Sep 21, 2008


"Even if the Treasury recovers some or most of its investment over time, this initial outlay of up to $700 billion is sobering. And in return for their support, the American people must be assured that the deal reflects some basic principles.

1. No blank check. If we grant the Treasury broad authority to address the immediate crisis, we must insist on independent accountability and oversight. Given the breach of trust we have seen and the magnitude of the taxpayer money involved, there can be no blank check.

2. Rescue requires mutual responsibility. As taxpayers are asked to take extraordinary steps to protect our financial system, it is only appropriate to expect those institutions that benefit to help protect American homeowners and the American economy. We cannot underwrite continued irresponsibility, where CEOs cash in and our regulators look the other way. We cannot abet and reward the unconscionable practices that triggered this crisis. We have to end them.

3. Taxpayers should be protected. This should not be a handout to Wall Street. It should be structured in a way that maximizes the ability of taxpayers to recoup their investment. Going forward, we need to make sure that the institutions that benefit from financial insurance also bear the cost of that insurance.

4. Help homeowners stay in their homes. This crisis started with homeowners and they bear the brunt of the nearly unprecedented collapse in housing prices. We cannot have a plan for Wall Street banks that does not help homeowners stay in their homes and help distressed communities.

5. A global response. As I said on Friday, this is a global financial crisis and it requires a global solution. The United States must lead, but we must also insist that other nations, who have a huge stake in the outcome, join us in helping to secure the financial markets.

6. Main Street, not just Wall Street. The American people need to know that we feel as great a sense of urgency about the emergency on Main Street as we do the emergency on Wall Street. That is why I call on Senator McCain, President Bush, Republicans and Democrats to join me in supporting an emergency economic plan for working families – a plan that would help folks cope with rising gas and food prices, save one million jobs through rebuilding our schools and roads, help states and cities avoid painful budget cuts and tax increases, help homeowners stay in their homes, and provide retooling assistance to help ensure that the fuel-efficient cars of the future are built in America.

7. Build a regulatory structure for the 21st Century. While there is not time in a week to remake our regulatory structure to prevent abuses in the future, we should commit ourselves to the kind of reforms I have been advocating for several years. We need new rules of the road for the 21st Century economy, together with the means and willingness to enforce them.

Top-rated economics and finance blogger Calculated Risk says there is "no upside ... for taxpayers":

[T]he cost is still unknown, but there is no way that the taxpayers will profit. My initial estimate is that the direct costs of the Paulson plan will be $700 billion to taxpayers. That is about double the cost of the S&L crisis (compared to GDP).

....The plan only limits the Treasury to "$700,000,000,000 outstanding at any one time", so the total purchases can exceed $700 billion. In fact, every time the Treasury sells some securities, they will probably plow the net proceeds back into more troubled assets until the entire $700 billion is gone.

Think of a drunk gambler at a slot machine. He starts with $100 and slowly loses. Every now and then he wins some money, but he keeps putting the coins back into the slot until he has lost everything. That is how this plan will work.

Unless there is a dramatic changes, there will be no upside participation in the financial companies for taxpayers, and the taxpayers will recapitalize the banks by, in Krugman's words, "having taxpayers pay premium prices for lousy assets".

Prof. Paul Krugman agrees, saying this is a con-game at taxpayer expense:

It seems all too likely that a “fair price” for mortgage-related assets will still leave much of the financial sector in trouble. And there’s nothing at all in the draft that says what happens next; although I do notice that there’s nothing in the plan requiring Treasury to pay a fair market price. So is the plan to pay premium prices to the most troubled institutions? Or is the hope that restoring liquidity will magically make the problem go away?

The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system — that is, convince creditors of troubled institutions that everything’s OK — simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem — which seems doubtful — or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.

And there’s no quid pro quo here — nothing that gives taxpayers a stake in the upside, nothing that ensures that the money is used to stabilize the system rather than reward the undeserving.

Even right-wing economist Harvard Prof. Greg Mankiw is aghast:

A Blank Check

A friend emails me a link to the proposed bailout legislation and asks,
Has more money ever been given with fewer restrictions on how it is used? Ever?
Update: Naked Capitalism's analysis of the plan is well worth reading.

And here is the aforementioned analysis by Naked Capitalism. If you truly want to understand Paulson's Wall Street bailout plan, this is the gold standard. That the taxpayer gets cleaned out isn't a bug, but a feature of the plan, and Paulson has admitted so behind closed doors:

The increase of the request from the initial $500 billion and the release of the shockingly short, sweeping text of the proposed legislation has lead to reactions of consternation among the knowledgeable, but whether this translates into enough popular ire fast enough to restrain this freight train remains to be seen.

First, .... here is the truly offensive section of an overreaching piece of legislation:
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

This puts the Treasury's actions beyond the rule of law. This is a financial coup d'etat, .... Given the truly appalling track record of this Administration in its outsourcing, this is not an idle worry.
Nouriel Roubini does not think it passes the smell test:
`He's asking for a huge amount of power,'' said Nouriel Roubini, an economist at New York University. ``He's saying, `Trust me, I'm going to do it right if you give me absolute control.' This is not a monarchy.''
Now to the substance. The Treasury has been using the formula that it will buy assets at "fair market prices". . ....
Yet as we discussed, the plan makes no sense unless the Orwellian "fair market prices" means "above market prices." The point is not to free up illiquid assets. Illiquid assets (private equity, even the now derided CDOs were never intended to be traded, but pose no problem if they do not need to be marked at a large loss and/or the institution is not at risk of a run). Confirmation of our view came from a reader by e-mail:
I worked at [Wall Street firm you've heard of], but now I handle financial services for [a Congressman], and I was on the conference call that Paulson, Bernanke and the House Democratic Leadership held for all the members yesterday afternoon. It's supposed to be members only, but there's no way to enforce that if it's a conference call, and you may have already heard from other staff who were listening in.

Anyway, I wanted to let you know that, behind closed doors, Paulson describes the plan differently. He explicitly says that it will buy assets at above market prices (although he still claims that they are undervalued) because the holders won't sell at market prices. Anna Eshoo pressed him on how the government can compel the holders to sell, and he basically dodged the question. I think that's because he didn't want to admit that the government would just keep offering more and more.

.... this program is going to swing into action with the clear but not honestly disclosed intent of buying assets at above market prices when future markets and the analysts with the best track records on forecasting this decline (you can add Robert Shiller, CR at Calculated Risk, and Nouriel Roubini to the list) believe it has considerably further to fall.
Losses on the paper acquired are guaranteed. This is not a bug but a feature. The whole point of this exercise is an equity infusion to banks. ....

Taxpayers have no upside participation.

There is no regulatory reform as part of the package. ....

U. Cal. Berkeley economics Prof. Brad de Long also begs Congress to turn down this plan:

John McCain chose Sarah Palin to be his vice president.

There is a 40% chance John McCain will be president on January 21, 2009.

There is no way in hell that anybody should give any extra power to any Treasury Secretary chosen by John McCain.

I beg the Democrats in congress: write a bill that makes sense.

Prof. of Finance Luigi Zingales of the U. of Chicago agrees that the plan "crreate[s] a charitable institution that provides welfare to the rich -- at taxpayer expense" and offers a good alternative:

the solution is Chapter 11. In Chapter 11, companies with a solid underlying business generally swap debt for equity: the old equity holders are wiped out and the old debt claims are transformed into equity claims in the new entity which continues operating with a new capital structure.

Alternatively, the debt holders can agree to cut down the face value of debt, in exchange for some warrants. ..... So why is this well-established approach not used to solve the financial sector's current problems?

The obvious answer is that we do not have time; Chapter 11 procedures are generally long and complex, and the crisis has reached a point where time is of the essence. ....

The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich—at the taxpayers’ expense....

Since we do not have time for a Chapter 11 and we do not want to bail out all the creditors, the lesser evil is to do what judges do in contentious and overextended bankruptcy processes: to cram down a restructuring plan on creditors, where part of the debt is forgiven in exchange for some equity or some warrants. And there is a precedent for such a bold move. During the Great Depression....

The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain..... The appeal of the Paulson solution is that it taxes the many and benefits the few. Since the many (we, the taxpayers) are dispersed, we cannot put up a good fight in Capitol Hill; while the financial industry is well represented at all the levels.
The decisions that will be made this weekend matter not just to the prospects of the U.S. economy in the year to come; they will shape the type of capitalism we will live in for the next fifty years.

Another top-rated economic blogger, Mike Shedlock a/k/a Mish who has a Ron Paul-ian political bent, begs for a Senate filibuster:

Congress is lining up to give "Unreviewable Dictatorial Power"to the Treasury while increasing the size of the already ridiculous proposal.

Contact Your Senator Today!

It's time to contact your senator. Here is contact information for Senators of the 110th Congress.

Phone or Email your Senators today. Tell them in your own words
Urge your senator to Filibuster any bailout legislation.
Emphatically state you do not want a bailout of any kind for anyone.
No Dictatorial power for Paulson or Bernanke
Taxpayers should not have to bail out banks making bad loans
Tell them that "The Fed" and Paulson are systemic risk".

So does Lee Adler of the Wall Street Examiner whose views are generally more progressive:

Dear Senator:

By assuming most of the bad debt from the financial system (if that’s even possible), the government will be infecting itself with the disease it has been seeking to treat. Interest rates will soar as investors perceive not only an increased threat of inflation from the Fed’s money printing that has already begun, but also from the correct perception that the government is destroying its own creditworthiness.Through a combination of softening tax receipts, a thermonuclear explosion of government spending for bailouts, and rising expenditures in all other aspects of government, the US will soon be facing trillion dollar deficits at a time when the only way to pay for them is to sell more and more bonds.

..... The government has in turn taken us from the the brink of financial system collapse and added to that the threat of financial collapse of the government itself, a fate which I would suggest is far worse than allowing Wall Street to collapse and money market funds to break the buck. No question, that’s a bad thing, but a loss of faith in the financial system is one thing, a loss of faith in the government’s ability to pay its bills and protect the public is a catastrophe of unimaginable proportions. If this program is passed by Congress, I fear that our fate will have been sealed.

I have no hope that this can be stopped in the House. Let’s hope that enough of our Senators are wise enough and courageous enough to stop this madness before it destroys our beloved Republic.

Finally, Stirling Newberry who once upon a time was a top-rated diarist here at DK, says this is a "defining moment" for Obama:

Liberals have pined for a new deal moment, well, it has arrived.
One of the crucial moments of the New Deal was one which occurred before FDR was in office. He was offered, by Hoover, a chance to wield the powers of the Presidency early, if, and only if, he renounced the "so-called New Deal." .... FDR replied that he was still a private citizen, and would assume the duties of office at the constitutionally appointed time.
That is to say, FDR invited Herbert Hoover to engage in political auto-fornication. Now this is one of the most hard minded decisions that could have been made. It is absolutely true that some people who lost everything in the intervening months would have been temporarily spared had FDR accepted the agreement. It is also clear that millions more would have suffered far worse. FDR, as much as he would be the architect, or at least General Contractor, for the liberal state in America, was also willing to break eggs to make an omelet.
It is precisely this willingness to take short term losses, to not be held hostage by a mad man, that made FDR able to see through the project to its conclusion.
They key is to avoid being saddled with the debt, and leaving the same bums in charge. It's really that simple. That's why the Village is all fuzzy for the RTC all of a sudden: the consumer takes the shaft, and the people who crashed the sports car walk away scott free.

Stirling Newberry is back! after a 2 year absence from DK, he has just posted his own diary. (warning, it's very long). Stirling will definitely make you think, and he may just be the most erudite diarist on this blog.

Prof. Krugman has just updated his material. He is even more skeptical of this bailout, saying it doesn't even address some of the major issues and may well not work. (Thanks to the commenter who brought this to my attention).

Calculated Risk reads the Treasury's "fact sheet" and discovers that FOREIGN INVESTMENT BANKS are eligible for the bailout!* And 2008-vintage securities (what, were those people absolutely nutz!) are included.
*I wonder if China and the petrosheikhdoms, our big creditors, insisted. If so, this is the second time in 2 weeks they have insisted on guaranteed payment by their US taxpayer serfs.
UPDATE 5: Economic blog Housing Wire says that even market participants are growing uneasy about the implications of the vast power grab of Paulson's plan:

While market participants conveyed to HW just how close much of the nation’s debt markets came to collapse last week, many were increasingly uncomfortable with the Treasury’s response after having time to consider it. Others were downright apocalyptic in their assessment of the bailout proposal.

“Buying bad assets from solvent institutions is a really bad idea. I think they need to wait for them to go bankrupt,” said one equity fund manager, who asked not to be named. “They had a liquidity crisis on their hands, but that was not the way to fix it.”

Let's cross our fingers and hope that this means there will be pushback against passing without amendment or restriction Paulson's bill.

William Greider of The Nation joins the chorus:

Financial-market wise guys, who had been seized with fear, are suddenly drunk with hope. They are rallying explosively because they think they have successfully stampeded Washington into accepting the Wall Street Journal solution to the crisis: dump it all on the taxpayers. That is the meaning of the massive bailout Treasury Secretary Henry Paulson has shopped around Congress. It would relieve the major banks and investment firms of their mountainous rotten assets and make the public swallow their losses--many hundreds of billions, maybe much more. What's not to like if you are a financial titan threatened with extinction?

If Wall Street gets away with this, it will represent an historic swindle of the American public--all sugar for the villains, lasting pain and damage for the victims. My advice to Washington politicians: Stop, take a deep breath and examine what you are being told to do by so-called "responsible opinion....
The people should make themselves heard in Washington, even if only to share their outrage.

Dean Baker asks the obvious question about Paulson's insistence that exactly his bill
must be passed NOW!:

Paulson Missed the Bubble and Understated the Financial Crisis at Every Point

Treasury Secretary Henry Paulson is telling Congress that if it doesn't give him a $700 billion blank check the financial system is going to collapse. It would be reasonable for reporters discussing this request to present some background on the track record of the person asking for this enormous blank check....

At every point along the way, Secretary Paulson has failed to see the extent of the crisis resulting from the collapse of the housing bubble. This raises serious questions about his judgment. Reporters should be discussing Paulson't track record in the context of this bailout proposal.
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