God's commandment even in its violation, she appealed to other principles. She told herself that the tree was good for food, was pleasing to the eye, and would make her wise - so she plucked the fruit (Genesis 3:3-5). This, for Kant, is a classical representation of real, radical evil. Food is good, beauty is good, and knowledge is good; they all contribute to happiness, and happiness is a permissible incentive to morality. But that happiness must always be subordinated to morality, which offers its own incentive. When Eve chose the good over the right, she inverted the correct order of incentives, adopting, in Kant's terminology, an "evil maxim"».
Right now, America is in the position of Eve. But will she "accept her sin" or will she be seduced by the "honeyed voice of reason"? In Eve's metaphor, to be seduced, means the downfall of humanity. In America's case, to be seduced will mean the downfall of it as polity and it's definitive transformation into a strict economy of unscrupulous finance and avid consumption (no "regulation" will make up for the lost inocence, for the lost vitality, for the lost goodness...).
Do whatever you can to prevent this crime: contact your Congressman by every possible mean, demonstrate on the streets... Do whatever you can...
- luispc
September 28, 2008 at 4:47am
So the armchair general called down to the battlefield to inform the colonel that the bullets whizzing past his head aren't all that much to worry about and that the guns pointed in his direction can be mollified by getting on the bullhorn and telling the enemy that the shape of the battlefield has changed and is not what it appears to be. Tell them to shoot the other way. That should do the trick. Its all mind over matter. Meanwhile......
- boxofrox
September 28, 2008 at 8:19am
The armchair general called down to inform the colonel not to be manipulated to the point of killing himself. To remember himself.
- luispc
September 28, 2008 at 10:38am
Luis. I respect your passion and sense of justice. I also know that the patient was on the table having suffered cardiac arrest. Paulson's offer was merely an application of the paddles to revive the patient and give him time to consider stents as a means to save his life. His peripheral arteries were choked and his main artery was next.
I don't take this lightly. But I've seen enough to know that this was very likely to be a crash of unprecedented proportion. It was melting down before my eyes and many, many people were going to get hurt badly. Wall and Main. It wasn't a matter of ATM machines not working anymore. It was a matter of taking years to dig through the wreckage and sort out those left alive and dead under the rubble. Why suffer for things and provision but for a solution? Do I have some skin in the game? A bit, but all things considered I would weather better than most. Maybe even profit if I'm smart enough.
This solution is better than the alternative for everyone involved. It isn't a payoff or bailout. It is a collective rescue plan.
- boxofrox
September 28, 2008 at 12:10pm
I know that you don't take this lightly Jack.
But I still don't know. Anyway, now it seems, nothing can be done anymore. They've already reached a deal, so I've heard.
I do hope that long term consequences are not going to be as bad as I imagine they will be. Sorry if I'm pessimistic. But I think they will be. The founding political material is at stake. And I think the monster will come back. Sooner or later you're going to have to face it without any rescuing devises.
I hope I'm wrong. And anyway, I hope that those that signed this "deal", know so much about what's at stake and about the long term consequences as you do. And, supposing that your terminal patient scenario is right, I do hope that they know that their patient needs lenghty, painfull recovery. Also from his rescue.
- luispc
September 28, 2008 at 1:35pm
And at least I wished people like Buffet ("Bail out economy of face meltdown") had the decency to be quiet.
- luispc
September 28, 2008 at 2:46pm
Luis. I, too, think that extended convalescence is quite likely. I'm an optimist but realistic about the dislocations this regrettable situation has wrought. Under the best of circumstances there are no guarantees. Chances are pretty good that this hangover induced heart attack will have its way and demand a pay up of its own reckonings.
Be well. Jack
ps. It is easy to perhaps have the wrong impression about Buffet simply because of his famous success. His influence on the markets has primarily been of the old school conservative philosophy. A penny saved is a penny earned and all that. He is watched so closely these days that it is almost impossible for him to remain quiet about anything he does. He isn't a saint but he does have a degree of ethics at least within the parameters of market realities. It ain't pretty but then there are some unique realities in the law of the seas and creatures therein.
- boxofrox
September 29, 2008 at 5:41am
Only a few comments so far reflect an understanding that confidence in the system really is teetering on a knife edge. Let's just spell out the issue. If confidence cracks, the payments, let alone any extensions of credit, start freezing up. First effect is writeoffs, over a matter of (sadly, too few) months, which could break the FDIC. Second effect is bankruptcies of companies, big and small. Extended effect is a prolonged and very deep recession. Not to say that alll those things will certainly happen, but all the people who have money, from large investors to the guy with the pillowcase of cash, are already acting in ways that will tend in that direction.
Which is to say that this bill, which was rejected today, was not to bail out the bigwigs and buccaneers, it's to try to shore up the system, which is the taxpayers, the salary earners, the savers. Actually, when and if things stabilize, a significant portion of the financial system will be in federal hands and there will be much room to debate how to treat those properties and how to structure the next financial system. There will also be much time to investigate and impose sanctions ranging from new regulation to criminal penalties and jail.
But all of this is in the future. Right now we're playing with fire, for all of us, out of partisan politics, out of resentment, out of ideological fantasy. And we're acting collectively about like Nero. Not a very good advertisement for freedom and democracy. Pray we get it together fast.
- paikgf1
September 29, 2008 at 4:59pm