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COLUMNISTS
TODAY'S STORIES
29.09.2008
Celebrating The Bailout Bill's Failure--And Looking Ahead

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).

Whether you favor the $700 billion bailout or not, the House vote today should make you cheer--loudly.

Why?

Because the majority vote against it shows that Washington is not entirely in the service of the political donor class, by which I mean Wall Street and the corporations who rely on it for their financing. These campaign donors, a narrow slice of America, have lobbied and donated their way into a system that stacks the economic rules in their favor. But faced with as many as 200 telephone calls against the bailout for every one in favor, a lot of House members decided to listen to their constituents today instead of their campaign donors.

The GOP members voted overwhelmingly against the bill, while two-thirds of the Democrats favored it. Right now you can be sure that cajoling and arm twisting is underway in an effort to persuade 16 GOP members (or perhaps a dozen Republicans and a few Democrats) to vote the public largesse for Wall Street.

None of this is to say that we need, or do not need, some government intervention in the markets. Rather it is to say that the administration has failed to make its case, instead assuming that just as with the war in Iraq and the Patriot Act, it could stampede Congress into thoughtless action and terrify the public into going along.

Also, do not get stampeded by the awful, ill-informed, and heavily one-sided coverage on cable TV, which I have been monitoring.  Several friends have emailed me in a panic asking if they should sell their holdings. Politicians and cable news deserve a lot of blame for fostering fear.

The Dow Jones Industrial Average, a measure of just 30 companies out of millions, closed down just under seven percent. Back in 1987 the Dow fell 22 points in a single day, and it was not the end of Western Civilization or even investing.

The stock markets may fall more. They also may rise. After all, Goldman Sachs shares were in a free fall just before the Bush administration declared a crisis, and even with today's 12.5 per cent drop, they are trading at more than $30 per share higher than at the low point eleven days ago.

Questions abound: Do we believe in markets, which can be volatile--or only in managed markets biased by government policy to the upside? Or do we believe in corporate socialism?

Is our economy so fragile that it cannot withstand shocks? Or is it fundamentally sound, as Senator John McCain was declaring until just days ago? And if our economy really is fragile, just how will borrowing $700 billion more to pay for bad loans make things better for anyone but the lenders and some of their customers?

What assurance do we have that borrowing $700 billion will not make things worse? None.

Keep in mind a paper released last week by two economists at the International Monetary Fund, who studied 42 banking crisis over the past 37 years. Their conclusions (not the IMF's) are: bailouts often do not work, they often result in more bad practices, and they distort economies by transferring wealth from taxpayers to bankers and their customers.

Congress held hearings last week, but it only listened to the advocates of the bailout. We deserve better. If Americans have to give up, on average, more than $2,300 of our substance, then it's incumbent on the plan's advocates to make a compelling, coherent case for sacrifice to the national good. But remember, this money is being sought by an administration that told us not to sacrifice after 9/11, but to go shopping.

It is also an administration that, as I revealed in a story in The New York Times in 2004, said that the American taxpayer could not afford an extra $12 million to pursue Osama bin Laden's financing of terrorist plots. And how tiny is this sum?  Roughly the interest every three hours on $700 billion. Ponder that--we cannot bear $12 million to get a murderous zealot determined to strike again, but we can afford 58,000 times that much in a bid to avoid the inevitable declines in asset prices that were artificially inflated by the offerings of Goldman Sachs and other Wall Street firms?

Perhaps the dissolution of this bailout bill means that we will now get a serious look at just where the problem is, how pervasive or concentrated bank problems are, and whether there are less expensive options, as suggested by economists like NYU's Nouriel Roubini, BU's Larry Kotlikoff and Columbia's Perry Mehrling, and the Center for Economic Policy and Research's Dean Baker.

Maybe we will also get answers to some hard questions. Like:

--Why was the CEO of Goldman Sachs in the room when government officials decided to bailout the insurer AIG, especially since Goldman has about $20 billion, half of its shareholder equity, at risk on AIG? Keep in mind that Treasury Secretary Paulson is the immediate former CEO of Goldman.

--Why was Lehman Brothers, a Goldman competitor, the only Wall Street firm in trouble so far left to collapse on its own? The Wall Street Journal reports today that it was the collapse of Lehman (which because of its structure may not have been an attractive firm for purchase) that "triggered cash crunch around the globe."

--Has Treasury obtained from every bank the amount of its illiquid assets, which would tell us if the problems are concentrated at a few banks or are pervasive?

--Would a temporary provision in the bankruptcy code, allowing people with toxic mortgages to get their loans rewritten or pursued to foreclosure, be a cheaper and better alternative?

Disclosure, transparency, options--those should be the issues in the next few days.

--David Cay Johnston

Posted: Monday, September 29, 2008 8:41 PM with 52 comment(s)

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randyandy said:

Thank-you, thank-you, thank-you for giving us perspective, questions that need to be answered, and possible options.  The mentality that reigned after 9/11 rules the day:  anything, do anything!!!!  But honestly who can believe anything said by Mr. Bush and his minions for they have provided us with renewed faith in the age old parable of the Boy Who Cried, "Wolf!."

September 29, 2008 9:06 PM

cal80 said:

All the above, and why did this bill provide the Treasury Secretary the ability to buy back bad loans from foreign entities?  Were we really going to bail out Norwegian hedge funds with taxpayer money?  

September 29, 2008 9:19 PM

teplukhin2you said:

Buy, baby. Lots of nice pickings.

September 29, 2008 9:24 PM

jamie322 said:

So let me get this straight -- ignore the one-sided media coverage but freely accept the unsubstantiated suggestion of constituent phone calls allegedly as much as 200-1 against the bailout?  The former suggestion seems reasonable, but the reliance on the latter figure is cheesy.  Some members have said publicly that their calls are not nearly so one-sided, and (in my experience as a former House aide) phone calls and letters are hardly a scientific measure of the public's opinion.  All it takes is a few well-placed ads or talk radio rants to stir up a wave of calls.  They are anecdotal and unreliable as a measure of prevailing views.  In other words, not much more useful than cable news analysis.

September 29, 2008 9:39 PM

teplukhin2you said:

I mean stocks in real companies. Not buying up the sh*t assets of the moneyfiddlers. Let Goldman and Morgan Stanley fall. (Sorry Warren; can't win 'em all).

September 29, 2008 9:41 PM

tpinter said:

Rather than twisting arms to get this questionable bill passed, maybe Congress should adjourn for the elections to give people the opportunity to entertain other options and talk to their constituents. Hopefully in November they will not be in panic mode.

September 29, 2008 9:58 PM

drdannyu said:

As God is my witness, I have no earthly clue what to think about all of this.

September 29, 2008 9:58 PM

lesserliz said:

As Tony Montana said, "Now you're talking to me baby! That I like! Keep it coming!" ...

Its Paul not Paulsen who has the solution!

September 29, 2008 10:29 PM

JEFF FREY said:

Ron Paul has proposed a return to private currecy. So now a bank collapse can invalidate all your paper money as well. What progress! Back to the 19th century!

September 29, 2008 10:57 PM

gennitydo said:

Let's see what those constituents think in a week or two.  Sure they're against the bailout now (who wouldn't be?) but when the meltdown hits, they will be suffering.

Leaders are supposed to lead and sometimes in a democracy this means being more far-sighted than the average person.

Sure, the plan had plenty of flaws and sure the Administration deservedly has no credibility, but that does not mean that the risks are not real.  Sure, they did a bad job selling the package (although the Dem leadership was on board), but they were a bit constrained in that if they released the info that they have it would cause the banks they are trying to save to go under.

Maybe we will get a better package with more time and more work, but I doubt it.  With the election looming and the crisis due to worsen imminently, the pressure will ramp up not down. Either there will never be any bailout package or the one we get will be too late or worse.

Nothing to celebrate today unless you are an anarchist.

September 29, 2008 11:19 PM

Rhubarbs said:

The problem is that the immediate viability of even healthy, profitable, growing companies depends on the ready availability of short-term credit at sub-usurious interest rates. For slightly more than a week, that credit has simply not been available to most companies because of the credit crisis. Even as bank paper has dried up, some companies with cash on hand have been making their cash available through brokers as a form of substitute short-term paper, but at very high rates. That is not a sustainable substitute market.

So, yeah, shares in Acme Corp are probably lower tonight than they should be, based on the fundamentals of the company itself. So buy buy buy at opening Tuesday morning. But keep in mind that if the credit crisis persists into mid-October, even healthy companies like Acme are going to have to shut down cost centers, delay new investment and hiring, and start calling in their own floating AR just to make the October 31 payroll. If commercial credit is not flowing again at pre-crisis levels by the end of October, Acme will have to start shutting down profit centers like production and laying off workers for lack of ability to maintain its supply chain and meet payroll in the absence of affordable short-term credit.

That's the problem with a financial panic: If it persists for more than a couple of weeks, it will inevitably start destroying companies, and whether a company goes down will have very little relationship to the fundamental health of the company. A perfectly sound company that just happens to time its cash situation to have been highly liquid in the second quarter but cash-poor in fourth quarter could be out of business by November 15 if current conditions continue, whereas a fundamentally unsound company already teetering on the brink that just happened to bank payment on a major contract this week could ride out the storm for a couple of months.

So yes, a grassroots-level recovery program is in order, to help mortgage-holders who could become current under more favorable terms rewrite their loans (as well as other efforts to prevent a probable spike in unemployment from becoming a deflationary feedback loop). But immediate action is also required to kick-start the currently seized-up credit markets. If the credit markets are restored, we're looking at a recession, possibly a longish but not too deep recession, in line with any periodic bubble-burst. Under such a situation, there will be time to ameliorate the worst individual and community hardship. But if the credit markets are not restored, in hours not days, days not weeks, then we're looking at the kind of economic collapse we haven't seen since before WWII. More like the Panics of 1837 or 1893 than the Great Depression, but that's plenty bad enough.

Worth everyone's while to refresh one's memory of FDR's Fireside Chats, particularly the first, explaining the banking crisis, and the fourth, laying out plans for relief of individual hardship:

www.mhric.org/.../fdr.html

September 29, 2008 11:23 PM

gennitydo said:

Tep- By all means, buy up today.  Just make sure that you buy shares of companies that don't have any debt and have plenty of liquidity.

Any company that needs debt to run its business (essentially all businesses bigger than a lemonade stand) will be impacted by this.  No credit = no liquidity which means no money for investment or payroll or pensions or taxes or anything else.

And if the company had outstanding debt which comes due?  Forget about re-financing which means much of the Fortune 500 will shortly be facing insolvency too.

September 29, 2008 11:42 PM

2736298 said:

The failure of the bill to pass is an example of one thing and one thing alone. Cluelessness on the part of the people who represent the people. If you understand finance, and you watched the hearings last week and the 'debate' today, the rampant cluelessness was rampantly obvious. Many of those who spoke against it and undoubtedly voted against it, read papers which were clearly written for them by people who were slightly more clued than they but still clueless. It was flagrantly obvious as they fumbled with words, mispronounced financial terms and generally raced through the reading as anyone who has ever been in the position of reading something that they were unsure  of  in front of a group of is wont to do. This is the true national tragedy evidenced today. The leadership themselves, only came to understand some of the needed concepts late saturday evening and started to speak sensibly about the plan identifying it not as a 'bailout' but as an infusion of liquidity in the form of investments. As happens all too often, what we now get as analysis is all these different conspiracy theories portraying these dolts as complex strategists when all you just witnessed was massive ignorance. I guess we must concoct these idiotic fantasies in some vain effort to make ourselves feel better for allowing this insanity (i.e. that we allow ourselves to be governed by the clueless) to continue. Sad sad day for America and Americans.

September 30, 2008 12:19 AM

lvt91555 said:

here is my take on this crisis.

i believe that this is an incredible excersize in extreme capitalism and profit taking ability.

i just read the "shock doctrine" by naomi klein---and was blown away by the principals laid out by milton friedman. this total bush administration and its time in power is an absolute blueprint for extreme capitolism as laid out by friedman----THE FRIEDMAN PRICIPALS NEEDS CRISIS TO WORK AND TO CREATE REFORM...move quickly and implement the principals and the doctrine. bush, chaney and runsfield are students of this extreme doctrine along with conservative republicans---it was the foundation of regonomics the almighty bible to these people. here is what i think has gone on and is going on:

---in 2001 this starts with the urgency of war 9/11

---puts the focus on bin laden as the bad guy...never gets him because he is the posteer guy for war...get him and the war is over...that is why he is still alive!

---then go to iraq with "shock and awe", another milton friedman excercise to impose capitolism in iraq with all the oil reserves---results... this gives rumsfeld & chaney the ability to privatize the army to a massive corporate level making war profitable (the main principal taught by friedman... "deregulate the government")  and to make the oil fields available  for corporatization...as it has just happened

now the final element---PUSH US INTO DEEPER DEBT TO CREATE A BARGAIN SELL OFF OF OUR ASSETS AND LET THE FRENZY BEGIN WHICH THEN LAYS THE GROUNDWORK FOR EVEN MORE REFORM----these are the steps i see unfolding:

1- bush goes on tv to address the world establishing the crises and prompting us to act fast

2- the world is in shock over this crisis and the enormous size of the bail out (shock is a key freidman element)

3- they push for a fast sell knowing it won'yt fly because the conservative republicans won't go

4- they push hard and on sunday leading us all into believing there will be a bail out agreement

5- it falls apart driving the market to a massive low---this is what they want --- drive the market into a bargain basement level

6- this will go on for a few days until the market is driven to such a low that it almost looks like we are dead-- a sense of chemo-therepy tied to shock therepy!

7- then the buying of the bargain stocks happens (only when the market reaches this all time low) from the players with allot of cash and in the know

8- the house then reaches an agreement (because these house republicans have accomplished their task and now are going for the big bucks) and the market springs back with the passing of the bill is announced ....this results in a massive upward surge and huge profits are taken by a limited few that are liquid enough to take advantage of this situation

9- now the bailout has the feds taking over all this bad paper opening up the flow of new business

10- money rushes back into the system and business as usual starts and profits start again

11- then in less then a year when the new admin is in office and debt is so great, they will sell this risky paper back to the private sector at cents on the dollar ...the new admin then boasts how they are lowering our debt by dumping the crap paper which in realty is actually valuable especially at the level the private sector buys it back for

12-  new funds or financial vehicals will be created around this paper and sold like crazy in the market. this is possible because the new bailout money is pumping the realestate market back up...new reforms and loosened regulations around banking will now have to be created to sell these new funds

13- BINGO---here is what the extreme capitailists achieve:

      1- you have a new massive level of profit taking from these big guys all funded by the taxpayer .....never seen befor in history.

       2- reduced banking, stock and government regulations relating to the financial markets(the ultimate goal of the friedman doctrine)

       3- finally a new level of extrem e wealth for a limited few  and the middleclass stuck with the bill.....LET THE CAPTIALISTIC GAMES BEGIN!

THE FINAL RESULT IS A MASSIVE SWING IN WEALTH AWAY FROM THE MIDDLE CLASS AND INTO THE FEW AND A MORE DEREGULATED AND PRIVATIZED GOVERNMENT DUE TO ITS NEED TO REDUCE DEBT AND A DESPARATE NEED TO INCREASE REVENUE..."IT'S A BRILLIANT  AND SADISTIC, GREEDY SCHEME"... AND IT FITS THE FRIEDMAN PRINCIPAL OF CAPITALISM AND ALL THAT IT HAS HISTORICALLY DONE SINCE THE LATE 1960'S...UNFORTUNATELY I TRUELY FEEL NONE OF THIS WAS AN ACCIDENT....IT IS  IN PLACE AND HAPPENING!

I FEEL SICK THAT I CAN EVEN THINK THIS WAY....GOD HELP US HARD WORKING PEOPLE!

September 30, 2008 12:27 AM

asnevitt said:

Rhubarbs, I've been talking to people who are in finance departments at small to medium-sized companies, asking them if they've been experiencing a credit freeze. What I'm hearing is the opposite. One drew down his $500,000 line of credit for cash flow purposes during an expansion, then they realized the cash flow would be more comfortable if they could finance the purchase of furnishing new office space. They called their banker of Friday to ask for $200,000 more. The banker offered $400,000.

While it may be true that big banks and investment firms who fattened up their balance sheets with derivatives and bad mortgages are suffering and are not distributing credit, a lot of smaller banks with more sensible balance sheets are doing just fine and are seeking good companies to make loans to.

While there may be a scary economic time on the horizon, I do think we deserve the wisdom of our leaders taking the time to consider ALL options and not just being rushed to amend the heinous plan that was put before them. They need to talk to a broader array of economists and create a new plan from scratch that is based on jump-starting the economy, not on saving the butts of the extortionists on Wall Street.

September 30, 2008 1:33 AM

luispc said:

Excellent post, Mr. Johnston! Excellent!

September 30, 2008 1:54 AM

luispc said:

"They called their banker of Friday to ask for $200,000 more. The banker offered $400,000"

Of course, and today if their credit is good and they actually produce something, the bank would probably offer $500 000. You should have undestood by now that the melting down / sky falling scenario invented by Paulson and his army of economists/extorsionists was nothing but a most disgusting political move, well knowned by totalitarian politics: create emergency and chaos, then break all rules, then reinforce your power...

I'm so glad the American people said NO to this crime. I'm so happy with those tyreless people that called, faxed, e-mailed Congress and demonstrated that they were free from fear and blackmail. What a beautiful day!

September 30, 2008 2:01 AM

luispc said:

"The failure of the bill to pass is an example of one thing and one thing alone. Cluelessness on the part of the people who represent the people. "

I don't think so. They were cluelessness when they passively watched deregulation + supply side + the myth that the private sector would solve everything.

And they were cluelessness because they were bovinely trusting an army of economists pretending to be "scientists" knowing what everyone "else ignored on finance" and "on the markets", but that were nothing more than lousy ideologues and guessers.

Lousy ideologues that were taking the place of medieval priests in the defense of a society of undeserved privilege and extortion.

The tyranny of that pretentious "knowledge" (a knowledge that is nothing but ideology) is ending! How beautiful these last days were! Days in which Americans demonstrated that they are still free from every sorts of tyranny!

September 30, 2008 2:16 AM

gennitydo said:

Yes, the credit crunch has not yet hit Main Street yet.  But it it just a matter of time.

Unless there is some sort of bail-out (Congressional approved or otherwise) or someone buys Goldman Sachs and Morgan Stanley (calling HSBC!), there will be a systemic meltdown when these banks go under which is days or weeks from now.

The credit for business will end when the crisis starts to bring down commercial banks.

Don't take my word for it.  Here is Nouriel Roubini:

www.rgemonitor.com/.../the_us_and_global_financial_crisis_is_becoming_much_more_severe_in_spite_of_the_treasury_rescue_plan_the_risk_of_a_total_systemic_meltdown_is_now_as_high_as_ever

September 30, 2008 2:47 AM

teplukhin2you said:

gennity - before we bail out Goldman Stanley, how 'bout we ask them to open their books and show us all just where the financial weapons of mass destruction are hidden?

Enough of these "unknown unknowns." Where are the toxic assets? Who's on the hook, for how much, what % of their balance sheet is at risk?

Don't you think that, in a democracy, it makes more sense to get answers to these questions, NOW, before we vest sweeping powers in one man who just so happens to be an ex-director of one of the few remaining leverage hogs left standing-- the same one that America's wealthiest man just took a major stake in?

What is preventing them from opening their books and telling us what amount of capital they have at risk?

September 30, 2008 3:03 AM

gennitydo said:

Tep - No doubt they have shown their books to Paulson & Bernanke.  But if they post them on the internet, all their creditors will declare an immediate acceleration and no one will ever do business with them again.  It would make putting them out of business a precondition for the rescue which somewhat obviates the point of the rescue in the first place.  See the financial markets are all about confidence and if no one has confidence in MS and GS, then they die.

The books will show the assets and their valuations, but it will also show liabilities so all the creditors will know who the other creditors are and how much they are owed.  When they see this and compare it to the assets, they will need to act immediately to avoid the other creditors make prior in time claims.  It will create a creditor run on GS and MS.

September 30, 2008 3:50 AM

teplukhin2you said:

gennity - I don't care, and neither should you (unless you're employed by one of them), about Goldman Stanley's survival. Given their business models, and the leverage they took on, I don't see how they can possibly come through this, absent some kind of government favoritism.

My only concern is freeing up credit for the 90%+ of the world's financial institutions and borrowers who will not be significantly affected by Goldman Stanley's demise.

Or ar you arguing that Goldman Stanley are too sticky (ie they've gummed up the entire system with their trash) to fail? That's a new one. Credit (not the financial sort) you for originality.

September 30, 2008 6:16 AM

Rhubarbs said:

asnevitt, anecdotes are meaningless. Which is why my own gloomy outlook should be discounted -- it is, like your sunnier view, informed primarily by anecdotes. In my case, I'm in regular contact with a pool of nonprofit donors who tend to be finance execs, corporate CFOs, professional board members, and LLC partners. The stories I'm hearing have me scared shitless, but they are only stories from a small pool, so there's every chance I'm just hearing from the dozen or so worst-hit individuals in the crisis right now. An important reality check to keep that in mind.

Nevertheless, I'm hearing tales of 14-day paper offered at 11 percent (sure, we'll loan you $900,000 today, for $1,000,000 next Friday), of boards of directors turning themselves into emergency credit brokers, and cost centers being frozen just as the new fiscal year (starting tomorrow for many companies) would normally produce a flush of capital investment. I'm also hearing of LLCs tightening their AR practices, but knowing the world of professional partnerships as I do, I try not to read too much into LLCs getting panicky. Worst possible form of corporate governance, that.

Nonetheless, the mechanics of a system collapse are as I described them. It would be good news if the collapse in liquidity were not imminent, or if imminent slower than I've been led to fear. But the sequence of events really is as I describe, and the more-or-less random distribution of consequences outside the banking sector among healthy and troubled businesses alike is as I describe. We know this because we've had credit seizures before, and we've witnessed them recently in other countries, and the dominos really are lined up in a particular, predictable, devastating sequence.

September 30, 2008 8:06 AM

luispc said:

Well for those who said the sky would fall and we'd all be doomed if this bailout did not pass, extraordinary things are happening:

FTSE, 0,50% up;

AEX, 2,00% up;

CAC 40, 0,45% up,

BEL, 1,50% up

PSI 20, 1,02% up;

Euronext 100, 0,65% up,

etc., etc.

And guess what: people are placing money in companies that actually make things instead of just sorbing other people's money by creating debt. Yes, telecomunications, energies, industries are the winners... Banks (and most importantly investment banks) are losers...

And from what I've heard there is plenty of money being lended to banks.

Well if this bailout dementia ceases completely (and if Paulson quits on his permanent blackmailing talk on how we are all doomed if Goldman Sachs doesn't keep it's Persian-like profits...), then maybe, just maybe, this time the good guys get the advantages they deserve and the bad guys rot.

September 30, 2008 8:32 AM

gennitydo said:

Tep - It is not me,  It is Nouriel Roubini (and Paulson/Bernanke for what that's worth) that view the insolvency of GS and MS as a systemic risk.  To translate, this means that their insolvency will create a risk that the system fails.

I am not employed by either, but I am employed by a bank which will be impacted by their loss.

I agree that they richly deserve to fail and that their business model is irretrievably broken, but there is a big difference between an orderly winding up and a disorderly winding up.

I hate the TARP but it is much better than doing nothing,  IMHO, I would nationalize GS and MS, pay off bondholders at 0.25 and shareholder get 0.

September 30, 2008 9:06 AM

roidubouloi said:

Very few people in or out of government understand what this crisis is about.  The simple  answer is that highly levered financial companies that participate in the credit/money supply have lost their equity due to the market decline in their mortgage-backed assets and related derivative contracts.  That freezes the flow of credit/money supply.  So, something needs to be done if the economy is not going to tip into sharp recession because credit/money are essential lubricants for transactions.

However, there is a correct and visceral negative reaction to the notion that the best or only way to stabilize the credit system is for the public to eat the losses generated by rapacious finance types by buying up their bad paper at above market values -- which is what the Paulson plan is about.  Dress it up how you will, it is nothing more than a giant handout to the very people who are to blame for the problem at the expense of everyone else.

It is simply unnecessary to do this in order to stabilize the system.  The right way to do it is a variation on what has occurred at AIG and WaMu, which is that the investors, both debt for money borrowed and equity, get wiped out in the course of the recapitalization of the operating assets.  It isn't even necessary to wipe out the debt and equity.  They can be left in a position to realize the full value, and more, of what they own today.  How can this be done?

It can be accomplished with a law that, by fiat, removes from the books of the operating companies their bad assets, their indebtedness for borrowed-money, and their derivative contracts (which combine both an asset and a liability) and spins them off to a parent or trust that is free to realize them as a pass-through tax entity (meaning there is no taxation at that level, only at the level of the ultimate owners).  The trade/operating liabilities (deposits, customer accounts, and such) are left undisturbed.  The owners and investors have exactly the same pool of assets and liabilities that they did before this maneuver, but now there is an unlevered operating subsidiary that is free to do business, borrow money, and raise capital without the burden of past mistakes.  In those cases where the operating entity is still under-capitalized (too many liabilities for its good assets), THEN the Treasury can be authorized to inject capital by purchasing a combination of preferred stock and warrants (the same deal Warren Buffet got at Goldman).

In this manner, the investors are left free to realize the pool of assets, liabilities, and fresh equity that they hold, but without invading the capital of the new subsidiary to do it.  They are no worse off in financial terms, other than the fact they they cannot liquidate the operating company, and are likely better off as the market as a whole returns to equilibrium.  They can hold instruments to maturity for their cash flow, sell them in the market, sell the equity of the subsidiary, whatever they want, without clogging up the flow of credit.  It reorganizes the situation so that it is the shareholders and investors who bear the losses, not the operating entity, as if, for example, the shareholders of Lehman had gone bankrupt, not Lehman itself.  Best of all, this "recapitalization on the fly" does not redistribute losses from those who produced them to anyone else.

Now, you tell me why the Bush administration prefers just to hand out money to the very people who caused the problem -- the dying gasp of the Bush kleptocracy.  People may not understand the intricacies, but their visceral negative reaction to the Bush/Paulson plan is spot on.  It is a pity that the Dems seem to have no one who can figure out what is wrong with the Bush plan and how to fix it.

September 30, 2008 9:07 AM

luispc said:

"Mixed Markets Reflect Hope for Bailout "

This is the main title on NYT. And it pretends to be the title of news story.

Well, from my modest perspective, this is not news! This is an editorial!

Why don't they present another title? Something like"Markets are mixed in spite of bailout rejection"?

Bailouters simply cannot accept that the "falling sky" scenario presented by Paulson is not accurate but they still try to adapt the reality (that denies it!) to it.

I can be wrong of course. But only if NYT actually has access to the minds of millions of investors buying stocks all over the world (fleeing from the financial sector...) confirming that they actually are thinking the way Paulson thinks and expecting a bailout...

Well those investors putting their money on a likely bailout at this time (or on their "hope" for a bailout at this time) would not be wise investors, from my perspective...

We have here one other example of ideology being sold as objective knowledge, in this case, as objective news.

September 30, 2008 9:21 AM

luispc said:

"Now, you tell me why the Bush administration prefers just to hand out money to the very people who caused the problem -- the dying gasp of the Bush kleptocracy.  People may not understand the intricacies, but their visceral negative reaction to the Bush/Paulson plan is spot on.  It is a pity that the Dems seem to have no one who can figure out what is wrong with the Bush plan and how to fix it."

Exactly. Thanks for your post, Roid.

September 30, 2008 9:24 AM

luispc said:

"Because the majority vote against it shows that Washington is not entirely in the service of the political donor class, by which I mean Wall Street and the corporations who rely on it for their financing. "

A text by Rudolf Von Jhering:

"It's not the law that scares arbitrary power. What scares arbitrary power is the force behind the law, the force of the people. Of a people that, when the law is violated, feels himself as the one being violated. Whenever and wherever such a people exists, righteousness exists".

September 30, 2008 9:43 AM

luispc said:

30/08/2008, "US President George Bush has [just] said that legislators must act to prevent further damage to the financial markets."

It seems the man waits for opening bell hour in Wall Street to offer his "falling sky" mantra, so he is able to provoke more chaos and extort more easily...

God, how Americans did NOT deserve this President.

September 30, 2008 9:52 AM

roidubouloi said:

I should have added that the proposals to allow bankruptcy courts to re-write mortgages (down to liquidation value) is essential.  It would stabilize both financial and real estate markets and the claim that "moral hazard" requires sticking it to homeowners while bailing out investors is utterly despicable.  You would think that they greedy investor class would have some sense of shame, but it doesn't.

September 30, 2008 9:53 AM

Rhubarbs said:

Wow. roid distills the best of the proposals I've seen into one convincing package. Kudos. Also on the bankruptcy thing, since that's one of the few ways the Constitution allows Congress to touch private contracts. We also need a mechanism to assist mortgage borrowers to remain current outside of bankruptcy.

There's a kind of reverse prisoner's dilemma at play here, where if the problem is as bad as it might be, then almost any government action is better than no action. So even a crap sandwich cash infusion is better than nothing. Unfortunately, the administration presented Congress with a bad plan that was nonetheless better than no plan. Congress tinkered with the plan to make it marginally better, but not particularly more likely to be any more effective, and the GOP opposition in Congress has so far proposed two proposals: Do nothing at all and let the economy crash, or Enact more tax cuts that cannot even in theory prevent the economy from crashing because what the hell we're Republicans and our solution to everything up to and including kittens stuck in trees and house fires is to cut taxes.

Also, it's a mistake to try to interpret any one-day market movement as a sign of the imminence of system failure. The fact that American markets crashed yesterday does not mean that a true panic is any closer today than it was on Friday. Nor does a market rise today indicate that a true panic is any further away today than it was yesterday. All sides, including advocates of any given measure, need to stay away from using the short-term behavior of stock markets to justify the urgency of action or inaction.

September 30, 2008 10:26 AM

purcellneil said:

I posted this comment elsewhere here today, but it fits better here:

The excitement / despair reflected in the 777 point drop in the Dow yesterday has put the failure of the bailout bill in an odd and unforgiving light. Much has been made of the "failure" of Congress to act, and heavy criticism has been leveled at Boehner and Pelosi, and on all those who voted "no" on the bill.

From where I sit, if we are going to pass a bad bill, it can wait till next week. Maybe - just maybe - we can get a good bill passed instead, but in any case I can hardly be disappointed that we "failed" to rush a bad bill to the President's desk.

And make no mistake - this bill gave way too much leeway to Secretary Paulson and committed far too much money to a purpose that may not be as important to our economy as preserving social security, improving educational opportunities, and providing middle class tax relief - not to mention universal health insurance, investment in green industries, enhanced re-training and extended unemployment benefits, and a stay of execution for those facing foreclosure. How many of these will be able to proceed once we have spent $700 billion to save Goldman Sachs?

The reason the bill failed is that it is a bad bill, and because a lot of Americans (including this American) wrote to their elected representatives and expressed their disapproval. I don't know what failed yesterday, but it wasn't democracy.

As for the stock market, it hasn't grown at all in 8 years - in real terms it is down much more than the drop that took place yesterday. This in itself is not a crisis. At some point, the stock market will rebound -- as long as we don't do anything foolish -- and borrowing $700 billion from the Chinese to let Hank Paulson buy toxic securities from mismanaged bankers is pretty goddam foolish.

After 8 years of shoot-from-the-hip, government-by-gut-instinct, aren't we ready for something better? Let's not rush into something we cannot afford.

September 30, 2008 10:44 AM

luispc said:

"All sides, including advocates of any given measure, need to stay away from using the short-term behavior of stock markets to justify the urgency of action or inaction."

I don't know.

A person that was under threat ("approve bail out or face meltdown") and that watches a sharp market rise the day after the bail out is rejected (well, real people are putting real money on the system...) will legitimately think that the blackmailer was bluffing...

And banks are working and all, lending and borrowing...

Well, Economics, it seems, is the only "science" no one can understand if not placed on a certain perspective of things. We can intuitively grasp Biology, Physics, Chemistry's conclusions as right, even when we don't understand the specifics...

But in Economics not only are we completely unable to understand it intuitively, we must face it being denied iby reality and continue to believe in it... Well, next Sunday, I'll attend some weird mass and buy it, at least I won't be financing "supply side" with tax payer's money.

At least I won't be building a financial sector with it's own "logic", a logic that is so other-wordly that at a certain point, to "insulate Main Street from it", I must take 700 billion out of Main Street and put it on Wall Street! Yes, there is definitively something I'm missing here.

Roi's proposal has the great benefit of subordinating the financial activity to general economic activity. Not the other way around. WHich is something I can intuitively understand as right.

September 30, 2008 10:49 AM

boxofrox said:

I'll second Rhubarbs nod to the illustrious Mr. Roid. Is it doable within the realtime very real consequence of market greed/fear realities? That is the wild card. Good on you, Roid. Simple and elegant. Very outside the box in a very inside the box kind of way. I'm going to have to ponder on this a bit more.

As an aside, I'm given to understand that Paulson et al began developing a response to this scenario as soon as he assumed his duties. I don't think his and Bernake's proposals are motivated by anything other than the best of intentions in dealing the problem as they see it.

September 30, 2008 10:54 AM

boxofrox said:

Again there are real consequences to the time elements. Destruction of market cap and its effects need to be considered. I suppose no more martini lunches for CFO's these days.

September 30, 2008 10:57 AM

teplukhin2you said:

what roi said. Deleverage and recapitalize if possible, or let the sunken financial entity die. Rinse and repeat.

September 30, 2008 11:02 AM

newdex said:

"the claim that "moral hazard" requires sticking it to homeowners while bailing out investors is utterly despicable."

Roid, I wish you were leading the negotiations.

September 30, 2008 11:16 AM

Rhubarbs said:

but luis, the point is that it's not the stock market that's facing potential catastrophe. If we go over the cliff into a true financial panic, the stock market will crash, sure, but only after the fact as a trailing indicator. A person who reacts to a little bit of morning-after-crash discount buying and says, "See? There was really no danger after all" is just as great a fool as a person who reacts to an 800-point drop and says, "See? Congress needs to act in the next twenty minutes or we're all doomed!"

The Dow or the S&P is simply the wrong metric here, and largely irrelevant to the urgency of the problem either way. Looking at the market's performance on any given day to assess the urgency of the financial crisis is a bit like looking at the Coyote's head to determine whether or not he's already walked off the cliff. Until the Coyote looks down, he won't fall -- and the point isn't whether he's still in the air, the point is what's beneath his feet.

September 30, 2008 11:28 AM

luispc said:

"I don't think his and Bernake's proposals are motivated by anything other than the best of intentions in dealing the problem as they see it."

I do not question their integrity. But I do think that they are looking at the world through the glasses of their ideology (an ideology disguised as "science": to understand the phenomenom see the recent "The Flight from Reality in the Human Sciences" by Ian Shapiro).

A "science" according to which "tax cuts for the rich" would promote general welfare, "deficits don't matter", "consume your way to prosperity", "the market fulfils all needs", etc., etc., etc.

An ideology with such a blinding effect that, at a certain point, silences the most basic moral instincts and defies every possible form of good sense.

Well, this is not new. It has been repeatedly the effect of secular ideologies builted on these last 200 years when taken to radical form. And men taken by the same ideologies are, almost always, men that actually believe in what they are doing and proposing. In this case, perhaps Paulson actually believes that "what's good for Goldman Sachs is good for America"...

And perhaps Paulson and Bernake were not the Authors of the terrorist political tactics, that turned all this into something that can only be qualified as criminal extortion activity...

What scares me even more is not even Paulson and Bernake. I can understand their existence by general standards on radical ideology and it's capturing effect (even more capturing when it comes disguised as "science").

What scares me is how easy it was to have so many Democrats (including Obama himself) buying this morally and politicaly repugnant absurdity.

To the point of hearing Pelosi saying that "we must insulate Main Street from Wall Street" through a "bailout" that would take 700 billion out of "Main Street", placing them on "Wall Street" and feeding a financial sector with a predatory logic all of it's own!

This last part is the more demential one and the most difficult to understand by any standards.

September 30, 2008 11:43 AM

Sirhc said:

Mr. Cay Johnston, with appologies to George C. Scott (as Patton), I read your book.  

Based on your books, shouldn't the first thing that comes out of this debacle be the graduated repeal of all of the tax benefits of owning a home?   Wouldn't we be a lot better off, if housing prices weren't artificially inflated (from an economist's view) by the government giving money to people who buy homes?  

Shouldn't the next thing be to eliminate the capital gains tax break?  Doesn't this tax break encourage banks to turn mortgages into securities?

It is these two tax breaks that are at the root of of these problems.  

(Actually there are about 10 tax breaks associated with owning a home and several more for owning securities).  

September 30, 2008 11:48 AM

gennitydo said:

Roi - I beg to dissent.  If you wipe out the debt holders, you are in fact going to bankrupt solvent commercial banks like Citi.  This will have even more detrimental effects than allowing the two remaining investment banks Goldman and Morgan to go insolvent.  Putting the assets in a pass-through trust is irrelevant,  If there were enough (liquid) assets to pay off the bondholders, then the banks would not be (technically) insolvent to begin with.

I totally agree that the Dow or S&P is the wrong measure.  What the market is looking at is Fortis, Hypo Bank, Bradford & Bingley and Dexia today.  That is 4 commercial bank insolvencies in 2 days and there is more to come.  This is why time is of the essence.  Wake up and smell the coffee.

W is a liar and there never was any WMD, but there is a real crisis here and it would be better to do something rather than nothing and it would be best to do it soon.

September 30, 2008 11:56 AM

boxofrox said:

Rhubarbs: Do you discount market viability as a measure of ability and worthiness for operations? Thus having both cause and effect characteristics? Point taken that the credit markets are the central focus and main game breaker. But Credit and Stock market do not live in exclusive domains. I can easily see a scenario which coyote wraps his ever lovin arms around the roadrunner for a mutual death dive.

September 30, 2008 11:58 AM

luispc said:

OK Rhubarbs. Point taken. I won't look at today's market performance.

And please don't think that I deny that there are measures that must be taken. I'm no free marketeer or libertarian. Nothing of the sort.

But on Paulson's plan I cannot see how throwing money at a furnace that actually caused the fire will be a solution to anything. From where I stand it would only make things worse in the long run.

The deep problem from my perspective is the existence of a financial sector with a logic all of it's own that pretends to subordinate everything, including politics. This is the MAJOR problem. And the solution must be one that subordinates it to actual everyday activity and general welfare. That places it, once again, on it's "right place".

And I would never consider approving a bad plan, because something must be done "in a hurry". Least of all, a plan as morally repugnant as this one. Because this is the issue that moved the American public: they felt outraged by the moral meaning and effects of this. They felt this as being totally and irresponsibly arbitrary.

And I think they were absolutely right. And, from my perspective, no good immediate economic effects of a bad plan would ever compensate for the moral outrage the American public would feel. A moral outrage that would place the same people completely at odds with it's political institutions. And that would have very damaging effects on the health of American democracy.

So yes, I think yesterday America experienced a beautiful day that will have incredibly good effects in your future. Not only on the health of your democracy (which is the most important thing), but also on the health of your economy. Since, from my perspective, yesterday some myths (very damaging myths) were broken.

September 30, 2008 12:01 PM

boxofrox said:

Luis. I understand where you're coming from and acknowledge the validity of many aspects of your concern. I'm going to apologize for being unable due to time constraints to offer a worthy reply. It is a worthwhile discussion. I just have some other demands right now that require my attention.

September 30, 2008 12:09 PM

luispc said:

More ideology disguised as objective news: "European, U.S. stocks rally on bailout hopes" (CNN)

God, the American people is really heroic.

To stand by it's guts and moral instincts even when placed under this intense, absurd and demential pressure. This is beautiful. Any European people would have already sucumbed...

And even if these conscious or unconscious criminals end up getting the approval of their extortion plan and end up throwing money at the furnace that caused the fire (which is something I honestly hope they wont...), long live the American people!  Ode to the common man!

September 30, 2008 12:26 PM

gennitydo said:

Luis - Sometimes it is needed to work quickly even if you would prefer not to work that way.  There are real crises in this world of ours and there are events beyond our reasonable control.

If you had been in the Kremlin on June 22, 1941, would you have said: let's not set a military strategy in a hurry?  We have plenty of time?  We can wait until the Germans reach Kiev before we start to think about a response?

Sometime doing something even if badly flawed is better than doing nothing.

September 30, 2008 12:30 PM

luispc said:

Gennit. If I had been in the Kremlin on June 22, 1941, I don't know what I'd do. But I would surely not open fire at Russian military after some absurd idea according to which the Germans would kill themselves if I killed my own...

September 30, 2008 12:38 PM

roidubouloi said:

Sorry, gennity, but I disagree.  Emphatically.  The crisis is real, as rhubarbs also states, but the answer being given is the wrong one, not just from a moral standpoint but because they problem may be bigger than currently envisioned and if the resources available are squandered by re-filling the pockets of the losers, we could actually run out resources.  Even if we give the bad guys treasury securities rather than cash (saves the marketing trouble, a good idea in any case), there is SOME limit to the ability of the market to absorb Treasuries without also destroying credit markets.  If they trade too low because a glut is created, borrowing costs will be too high for anyone to afford.  The Paulson plan is flat-out stupid from almost any standpoint other than avoiding immediate panic.

To take your example,

Let's assume that Citibank is insolvent because it is a holder, directly or indirectly, of too much paper that is underwater because of the decline in the value of mortgage-backed securities.  The direct holders are recapitalized as I have described.  That does not decrease the value of the paper that Citibank holds; if anything it increases its value, because nothing is taken away from the existing debt and equity holders other than their ability to liquidate the assets of financial companies to satisfy themselves -- they have to wait for what those companies can generate over time.  If, despite that upside, Citibank is still insolvent after the general recapitalization, then that circumstance needs to be addressed directly, not by giving all and sundry $700 billion just so that Citibank doesn't have to recognize losses on a fraction of that.  Why do we need to spend $700 billion to just to rescue Citibank?  We'd be better off nationalizing Citibank.  I agree that its collapse would be catastrophic for the economy, but it too can go through a recapitalization in place, if necessary, at far less cost and risk to the public by having the Treasury invest directly in its equity in the event that recognition of its already incurred losses leaves it under-capitalized.  

Fact is, that if the scale of the underlying losses is such that, if Citibank is threatened by the recognition of already incurred losses elsewhere in the system, then $700 billion is not going to be enough and we are just throwing good money after bad.

The key to solving this crisis is not to redistribute losses; it is to recognize them, get them off the books as a residual value for the people who already own them, and then fill the holes that remain as necessary for credit flow.  You don't have to nationalize every investment loss in the whole system in order to protect credit flow, and that is what is being proposed.  It is wasteful, prone to failure in any case, and immoral.

September 30, 2008 12:56 PM

Rhubarbs said:

"I can easily see a scenario which coyote wraps his ever lovin arms around the roadrunner for a mutual death dive."

No no, Coyote and Roadrunner are not both at risk here. Roadrunner by definition cannot be caught or killed. Roadrunner is an asymptotal reification of the ideal of uncatchability. So in this metaphor, Roadrunner is, let's see, the concept of perfectly leveraged profit itself. It is the pursuit of this ultimately unattainable Roadrunner that has led Coyote to launch himself toward the cliff's edge from a giant rubber band. Holding an anvil. Which in this metaphor symbolizes both the subprime lending bubble and the much greater mortgage-backed securities market, which even smart observers seem to have a difficult time telling apart. Because the anvil itself cannot stay in the air once you throw it off the cliff, but it can stay up as long as Coyote holds it and doesn't look down, but if Coyote does look down, they both fall, and Coyote will hit the ground first, such that as soon as he staggers upright in the Coyote-shaped crater he will make when he hits the canyon floor, the anvil will hit him on the head and knock him out again.

Now, if only we can get Congress to enact roid's plan, but phrasing the legislation entirely within the language of this extended Roadrunner metaphor, like some sort of biblical parable.

September 30, 2008 1:12 PM

boxofrox said:

Rhubarbs: Well done and fun at that. I don't have the energy to match and translate competing metaphors potentials. Maybe tomorrow.

I like Roids solution from a clinical diagnosis perspective. I'm still going to have to digest a bit with the leaven that markets are made by people and people are ...... people. Will such an arrangement satisfy when seasoned with caveat that nothing is going to be satisfactory? At best it will be less offensive than something else. It's still a matter of the least repugnant choice.

As it is I want to address Luis's philosophical objections with the degree of care which it warrants.

September 30, 2008 3:30 PM

teplukhin2you said:

"You don't have to nationalize every investment loss in the whole system in order to protect credit flow, and that is what is being proposed"

Bingo. Let's be crystal clear about the problem that we are solving: ensuring that the credit spigot remains open to the real economy. Which is not at all the same as trying to buy up every junk asset cluttering the books of the big gambling houses, er, highly levered financial institutions.

September 30, 2008 4:59 PM