Thursday, October 02, 2008

Better Alternatives to Congress' Bailout Plan

October 2, 2008, 7:00, 11:45 a.m.

Senate Bill: Wrong Plan, Favoring Wrong People, at the Wrong Time

Look, I understand that I don't have a Ph.D. in economics or an MBA in finance. But I can smell a hog confinement when the breeze blows in from south of Iowa City, and what is floating in the hot air coming from Washington smells very similar.

I really don't like to say "I told you so." But I predicted almost step by step what was going to happen with our war in Iraq, and it has. And I don't like what I see coming down the road over the next few years as a result of what Washington thinks is a "solution" to our financial woes either.

Nonetheless, I realize that most rational readers of this blog would like to have a little more reassurance on something of this magnitude than just my gut instinct and intuition. So this morning I'm going to wheel in the support of 200 economists and another nation's much more sensible solution to an almost identical challenge.

Do we need to "do something"? Absolutely. I just don't think we ought to be doing "something" that is going to make the situation worse rather than better, and is inherently unfair in terms of whom it benefits (the excessive-risk-taking greedy bankers who created and profited from the problem, along with the excessive-campaign-contribution-taking elected officials who, in exchange, deliberately failed to regulate it) and whom it burdens (the unemployed, working poor, homeowners, and present and future generations of taxpayers).

Don't you have just a little deja vu with the rhetoric from the White House? Doesn't it sound a little like the "mushroom cloud" we were going to be witnessing if we didn't invade Iraq?

[S]ane people were rightfully a little suspicious of the plan to upright the finances of the U.S. by a $700 billion handout funded by taxpayers.

The House was rightly skeptical too, failing to pass the proposal Monday.

But George Bush skipped talking about sacrifice and buckling down in his speech promoting the bailout to the nation. He preferred to persuade us mere peons using fear, as he has in the past. The phrases he chose were dire, scary even: “a long and painful recession” and “our entire economy is in danger.”

"More banks could fail, including some in your community,” he warned. “The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. Foreclosures would rise dramatically.

“And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs.”

OK, we get it. The markets are falling apart, and with such a high percentage of people with some funds in the stock market, some sort of action will be taken.

But how long will it take before an accounting of the long term cost of fixing this financial mess will occur?

I’m awaiting the politician who admits that some will be shortchanged in the public arena as billions are leveraged to stave off the crisis. . . .

The money will come from somewhere. We just want to have a more honest accounting of the situation, of who will actually suffer, who will profit by the plan, and whether it will really fix the problems of the U.S.
Mary Sanchez, "We're Ready to Sacrifice, But Not be Suckers," Kansas City Star, October 2, 2008 (in this morning's Gazette as "Americans Ready to Sacrifice, But Not to be Suckers," p. A4).

Even Nicholas Kristof, a solid backer of the Paulson approach, acknowledges,

"[C]ritics of the bailout have reason to be furious. It is profoundly unfair that working-class American families lose their homes, their jobs, their savings, while plutocrats who caused the problem get rescued. . . .

Congressional critics of the bailout . . . should come back in January . . . with a series of tough measures to improve governance and inject more fairness in the economy: . . . remove tax subsidies on executive pay and allow courts to restructure mortgages as they do other kinds of debt. . . .

Among the strongest critics of inflated executive pay have been Warren Buffett and the late management guru, Peter Drucker, who argued that C.E.O. salaries should peak at no more than 20 or 25 times those of the average worker. (Last year, C.E.O.’s got an average of 344 times the wages of the typical worker.) . . .

C.E.O.’s hijack shareholder wealth in ways that are unconscionable. . . . [I]f [Nabors Industries] Eugene Isenberg . . . were to drop dead one of these days, his estate would be entitled to a “severance payment” of at least $263 million — more than the firm’s first-quarter net earnings.

Nicholas D. Kristof, "Save the Fat Cats,"
New York Times, October 1, 2008

Last night the Senate passed -- over the opposition of a full fourth of the body (25 senators) -- a "sweetened" version of the Paulson/House bill. FDIC insurance on depositors' accounts in banks would be raised from $100,000 to $250,000, and even more tax cuts are promised, among other things.

Think about it. More for the wealthy. How many of the 600,000 workers laid off this year will be helped by tax cuts? How many of your neighbors keep so much more than $100,000 in their checking account (and are so lazy or ignorant they haven't opened additional accounts elsewhere) that they really need the reassurance that it's guaranteed up to $250,000? Are House Republicans who voted for common sense (and their outraged constituents) really able to be bought with such tarnished coin?

And with the dollar continuing to drop, please explain to me how adding even more debt (from unfunded additional tax cuts) to our current national debt of $10 trillion, unfunded future obligations of $55 trillion, Iraq future costs of $2 trillion, and Paulson's added debts of $1.3 trillion, is going to make things better for future taxpayers.

There is even more reason to vote against the Senate's plan than there was to vote against the House proposal.

So where is my support from the nation's economists? Here it is. Some 200 of them, from some of the most prestigious public and private universities in the nation. I'll provide the link if you'd like to look for your own school, but my truncated listing of all the signers -- those whose last names begin with "A" or "B" -- will give you an indication of who's on board.

And what do they think of the Paulson proposal? Not much:

To the Speaker of the House of Representatives and the President pro tempore of the Senate:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwords.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.
The online letter notes, "This letter was sent to Congress on Wed Sept 24 2008 regarding the Treasury plan as outlined on that date. It does not reflect all signatories views on subsequent plans or modifications of the bill."

Here is a link to the letter, where you will find the names and institutions of the signers as "updated at 9/27/2008 6:00PM CT."

Meanwhile, as promised, here's a sampling of the names and institutions -- those whose last names begin with "A" or "B":

Acemoglu Daron (Massachussets Institute of Technology)
Ackerberg Daniel (UCLA)
Adler Michael (Columbia University)
Admati Anat R. (Stanford University)
Ales Laurence (Carnegie Mellon University)
Alexis Marcus (Northwestern University)
Alvarez Fernando (University of Chicago)
Andersen Torben (Northwestern University)
Baliga Sandeep (Northwestern University)
Banerjee Abhijit V. (Massachussets Institute of Technology)
Barankay Iwan (University of Pennsylvania)
Barry Brian (University of Chicago)
Bartkus James R. (Xavier University of Louisiana)
Becker Charles M. (Duke University)
Becker Robert A. (Indiana University)
Beim David (Columbia University)
Berk Jonathan (Stanford University)
Bisin Alberto (New York University)
Bittlingmayer George (University of Kansas)
Blank Emily (Howard University)
Boldrin Michele (Washington University)
Bollinger, Christopher R. (University of Kentucky)
Bossi, Luca (University of Miami)
Brooks Taggert J. (University of Wisconsin)
Brynjolfsson Erik (Massachusetts Institute of Technology)
Buera Francisco J.(UCLA) . . .

Consistent with the concerns of these economists are those of Senator Russell Feingold:

“I will oppose the Wall Street bailout plan because though well intentioned, and certainly much improved over the administration’s original proposal, it remains deeply flawed. It fails to offset the cost of the plan, leaving taxpayers to bear the burden of serious lapses of judgment by private financial institutions, their regulators, and the enablers in Washington who paved the way for this catastrophe by removing the safeguards that had protected consumers and the economy since the great depression. The bailout legislation also fails to reform the flawed regulatory structure that permitted this crisis to arise in the first place. And it doesn’t do enough to address the root cause of the credit market collapse, namely the housing crisis. Taxpayers deserve a plan that puts their concerns ahead of those who got us into this mess.”
"Statement of U.S. Senator Russ Feingold On Opposing the Bailout," October 1, 2008.

For the objections of other senators in the coalition of opposition see, David M. Herszenhorn, "A Curious Coalition Opposed Bailout Bill," New York Times, October 2, 2008 ("Their concerns spanned a panorama of issues: frustration over the lack of long-term regulatory changes in the legislation; alarm that $700 billion in taxpayer money would be at risk; anger that the Treasury secretary would not be subject to more stringent oversight; skepticism that executives of firms that seek help would face limits on their pay; and dismay that such an important bill was being rushed through Congress. And, perhaps most pointedly, they expressed skepticism that the bailout proposal would be able to restore liquidity to the credit markets, prevent the collapse of additional banks and safeguard the economy from a long recession.").

There are those who say (to me, and to other critics of what Congress is doing), "Now look, I understand you're angry, that you don't like this plan. But we have to do something. You can't just oppose the only plan we have. If you don't like it so much, tell me what you think would be a better plan."

OK. And I'm about to tell you what would be a better plan.

But not before I observe that I don't really think that's my responsibility. I'm with the secretaries with more than one boss who post the sign on the wall, "Your failure to plan does not constitute my emergency." It's like the profligate friend who wants to borrow money "because otherwise the electricity is going to be cut off." And you're thinking, (a) why didn't you think about that when you engaged in that last excessively expensive bit of discretionary spending (or trip to the casino), and (b) why didn't you let me know this was coming more than the day before the shut-off is going to occur?

Those who will bear the burden of this Wall Street bailout did not create the problem. It's not their responsibility to come up with a solution.

But because they (and I) will continue to be berated by the perpetrators unless we solve it for them, here's an idea.


It's not a theoretical, ivory tower approach. Not only did it work for another country -- it was actually the approach taken by Paulson with Fannie Mae, Freddie Mac and AIG! So please tell me: Why has he now suddenly abandoned this approach?

It's not as if no other country has ever dealt with a similar financial crisis, or that there is no other approach than that of Secretary Henry Paulson. The $700 billion we're talking about represents some 5% of our GDP. In 1992 Sweden put 4% of its GDP into its banks. (They had run into trouble for much the same reason as ours: "Financial deregulation in the 1980s fed a frenzy of real estate lending by Sweden’s banks, which did not worry enough about whether the value of their collateral might evaporate in tougher times," as the Times' Carter Dougherty reports, but they didn't use taxpayers' money to buy up "toxic debt." Dougherty continues:

Sweden took a different course than the one now being proposed by the United States Treasury. And Swedish officials say there are lessons from their own nightmare that Washington may be missing.

Sweden did not just bail out its financial institutions by having the government take over the bad debts. It extracted pounds of flesh from bank shareholders before writing checks. Banks had to write down losses and issue warrants to the government.

That strategy held banks responsible and turned the government into an owner. When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies as well. . . .

[T]he final cost to Sweden ended up being less than 2 percent of its G.D.P. Some officials say they believe it was closer to zero, depending on how certain rates of return are calculated. . . .

A few American commentators have proposed that the United States government extract equity from banks as a price for their rescue. But it does not seem to be under serious consideration yet in the Bush administration or Congress.

The reason is not quite clear. The government has already swapped its sovereign guarantee for equity in Fannie Mae and Freddie Mac, the mortgage finance institutions, and the American International Group, the global insurance giant.

Putting taxpayers on the hook without anything in return could be a mistake, said Urban Backstrom, a senior Swedish finance ministry official at the time. “The public will not support a plan if you leave the former shareholders with anything,” he said. . . .

Sweden formed a new agency to supervise institutions that needed recapitalization, and another that sold off the assets, mainly real estate, that the banks held as collateral.

Sweden told its banks to write down their losses promptly before coming to the state for recapitalization. . . .

Then came the imperative to bleed shareholders first. . . . Peter Wallenberg, at the time chairman of SEB, Sweden’s largest bank . . ., the scion of the country’s most famous family and steward of large chunks of its economy, heard that there would be no sacred cows.

The Wallenbergs turned around and arranged a recapitalization on their own, obviating the need for a bailout. SEB turned a profit the following year, 1993. . . .

[T]he agency had mostly fulfilled its hard-nosed mandate to drain share capital before injecting cash. When markets stabilized, the Swedish state then reaped the benefits by taking the banks public again.
Carter Dougherty, "Stopping a Financial Crisis, the Swedish Way," New York Times, September 22, 2008.


Are you really going to try to convince me that there are no American "Wallenbergs" out there who might come up with similar solutions if they knew their share of the $700 billion would be accompanied by a loss of ownership? There is a "market" out there as well as taxpayer money. J.P. Morgan bought the failing Bear Stearns. "In the midst of the subprime crisis, Buffett said during a media interview in June that he sees investment opportunities in the subprime market." He just put $3 billion into General Electric. Bank of America bought Merrill Lynch when it was near bankruptcy. Wells Fargo just bought Wachovia. There have been others.

Maybe the market, alone, is not enough to pull us out of this. But shouldn't that option at least be exhausted before loading an additional $700 billion (or more) debt on our great grandchildren?


Ireland has just come up with its own innovative approach (though not unprecedented, less satisfactory, and far more controversial), characterized by The Daily Telegraph as "the most dramatic and comprehensive bank bailout in Europe since the Scandinavian rescues of the early 1990s." The Irish Times, from which this quote comes, has published a summary of the response of many of the world's great newspapers to its government's essentially bank loan guarantee plan. "World View," Irish Times, October 2, 2008. For the Financial Times' take on what's going on in Ireland this week (as well as the British government's response) see Andrew Hill, "Guarantees Go Only So Far," Financial Times, October 2, 2008.


And Michael Moore (yes, that Michael Moore) has some solid suggestions among the ten in Michael Moore, "How to Fix the Wall Street Mess," October 1, 2008.


Now I'm not about to join those "I'm still angry," PUMA, former-and-for-always Senator Hillary Clinton supporters and "go Republican" on you. But I've always been more interested in ideas than ideology, proposals than partisanship, and when I find a Republican with a better one I'm not afraid to say so.

Though I must say it gives me some sadness to have to say, this close to election day, that I think Dr. Mariannette Miller-Meeks, the Republican opponent of my Democratic Congressional Representative, Dave Loebsack, has the better position on the Wall Street bailout. See, on her Web site, "Congress Must Set Aside Politics, Address Root Causes of Financial Crisis," September 30, 2008.

Not only do I not support everything she says, I have to candidly acknowledge I don't even understand everything she says. But I understand and agree with most of it, and offer it in the context of this blog entry as, at a minimum, one more response to those who argue that no one is permitted to dislike the Paulson approach unless they can come up with some other alternative. Well, here is yet one more alternative.

"We need to quickly stabilize the financial system with the least cost to the taxpayers. . . .

She said Congress should remove language from Community Reinvestment Act that encouraged excessive risk-taking by Fannie Mae and Freddie Mac and authorized the development of bundled mortgage debt obligations creating this morass and passing the risk onto others. Miller-Meeks advocates temporarily suspending mark-to-market accounting so that banks can stabilize their accounts instead of writing down good loans that will be repaid in full.

"Home owners who are dutifully paying their mortgages on their primary home and have been honest in their application, should be protected with new mortgage product or stabilization of the housing prices. We should penalize those responsible for the losses and keep current executives in place without golden parachutes. Unfortunately, those who benefited most are already gone from those institutions," she said. . . .

Miller-Meeks said the federal government does have an appropriate role in the crisis, including purchasing some institutions and securities at fair market value and selling them at fair market value to the benefit of taxpayers. She believes all proceeds from the eventual sale of such assets should pay down the national debt or provide a tax dividend to taxpayers. . . .

"Steve King is absolutely right when he says doing 'something' is not enough; we have to do the right thing. That means we need to approve a plan so that Wall Street won't expect a bailout every time they make the wrong decisions," she said. "To paraphrase Martin Luther King, Jr., we can't afford socialism for the rich and raw capitalism for the rest of us. Unfortunately, David Loebsack doesn't seem to understand that or the real-world challenges facing the people he's supposed to represent."

Miller-Meeks favors allowing the Federal Deposit Insurance Corporation to ease capital requirement for banks so they can ride out the current credit crunch. She also believes the Securities and Exchange Commission should modify fair value accounting so assets aren't considered worthless during a market panic and instead can be valued on the basis of their true economic value. She also favors development of a plan to let private investors fund the bailout through guaranteed recovery bonds or to set up insurance programs to ensure Wall Street bankrolls its own recovery. . . .
So there you have it. There are better ways to deal with our financial problems, at a minimum there are alternative ways that should be fully explored before rushing down the dangerous path Congress has chosen, ways that consider the plight of the unemployed and homeowners, ways that promise a little greater likelihood of a return to taxpayers, ways that don't reward those who created the problem, and ways that don't perpetuate their inclination to make short-term greedy profit by putting long-term probable risk onto taxpayers.

The route the Senate -- and perhaps on Friday (October 3rd) the House -- are taking (particularly given their role in criminally removing regulation from the industry) is not necessary and is certainly not the only, inevitable, approach; it's just the despicable approach.

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