Henry Paulson, Regent Dictator
Jesse Walker | September 20, 2008, 10:30pm
Sigh:
The Bush administration asked Congress for unchecked power to buy $700 billion in bad mortgage investments from U.S. financial companies in what would be an unprecedented government intrusion into the markets.
The plan, designed by Treasury Secretary Henry Paulson, is aimed at averting a credit freeze that would bring the financial system and economic growth to a standstill. The bill would bar courts from reviewing actions taken under its authority....
As congressional aides and officials scrutinized the proposal, the Treasury late today clarified the types of assets it would purchase. Paulson would have authority to buy home loans, mortgage-backed securities, commercial mortgage-related assets and, after consultation with the Federal Reserve chairman, "other assets, as deemed necessary to effectively stabilize financial markets," the Treasury said in a statement....
The plan would raise the ceiling on the national debt and spend as much as the combined annual budgets of the Departments of Defense, Education and Health and Human Services.
Let me quote that last part again:
the combined annual budgets of the Departments of Defense, Education and Health and Human Services
From the
occupation of
New Orleans after
Katrina to the financial
socialism-for-the-rich we're seeing right now, the Bush Republicans' instincts in a crisis have always been to seize more power. And then -- just wait! -- to demonstrate how enormously unsuited they are to wield it.
And the Democrats, those alleged alternatives? Maybe it's their innate affection for economic intervention, maybe it's just the same spinelessness they've brought to issues ranging from FISA to Iraq, but they don't seem to be objecting to the Paulson plan. ("The consequences of inaction could be catastrophic," says Harry Reid, according to the Bloomberg report I quoted above. The consequences of
really stupid actions must not be up for discussion.*) McCain's position on these issues keeps evolving; I expect that at some point next week he'll call for parading short sellers through the streets in dunce caps.
I'll exit with some
cheery thoughts from Glenn Greenwald:
Haven't we heard all these years that national health care was an extremely risky and dangerous undertaking because of what happens when the Federal Government gets too involved in an industry? What happened in the last month dwarfs all of that by many magnitudes.
The Treasury Secretary is dictating to these companies how they should be run and who should run them. The Federal Government now controls what were -- up until last month -- vast private assets. These are extreme -- truly radical -- changes to how our society functions. Does anyone have any disagreement with any of it or is anyone alarmed by what the consequences are -- not the economic consequences but the consequences of so radically changing how things function so fundamentally and so quickly?
Other countries are debating it. The headline in the largest Brazilian newspaper this week was: "Capitalist Socialism??" and articles all week have questioned -- with alarm -- whether what the U.S. Government did has just radically and permanently altered the world economic system and ushered in some perverse form of "socialism" where industries are nationalized and massive debt imposed on workers in order to protect the wealthiest. If Latin America is shocked at the degree of nationalization and government-mandated transfer of wealth, that is a pretty compelling reflection of how extreme -- unprecedented -- it all is.
* Maybe he's expecting a bailout.
Adam | September 21, 2008, 12:31am | #
There are some truly disturbing parts of that proposal, such as:
----
(a) Authority to Purchase.--The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.
(b) Necessary Actions.--The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:
(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;
(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;
(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;
(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and
(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.
-----
So Mr Paulson will be able to purchase any asset he deems necessary, issue any regulation that he deems necessary, write any contract that he deems necessary, and can even appoint financial institutions to act as government agents, to act on whatever plan he deems necessary.
And Congress also shuts down any review by the courts, and only asks the Secretary to report every 6 months, over the 2 year duration of the "emergency".
This is the shock doctrine all over again, and needs to be opposed by everyone who cares about our democracy and the separation of powers.
Paul | September 21, 2008, 4:30am | #
Ebeneezer,
It's complicated, but here it is in a very simple nutshell:
Many of these investment firms were involved directly in, or involved in injecting financing for complicated debt instruments mostly in the realm of sub-prime mortages.
Over the years many of these companies had to borrow money to create the loans to mortgagees. Over time, their debt to asset ratio got way, way out of whack. The number I kept hearing on Friday was as much as 35:1.
What this means is that company A had say, $1,000,000 in cash and assets, and $35,000,000 in debt.
What caused the final meltdown to happen all of a sudden may be too complex for me to answer. But because of the somewhat incestous nature of all these companies investing in eachother, and the sheer complexity of the debt instruments* when one fell, the others fell soon after.
*I heard these debt instruments described as so complex, that many of the corporate financiers had no complete idea how they really worked.
It's really no different than what was goin on in Enron, except that in Enron's case, there was clear fraud. Enron was using a complex web of paper transactions to sort of create the appearance of wealth and propping it up by diverting cash from their legitimate profit centers. In the recent scandle, while time will tell how much fraud played any part**, it seems to be mostly hubris, greed and a belief that this complex ponzi scheme wouldn't fail. These debt instruments required a continuous and expanding flow of cash input at the bottom to feed the expanding number of loans at the top. As the cash slowed down at the bottom, the system collapsed.
**It will be interesting to see if any fraud comes of this. If there was fraud, then we
had the regulations in place, they just weren't enforced adequately.
This wiki
article actually isn't that bad for a simple explanation.
tarran | September 21, 2008, 11:55am | #
fortyouncer,
You ask a good question. Here's what happened.
The Federal Reserve "printed" a great deal of money, which they used to buy various assets. The sellers deposited this new money into their banks, which then loaned it out. By a complex process, these loans end up expanding the apparent money supply by several times what was originally deposited.
Now, the banks offered this newly created money to prospective home buyers on extremely generous terms. Thus, a home buyer who would have been lucky to be eligible for a $100,000 loan was now offered a $500,000 loan. Now, these people, in effect, had much more money available to direct towards home purchases than they otherwise would. So they bid up the price of housing as they competed with each other for choice bits of housing.
That's how the speculative bubble began. Ina speculative bubble, people buy stuff primarily for their speculative value, not because they intend to consume it, but because they expect that as prices continue to skyrocket they will always be able to sell at a profit. And, so long as more money was being created, the banks had an ever increasing pool of money to loan out, and people could bid up the price of houses to ever increasing levels.
Then, Bernanke turned off the printing presses (because the home sellers were spending the newly printed money in other sectors of the economy and prices started going up in other areas as well). The pool of new money dried up. Loans became harder to get, and now people had less money with which to purchase homes. They started offering less and less money for the homes.
As a scheme to get more and more people in the door, many lenders had resorted to offering adjustable rate mortgages, where the rate would go up dramatically after some introductory period. Previously, when the rate hike hit, people could simply refinance or sell the home based on a much higher expected sale price for the home. But now, with prices falling, that became impossible. So the default rate exploded.
The situation was exacerbated by a very bad conflation of risk with volatility by financial houses. They thought that the rate of defaults would be some low, constant rate, and that if you "bundled" a bunch of mortgages into one investment vehicle, a few defaults wouldn't harm the bottom line too badly. This bundling failed to take into account the possibility of systemic failures. Thus, fund managers bought oodles and oodles of mortgage backed investment vehicles, and were left exposed to serious losses once the systemic collapse started. This incidentally is where "deregulation" comes in: it used to be under New Deal banking legislation that such bundling would have been illegal or raised flags. I think absent such regulations, this failure, and the collapse of the firms that made this costly mistake would serve the same purpose. Nothing so educates as the personal experience of screwing up.
The important point to remember in this fiasco is that this is a crisis of valuation. The real assets are not harmed. The factories won't go away if a few banks collapse. The houses will still be there. The mines and farms will continue to operate. There would b chocks, but any assets that would be able to operate in a profit would be snapped up by investors at fire sales after the wave of bankruptcies passed in the absence of a bailout.
Mr. Nice Guy | September 21, 2008, 2:18pm | #
"Now, the banks offered this newly created money to prospective home buyers on extremely generous terms. Thus, a home buyer who would have been lucky to be eligible for a $100,000 loan was now offered a $500,000 loan."
Tarran
Again, I am no expert on finance or economics. I'm not trying to insult you but I doubt seriously that you are as well (you're certainly very well read on that subject, my point is that I doubt you have, say, a PhD in economics, many peer reviewed journal articles, years of working as a top level financial analyst, etc).
Having said that, I have read a bit about these new "financial products" that banks and the like were coming up with, things for example where risky mortgages were turned into securities and then those securities were insured, all with the expectation of housing prices continuing to rise and that those struggling with mortgages would somehow not default on them. For a while these products made a lot of people a ton of money. That in itself incentives a lot of people to jump in (people are, alas, very influenced by short term benefits even in the face of known long term consequences [much less unknown ones], see for example the persitence of smoking).
It strikes me that one doesn't need to have any fancy Fed theory ("there was too much money printed") about why institutions and individuals would gamble on something like this and then conditions change and these people go broke. There is a simpler explanation out there: greed makes people gamble irrationally. Not only is this possible in markets, certain market conditions may foster it. And it strikes me as more than a coincedence that these products recently were de-regulated leading up to a mess in which these products are heavily implicated...
Now if you're the kind of person that simply can't imagine that market forces could ever foster irresponsible or irrational behavior, then, when faced with an empirical example of what looks like that on its face, you'd be driven to come up with some explanation where you just look hard enough to find some non-market factor that you can blame. But I have to admit, it looks like mental gymnastics or what Catholics used to call "apologetics" to someone who doesn't feel predisposed to defend or tear down "markets."
tarran | September 21, 2008, 4:18pm | #
Now if you're the kind of person that simply can't imagine that market forces could ever foster irresponsible or irrational behavior, then, when faced with an empirical example of what looks like that on its face, you'd be driven to come up with some explanation where you just look hard enough to find some non-market factor that you can blame. But I have to admit, it looks like mental gymnastics or what Catholics used to call "apologetics" to someone who doesn't feel predisposed to defend or tear down "markets."
MNG, I can see why you would think that, especially because some people are doing precisely that...
At the risk of sounding like I am doing such mental gymanstics, I would point out that deregulation coupled by imprudent behavior is not unexpected: it is the kind of reaction you see, for example when children raised in sexually repressive families go away to college and begin engaging in promiscuous behavior.
I have many family members in the financial industry. Most of them have no idea who Keynes or Hayek are ( gasp! ). Several of them are of the opinion that anything the government permits is OK to do. Of course that is crazy, the government can't prohibit all possible imprudent investments, investors have to exercise some judgement.
Now, absent a regulatory response to this fiasco, what would happen? Well, a bunch of financial houses would go under, a few would survive, barely, and a handful would prosper.
However, everyone would learn from what happened. They would fear going under. The cautionary tale would appear in business school classes etc.
As it is, the guys who made these disastrous decisions or followed the herd will not learn anything. There will be an incentive to sweep this under a rug rather than discussing this openly. There will be few lawsuits to drag the evidence of the poor decisionmaking out into the public record. Few people will buy books to read up on what haepenned, etc.
Now, to you, this may seem polyannaish, that it does nothing to the people harmed now. And that is right, to an extent. But my analysis of the situation tells me that we will all be harmed - badly, by the bailout. That the regulation, while preventing this particular form of the bubble would not have prevented the system fracturing and failing at some other stress point.
One thing that I, and every other ideologically honest proponent of free markets, admit is that free markets do not guarantee great outcomes. Rather they limit the impact of bad decisions and minimize the barriers of entry for people with new (and hopefully better) ideas. And regulations, which inevitably serve as barriers to entry for new firms, and thus help cartelize the industry they govern, tend to make the damage worse, because when a firm fails, rather than being a small firm that is easily replaced, it is a larger firm that is not easily replaced.
BTW, you are right, I am a dilletante in Economics and do not have any formal training whatsoever (although I helped my wife study for her Econ 101 exam in college).
DEMAND KURVE!
Marc | September 21, 2008, 4:55pm | #
Don't think anyone responded here to TrickyVic. I might oversimplify some things, and I'm not exactly sure how the bailout is going to work in detail, but here goes.
"Someone secures a mortgage from a bank, they owe the bank money. The bank then sells shares of that mortage, basically reselling the mortage but not the home in a type of stock. The bank is now getting the money from your mortgage and money from issuing a paper mortgage not backed by the home its self."
Not exactly. The investors are getting the payments from your mortgage. The bank is most likely collecting them (servicing the mortgage) and passing them on, taking a cut for itself along the way (the servicing fee).
"As the home loses value the homeowner and those holding the paper mortgages lose money on paper. But because the paper mortgages are not backed by the physical house, the people who lost money on the paper mortgages want us to replace their loss."
The paper mortgages ARE ultimately backed by the physical house. To spell out the chain of causation: as the home loses value, the borrower is more likely (in fact, has an incentive to) stop making payments and drop the keys off at the bank. The more likely default by the borrower, the less value the mortgage has to the investor. In particular, if the borrower defaults--which is not guaranteed--the mortgage is worth whatever the bank can recover from foreclosure, net of foreclosure costs. And not only does the likelihood of default increase when house prices are tanking, but the amount to be recovered is going to decrease at the same time. If the borrower doesn't default, the mortgage might be worth quite a bit. Probably the investor has the rights to the payments from a bunch of mortgages (note that these can be chopped up in all sorts of ways, but that's a further complication), so what happens on average over all the mortgages is relevant to them.
Note that the decrease in "paper" value has real consequences thanks to mark-to-market accounting. I'm not going to go into this.
"If the person home is foreclosed, the bank wants the home back, plus it wants the money back, via bail out on the paper mortgage. So not only do they take the property, they get to take the money on the paper mortgage as well."
That's double-counting. The gubmint is going to buy the mortgage from the bank (or the investor, I suppose, depending on who has the ultimate rights to the cash flows), so they get the property in the event of default. (This is something scary that hadn't occurred to me until now. Will they really sell them? Or hold onto them?) Effectively the investor will get back some of what they've lost due to the fall in house prices. Nobody gets both the property and "the money" in the sense of the outstanding loan balance.
I have no idea how the gubmint is going to decide what to pay for the assets. I am SURE that it will be more than what they're worth. Part of the problem in the first place is that they're hard to value, because they're complex and information available on the assets is often shitty in the first place. The savvier banks that are still in good shape would be in a better position to buy the mortgages (or securities based on them), either explicitly, or implicitly through mergers or acquisitions, but they're about to be priced out of the market by a gigantic investor with infinitely deep pockets.
Anyhoo. What I don't get is that as long as the government is going to spend a trillion dollars clearing up this mess, why don't they just bail out the homeowners directly? It would have more popular support. Or is that too clearly socialist?
tarran | September 21, 2008, 9:50pm | #
MNG said,
My point to tarran (and one I will note that he took quite well and, as it was meant, not as some personal slight) was that as neither of us were experts on the subject it might be best to try to talk about this on the level of common sense rather than empirical or theoretical claims that are widely disputed by folks who know much more about this stuff than we do (such as that the actions of the Fed "actually" caused all of this, or that the bulk of state/federal regulation was made not as a result of public outcry but according to public choice theory).
The thing is, though, I disagree with this. You are qualified to form an opinion on any subject on that man can conceive of. Yes, it might be difficult and require a great deal of time and effort to learn what is required, but I have no problem with non-experts trying to study a situation and come to their own conclusions.
Let us assume, for the sake of argument, that mainstream economics is in the same state as mainstream astrology was in the 14th century. Now, a 14th century tarran might make the claim that astrology was a bunch of bunkum. Would the 14th century MNG be correct when he said, "gee Mr 14th century tarran, I notice that you haven't graduated from astrology school or apprenticed in the field. There is a lot of dispute on the subject of astrology among experts so it is not a good idea for us to debate it as well."
Now, with the benefit of centuries of astronomical observations, we all know that astrology is bunkum, and I can say that today and not be criticized even though my knowledge of astronomy was acquired the same way I learned about economics, and I know nothing of what it means when Mars is ascendant in the house of Orion.
You, MNG, as an adult human, are qualified to form an opinion and discuss any subject you wish. I bet if you spent a couple of hours each night reading up on quantum mechanics, inside a year you could intelligently discuss all the modern controversies without making an ass of yourself.
So I disagree with your thesis very vehemently. You are right, however, that I took no offense. I didn't take what you said as an insult - it is after all the truth that I am not formally trained in economics. I don't agree with your thesis, but it's not an unreasonable one. If someone challenged me to a debate on anthropogenic global warming, I would demur - since I have no data to make an opinion, and will have to trust some other expert (and I lack the patience to wade through the thousands of websites that discuss the topic in an effort to separate the high quality sources from the charlatans). But, if I were convinced that I had to learn up on the matter, and devoted a few months of study, there is no doubt in my mind, that I would be qualified to debate and discuss the matter with any expert (of course, I might come up with conclusions that were full of shit - I famously asserted wiht 99% confidence that Saddam Hussein had an active and functional chemical weapon program in 2002 (based on the existence of the Al-Samoud missile)). That is why I disagree with you.
BTW, everybody knows that if you want to predict the future, go to a priest who is an expert in reading the livers of freshly sacrificed sheep. The astrologers managed to supplant them since people foolishly preffered inaccurate predictions that didn't involve the cost and grossness factor of sheep sacrifice. The god damn astrologers also had a more effective special interest group.
Fluffy | September 22, 2008, 9:09am | #
to innominate: how much of gov snooping is illegal is a mater of contention and political conviction. Immoral does not equate illegal.
Um...yeah. That's exactly the point. We disagree about how much privacy is warranted.
And if a person argues the point that no privacy is warranted, I just don't want them to come back to me later and whine about their own privacy.
It is like equating the police searching your apartment with your neighbor breaking in and taking your tv.
Yes, it is. And if someone were to advocate changing the law to allow police to kick in any door they want, at all times, without warrants, I would in fact laugh at that person if someone kicked in their door and stole their TV. Because whether you realize it or not, turning back the clock on centuries of common law regarding searches and warrants fundamentally alters the nature of property.
If you don't believe that citizens should be secure in their persons and effects, then you should be prepared to accept the consequences of that.
to Fluffy: it is people like you who make debate about anything impossible.
And people like you make debate a joke, because they are too intellectually dishonest to be held to a consistent point about anything, and so there's no "there" there to debate them about.
The list of items I included in my "screed" was precisely chosen, because each of them reflects a legal principle articulated by the Bush administration, or an actual event that took place under the Bush administration.
The Bush administration sent intelligence operatives to kidnap a legal resident of Italy off the street without bothering to tell the government of Italy about it and without requesting extradition.
The Bush administration has held persons in secret detention centers, and has also rendited persons for torture abroad.
The Bush administration has held persons incommunicado and without access to attorneys for extended periods.
The Bush administration created a legal regime in Iraq wherein female employees of government contractors who were raped by coworkers had no legal recourse or access to courts.
The Bush administration has repeatedly asserted a national security privilege to deny litigants discovery materials and to have lawsuits in US courts dismissed.
So basically you're saying that you're cool with the fact that all these things happened, but if I list them in a post and wish them on Republicans, I'm impossible to debate with. Whatever.
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