- ". . .address the need to recapitalize those financial institutions that are badly under capitalized: this could have been achieved by using some of the $700 billion to inject public funds in ways other and more effective than a purchase of toxic assets: via public injections of preferred shares into these firms; via required matching injections of Tier 1 capital by current shareholders to make sure that such shareholders take first tier loss in the presence of public recapitalization; via suspension of dividends payments; via a conversion of some of the unsecured debt into equity (a debt for equity swap)."
- ". . .explicitly include an HOLC-style program to reduce across the board the debt burden of the distressed household sector; without such a component the debt overhang of the household sector will continue to depress consumption spending and will exacerbate the current economic recession.
Another measure, which should be taken by central banks, apart from the rescue plan, is a coordinated 100 basis point reduction in policy rates in all the major economies in the world, as recommended by Dr. Roubini on September 29.
Yes, the Paulson proposal is wrong headed and would be ineffective, even after the Congressional improvements - though not as ineffective as doing nothing.
I do not believe, as many apparently do, that the need to recapitalize ought be delayed or neglected in favor of "progressive" interest group building actions, or appeals to substitute political agitation for effective legislative action to rescue the financial system.
What I Support
I support moving forward with a financial system rescue package - once the Obama campaign, and the Democratic leadership in the House and Senate have clearly and forthrightly considered and addressed the criticisms put forth by economists who are specialists in financial economics. Not one that is perfect, not one that is punitive, not one that presses advantage to gain political objectives other than the rescue of the financial system, but one that will pass, be signed by the President, and halt our slide into generalized panic in credit markets and toward a systemic meltdown of the entire financial system.
On Tuesday, September 30, I called the offices of Senator Obama's campaign, the Democratic National Committee, Senator Harry Reid, Speaker Nancy Pelosi, Senator Chris Dodd, and Representative Barney Frank. In these calls I expressed my understanding of the need to promptly pass an effective financial system rescue package, and described how I have been working with friends and relatives who have opposed that action to secure their support for it. They listened.
And they were concerned that I, a strong supporter of the Democratic party and of Barack Obama, am dissatisfied with the proposal currently before us and want full consideration of alternatives to it; that I believe it is absolutely essential that the weaknesses of the Paulson proposal be reexamined. I believe it is essential that the inclusion of purchase of distressed debt instruments using a $700 billion taxpayer funded program be reviewed in the light of criticisms by experts in this specific area of financial economics, including Dr. Roubini of RGE Economics, and Brad Setser, at the Center for Geoeconomic Studies at the Council on Foreign Relations.
I explained that the cautionary judgments of such critics needed to be explicitly and visibly discussed by the House and Senate leadership, and by the economic policy team of the Obama campaign. And that this should be done publicly, with the results publicly discussed and announced, so that those of us concerned about the suitability and adequacy of the Paulson proposal would know what action they were taking as a result of having considered criticisms of the Paulson plan, and why they were taking that action in the light of those criticisms and alternative proposals. And that my further financial support of the Party and the candidate would be dependent on their response to this need for visibility and transparency.
The Naysayers
In working to secure support for action on a rescue package I have been asked by friends who do not support it to explain myself. I've answered some of those questions in this way:
- This bailout is BS and not necessary. It is only a give away to greedy, selfish Wall Street millionaires. I think they're lying/manipulating once again to get what they want. There is no real systemic crisis in the global financial economy, and if there were that would be a good thing. They've hollered "wolf" too many times. Anyway, since big money so believes in letting the "free" market do its thing, maybe it should be proved once and for all that they're wrong. The $700 billion dollars should be used to (followed by a laundry list of sometimes worthy social and political reform programs).
A. Your pie in the sky, castle in the air, nihilist revolt against taking effective action to rescue the financial system is worthy of a Kieth Olberman award.
- Well who do you think made the bad judgments? And why? Maybe we need new representatives, not owned by 'fat cats'.
A. The "bad judgments" were made by many people, starting with the Reagan administration, continuing through Clinton's support of repeal of the Glass-Steagle act, down to people who let bad mortgage brokers sell them bad adjustable rate home equity mortgages and the financial advisers who encouraged them to take those mortgages, and finally to the financiers who packaged the bad mortgages and wrapped them into highly leveraged securities - whose value is now in doubt.
- Perhaps we need new financial systems! (call them nfs!) seems to me we've just created another version of the feudal system that we left England to escape (how about what is past is prologue..And if we don't learn from our mistakes, we're destined to repeat them).
A. The existing system is bad news, it permitted the system to get to the point it is at. We do need new systems. We also badly need to keep the one we have running until that can be devised and the transition made to it without stopping the worlds economies dead in their tracks for an indefinite period.
- Okay, well addressing these difficult political and distributional issues is way overdue so the time is now.
A. Decisions made under the kind of stress this will create are always bad, and always disadvantageous, negative, retrograde - not progressive. Remember Naomi Klein's "Shock Doctrine"? That is what you'd get. No improvement, only fascism and fear. Besides, it will take lots of time to resolve - unless resolved by a "strong man" dictator who imposes it, as in Germany the last time a major currency melted down - and in the meantime people will suffer, turn inward, become crippled and fearful emotionally, with all the personal, social, and political consequences of those conditions.
- We'll get it right this time, and wake up to the need to share wealth, cooperate, and have food and shelter and gardens for everyone on the planet.
A. Decisions, especially social/political decisions made under this kind of stress are negatively conditioned, there will be no such positive outcome to a crash in the world economy.
- Time to think outside the box.
A. It's a good idea, that thinking outside the box. But the doctrinaire oppositionalists on the left and right don't seem to be able to, or want to do it.
- Do you have confidence in any of those who will be designing the 'rescue package'? and in those who may be executing it?
A. The people I trust most have a high but not unconditional regard for them. I have felt Paulson was doing a good job at Treasury since he got there, but dislike the specifics of his proposal.
I very much like Bernanke, trust him, and have been reading his writings carefully for 4 years or more - he gave a superb speech in Richmond, VA, back then.
Treasury policy is one area that Cheney seems to have not screwed over, and the staff has been pretty much left to the Secretary. I suspect that O'Neill did a good job protecting Treasury staff - which may have gotten him fired, but held the place together.
Their recommendations and writings fit with my understanding of how these things work, and I've been studying that for 6 years or so, in some depth; and have written quite a bit about it - not that anyone pays attention.
The experts I like best - Gross, Setser, Roubini - quarrel with some of the details (and with one another), but all agree something along these lines has to be done. Roubini, Gross, and I think Setser have recommended action of some kind a long time ago; Gross recommended action of this kind explicitly a few weeks ago, months ago Roubini recommend a HOLC, which was not included, and should be.
I think a lot of economists who have criticized the program did so not realizing that their criticism could give cover to those seeking to derail the whole thing - and would wish that had not happened.
Of course the radical Right Wing is happy as hell about this. A real disaster will give them ample opportunity to apply "Shock Doctrine" type solutions.
- Why should those of us who didn’t borrow more than we could pay back and lived BELOW our means (old school) be penalized for those stupid bastards who bought way more home than they could afford and have maxed out all of their credit cards?
I understand the feeling, but that problem has been overstated, greatly. Most of the bad paper originated was because the mortgage brokers "sold" it to people who did not know better - I know this first hand from experience in California, where a broker almost trapped a friend into an ARM, and dropped it only when I called her on her lies.
And the problem that needs to be addressed is only superficially the result of over extension of this kind of credit - if those were the only mortgages going bad, it would have been easily dealt with. In housing there is a mismatch of high cost supply and low cost demand that was being disguised by crazy and illegal financing practices. When those practices are halted, it depresses the value of houses people had hoped to refinance, or sell. Those go on the market as distress sales, further decreasing the market value of all housing.
While this would fix the mismatch between supply and demand price, it also leaves a huge volume of "bad mortgages" in the hands of the institutions who bought them from the fakers brokers who originated them. This process made developers, flippers, brokers, and mortgage backed security originators rich. Everybody else goes underwater.
That puts people with straight 30 year mortgages "underwater" - they can make their payments, but their net worth has gone down, and they cannot sell with any hope of getting what they have in out. If they have medical expenses, or retire, or lose a job, then they are in the same position as the rest - facing foreclosure or simply walking away from what was once a good mortgage and a good house.
So the housing crash has at least three cycles - the first is "liar loans", where the broker inflated values and incomes to get approval of loans which should never have been approved. These failed first. That was a small set, but is the one the less informed "moral hazard" people so love to flog.
The next group - currently in play - are 5 year fixed "option" loans. These people could make only principal payments, added interest to the principal, and expected that they would be able to refinance at as good or better rate, on a property of greatly increased value, and having a higher income, at the end of the 5 years. That group, except for John and Joanie Flipper, was not so much stupid as ignorant - young couples with high hopes who had never seen a business cycle and believed their mortgage broker's BS. Now they are underwater in a sinking economy, and being foreclosed in droves.
The group coming up, and this is the one which will really kill the housing market and the economy if there is no mortgage relief, is the holders of traditional mortgages who suffer illness, or job loss or transfer, or retirement and find they cannot sell and cover the balance due on the mortgage. I don't know the stats, but the people who study this seem to think it's a very serious problem and will worsen if the economy falls into extended recession.
But housing is only the scab on the wound.
Under that is the fact that the entire world money supply has been built on top of "derivatives" or financial instruments derived from and built on these mortgages and other credit instruments. "I've an AAA rated bond I'd like to sell you that is secured by a 1951 grain elevator in Almena, KS." (And slices of which underpin various Credit Default Swaps, some between institutions in Hong Kong and Melbourne.)
After financial "deregulation the central banks found that the money supply increased pretty much in sync with measured output. That was convenient because it limited the need for central bank intervention to manage the supply of money and limit (measured) inflation. But that synchronization occurred only because the money supply was being increased by the growth of these financial derivatives, and the derivatives were the source of the measured growth. (A self referential system.)
The engine of money growth and much economic growth was not increased productivity and production, but inflation of the values of assets, based primarily on an increasing money supply - inflation that did not show up in consumer goods or the CPI. It was reflected, though, in the cost of homes, real estate, and high end amenities in the developed world, in cities like Moscow and in principalities on the Gulf.
When the weakness of that "asset value" base is exposed, and it is known that paper assets are not supported by the value of real assets, then the money supply based on the paper assets simply vanishes - and the entire financial system crashes.
No problem. Except that the real economy does need money to operate, and that money is no longer there. So it stops too.
So, when we pay for a financial system rescue we are not paying to help other people out. We are paying to save the system we all depend upon. And we are not paying all that much.
Despite fears to the contrary, even under the Paulson plan Treasury would probably get the assets it picks up for 65% of nominal value. It should be able to "clear" about 1.5 trillion in bad paper from the market with an operating fund of 700 billion; and even skeptics like Nouriel Roubini have said the net cost to taxpayers would probably not exceed 250 Billion - a pittance compared to what a deep recession would cost in tax receipts, and plain trivial in comparison to the cost of systemic failure of the system.
Of course the loss to private income resulting from a recession which might be avoided by spending this money would be much, much greater. (The simple announcement of the House failure to pass the TARP on Monday resulted in a temporary loss in stock markets of more than a trillion dollars! There are a lot of ways to lose that kind of money, but not to lose the kind of money that a systemic failure would take from us.)
- We must not let this $700 billion bailout increase the Treasury's debt, it will weaken the dollar!
Demand for U.S. T-bills and other safe-haven instruments have helped underpin the dollar, despite the fact the United States is the epicenter of the financial crisis.Summing up
The fear of a full blown destruction of the money supply and world economy strengthens the dollar, since holders of other currencies engage in a "flight to safety" by buying US Treasury debt instruments; this also forces the interest rates the US Treasury pays down, so our own debt is cheaper -- at least until the entire pond freezes over, after which we can all do subsistence agriculture to feed ourselves.
This strength is based on fear, uncertainty and doubt (FUD). When that fades, the dollar may well lose strength. A general sense that the markets world wide have hit rock bottom would reduce FUD, and may weaken the dollar. Passage of a rescue package may:
* weaken the dollar by reducing FUD
* weaken it by increasing the need for Treasury to borrow dollars
* strengthen it by improving the outlook for the US economy against others
* strengthen it by making it less necessary to lower interest rates as an alternative credit enhancement strategy
* be neutral as a consequence of increasing other central banks' willingness to assist in managing the flow of deposits and among national Treasuries to reduce exchange rate swings. Dr. Roubini has proposed a a coordinated 100 basis point reduction in policy rates by the central banks of all the major countries, which would help to guarantee a neutral effect for the reduction. (Non central bank flows have been reduced by private holders' fear of credit and exchange fluctuation risk.)
Beyond that, remember that, as Mark Weisbrot writes "for the vast majority of the country, a "strong dollar" is more like a "strong influenza virus" - something to be avoided whenever possible." The supposed strength of the dollar has, for the last 25 years, underwritten the hollowing out of the United States economy by raising the relative cost of our labor and the goods we produce. It has subsidized our purchase of foreign goods, and raised our annual trade and balance of payments to unsustainable levels. It is a mistake to desire a strong dollar, and a mistake to fear a weak dollar, so long as we are exporting to little and importing too much.
It is, to be honest, more than a little disturbing to me to see people who write about the need to restore the United States economy, rebuild our manufactures, and increase the wages of non-financial workers, who do not understand the part that over valuation of the dollar has played in destroying those values. And how our appetite for foreign goods and oil is fed by that same overvaluation.
I support moving forward with a financial system rescue package - once the Obama campaign, and the Democratic leadership in the House and Senate have clearly and forthrightly considered and addressed the criticisms put forth by economists who are specialists in financial economics. Not one that is perfect, not one that is punitive, not one that presses advantage to gain political objectives other than the rescue of the financial system, but one that will pass, be signed by the President, and halt our slide into generalized panic in credit markets and toward a systemic meltdown of the entire financial system.
A rescue of the financial system is absolutely essential, and it must be done soon.
Economists who are credible experts in the world financial system are almost universally in agreement with the need for effective action, but have substantive and well founded doubts about the effectiveness and appropriateness of the debt purchase plan proposed by Secretary of the Treasury Paulson.
Virtually all who are serious students of the subject are persuaded by daily events that, in the absence of action, there is a very serious and increasing chance that the world financial system will cease to perform its essential functions. These are functions which the entire world economy needs to continue producing goods and moving them to markets and consumers, and their failure would result in significant and long lasting human deprivation and tragedy.
After full and transparent consideration of criticisms of the plan presented by Secretary Paulson, in particular the proposal for debt purchase and the omission of the HOLC, the leadership of the Democratic Party should, if at all possible, adopt modifications to it which will meet the most significant of those criticisms and are consonant with Democratic values.
I will support the action that is taken, provided that there has been full consideration of alternatives, and the reason these modifications cannot be adopted have been communicated to the public.
Congress must take action to rescue the financial system from its current crisis, even if it is impossible to remove or modify the provisions I object to.
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