Bailout Bums

Libertarian-minded Republicans are caught with their pants down as Wall Street panics the Capital City

To understand how Washington, D.C.'s fiscally conservative and libertarian-leaning Republicans are handling Treasury Secretary Henry Paulson's proposed $700 billion bailout of the financial services sector, think of a child who's just learned that there is no Easter Bunny. Better yet, think of a guy who sunk his portfolio into Lehman Brothers or Bear Sterns and watched everything he was taught to believe about his investments declared moot, wrong, meaningless, at the mercy of the state.

The bailout "does ensure that President Bush will have a legacy," laughed Fred Smith, the president of the Competitive Enterprise Institute, a staunchly pro-free markets group, on Wednesday. "It's a legacy that will discredit every economic concept that we have on the right. It will set back the concept of economic liberty by a century."

Openly or secretly, a lot of Smith's fellow travelers in the Beltway agree. Three weeks ago in St. Paul, Republicans released a platform that declared flatly, "We do not support government bailouts of private institutions" and that "government interference in the markets exacerbates problems in the marketplace and causes the free market to take longer to correct itself." 

Yet as the panic over Wall Street woes has mounted, those principles got lost, and a critical number of Republicans are expected to support a $700 billion bailout of failing investment banks being pushed by a GOP president and his money man. Although serious problems with government-sponsored enterprises such as Fannie Mae and Freddie Mac have long been evident and despite longstanding anxiety about "too-big-to-fail" market players going belly up, the Republicans were caught flat-footed by recent events.

The experience of the most fiscally conservative members of Congress, the Republican Study Committee (RSC), is instructive. Throughout the Bush years, the RSC has proposed alternative budgets heavy on spending cuts. Now, forced to consider a spending package equal to a million earmarks, it was pushed to the side.

Its members did act fast. On Wednesday, September 17, RSC stalwart Rep. Jeff Flake (R-Ariz.) released a forceful statement: "The federal government's propensity to bail out failing companies in struggling industries ought to be troubling to all taxpayers….Aside from the fiscal impact of spending money that the federal government doesn't have, these bailouts will likely have the opposite of their intended effect." Flake also took aim at the then-rumored bailout of the automobile industry.

On Thursday, the RSC sent a public letter to the White House opposing any Wall Street bailout: "Regardless of the precautions taken, the risk to taxpayers and to the long-term future health of our economy remain just too great to justify." But on Friday, RSC Chairman Jeb Hensarling (R-Texas) put out a tentative, milquetoast statement on the proposed bailout that decried the idea without ruling it out completely. "Though my mind remains open," Hensarling said, "at the moment I remain skeptical, fearful, and unconvinced that this is the proper remedy for our nation at this time."

The next day the draft of Treasury Secretary Henry Paulson's plan was released, with a Tiffany price tag and enumerated powers such as buying up bonds galore and a two-year ban on any real oversight of Treasury's activity. Former RSC Chairman Mike Pence (R-Ind.) rejected "the largest corporate bailout in American history."

But other than that: Crickets. Fiscal conservatives mostly dared not come out swinging against a proposal offered by a White House they had, more often than not, trusted.

This past Monday at 5 p.m., the RSC met to strategize further. Who was opposed to the bailout, full stop? Who had alternatives they could put on the table? According to staff who were at the meeting, the mood was somber, with a majority opposed to the concept of a bailout but without a clear idea of how to challenge it. When the full Republican conference met on Tuesday, there was even less unity. At a Heritage Foundation luncheon, Flake told bloggers that about half of his party's members opposed a bailout.

While Flake was speaking, a dozen members of the RSC were beginning a press conference in the House to make their suggestions and state their positions. Reporters picked up a pithy one-page memo of RSC proposals, including

—a two-year suspension of the capital gains tax, after which "rates would return to present levels but assets would be indexed permanently for any inflationary gains."

—full privatization of Freddie Mac and Fannie Me "over a reasonable time period."

—repeal the Humphrey-Hawkins Full Employment Act, which the RSC fingered for the Fed's suppression of interest rates to artificially low levels (although the Act expired in 2000).

—a suspension of mark-to-market regulatory rules (assigning value to a financial instrument based on the current market price).

That was it. The rest of the press conference was, if not a circus, a carousel with a lot of mis-matching horse heads. Rep. Kevin Brady (R-Texas) suggested that business tax cuts could attract investors to our shores bring more revenue from "profits left stranded overseas." Rep. Joe Barton (R-Texas), a dogged supporter of more oil drilling, claimed that the policies he favored would, conveniently, pull us out of the crisis. "The oil revenues that we could get from ANWR have been scored by the Congressional Budget Office at around $200 billion," Barton said. Rep. Michele Bachmann (R-Minn.) excitedly agreed with him. "If we open up these areas for energy exploration, well, Katy bar the door! We'd see this economy turn around immediately!"

Mike Pence, still the only member at the press conference ruling out any yes vote for a bailout, tried to challenge the premise. "There are those in the public debate," he said, "who have said that we must act now. The last time I heard that, I was on a used-car lot."

"I would amend that statement," added Rep. John Shadegg (R-Ariz.). "The last time I saw the phrase 'act now' it was advertising one of those time-share condo deals that lock you in after a free trial period."

"Did you try it?" asked a reporter.

"No!" Shadegg laughed. But he didn't line up with Pence against any bailout.

The presentation had no notable impact on the debate in Congress. As the Republicans spoke, a few cameramen snickered audibly. When Bachmann called the bailout "the enslavement of the American people," the snickering reached its loudest pitch. And on the way out, Pence offered reporters more proposals that would probably come to nothing, such as a suspension of the capital gains tax by executive order. "There are learned legal scholars who think that's within his purview as president," Pence explained.

But enough Republicans are ready to support the bailout to make all of this moot. Rep. John Campbell (R-Calif.), an Ayn Rand fan and potential future head of the RSC, conceded that his party is divided. "People are struggling with it around here like you can't believe," he told me on Tuesday. "This proposal is anathema to everything I believe. I've voted against million dollar bills, and here's a $700 billion one. But to do nothing—that really threatens a massive expansion of government."

How so? Campbell doesn't shy from comparing it to 1929. "If John Q. Lunchbucket doesn't understand this stuff, and waits in line for a block to get into his bank, and then is told 'we don't have your money,' he will respond to any proposal to prevent that in the future. Any populist who says 'I'll make sure these guys never get your money again' will have his ear."

There is an external reason for the division of Republicans right now. They don't control Congress. The Democrats run both houses and are negotiating with the executive branch. They own the agenda. But it is striking how free-market economics have no place in the current debate. They are not seen as a credible response to a Wall Street crisis, even by the presidential nominee of the Republican Party, who is angrily attacking the "greed of Wall Street." Contra Naomi Klein, an economic shock has sent Republicans skittering away from free-market theories; the last thing the party of small government seems interested in letting markets work. The current political debate, not just between Democrats and Republicans but even among Republicans, is not whether the government should take over mortgage firms, but how effectively it can manage them.

"Nobody trusts Republicans on these situations," said Fred Smith. "For good reasons."

David Weigel is an associate editor of reason.

Comments

[The Chad]

Tips line (and totally OT): http://www.suntimes.com/news/watchdogs/1184049,CST-NWS-watchdog25.article

via insta

[Kolohe]

How so? Campbell doesn't shy from comparing it to 1929. "If John Q. Lunchbucket doesn't understand this stuff, and waits in line for a block to get into his bank, and then is told 'we don't have your money,' he will respond to any proposal to prevent that in the future. Any populist who says 'I'll make sure these guys never get your money again' will have his ear."

This, alas, is a really good point and likely why 'something will be done.'

Senator Bunning from Kentucky has been on TV most of the day speaking against the bailout. He's doing a really terrible job.

[Neu Mejican]

Something will be done.

Supporters of "do nothing" have to make the case that the crisis is not a crisis.

I am not convinced that the crisis is a crisis and I am a moderate.

Someone needs to make the case coherent so that reasonable options to the current plan can be discussed.

To my mind these would involve doing things to correct the source of the problem which seems to be the complex bundles of mortgages that include some that are likely to foreclose. Since the good mortgages are bundled with the bad it is difficult to value the bundle.

Is there a way to lower the risk of foreclosures so as to raise confidence in the value of the bundles?

Procedural reform of foreclosures?
Reform of adjustible rate mortgage rules that reduce chances of foreclosure?

Why is the fix being aimed at the effect rather than the cause?

[Mike Laursen]

The appropriate government response would be to immediately cut spending by $700 billion.

[JW]

Supporters of "do nothing" have to make the case that the crisis is not a crisis.

Wrong. Supporters of "doing something, ANYTHING!" need to make the case as to exactly why we have to take this one in the ass. If you're accused of a crime, the people who want to convict you, take the affirmative action, have to make their case. Same thing here.

What exactly will happen if we don't do something, other than cats and dogs living together? That we haven't been given any details tells me that they're just guessing.

[Mike Laursen]

Since the good mortgages are bundled with the bad it is difficult to value the bundle.

Difficult, yes. But I don't buy the argument that it is impossible. For example, one could look at a statistical sampling of the mortgage income streams included in a bundle. Or take $700 billion and divide by the number of bad pieces of paper.

[R C Dean]

To my mind these would involve doing things to correct the source of the problem which seems to be the complex bundles of mortgages that include some that are likely to foreclose. Since the good mortgages are bundled with the bad it is difficult to value the bundle.

Admirably summarized, sir.

Is there a way to lower the risk of foreclosures so as to raise confidence in the value of the bundles?

Depends on how you lower the risk of foreclosure. If you do it by subsidizing people who bought more house than they should, then you are rewarding bad behavior and transferring wealth from the prudent to the greedy.

If you do it by making it harder to foreclose, then you haven't reduced the exposure to the banks (their exposure is really with non-performing loans, not foreclosure per se), and you've likely raised the cost of mortgages for everyone by making them riskier to issue.

The real problem arose through a combination of things, but the main one is probably that the prohibition on Fannie and Freddie didn't buying "sub-prime" loans was lifted. That prohibition kept these loans from being issued in any volume. Reinstate the prohibition (which no one seems to be talking about), and you've taken a giant step toward cleaning up this market going forward. Doesn't solve the current toxic loan pool problem, though.

[Mike Laursen]

Wrong. Supporters of "doing something, ANYTHING!" need to make the case as to exactly why we have to take this one in the ass.

I don't think Neu Mejican means that they have a logical or ethical burden of proving a negative: either that there is no proof that there is a crisis or that there is no proof that this is the right response to the crisis. In an ideal world, the public and politicians would understand that the positive needs to be proven, but in the real world there is a practical need to actively shoot the weak justifications given for this bailout as full of holes as possible.

[Dello]

"Or take $700 billion and divide by the number of bad pieces of paper."

My home is not one of the ones in default, but I would happily sell it to you for my proportion of that $700 billion.

[Mike Laursen]

My home isn't in default either, but I'm looking for some way I can use this crisis to buy my own mortgage at a discount. Then negotiate higher interest payments, so I can deduct them.

[Dello]

Mike,

I like how you think.

[Kevin Peterson]

My take on it: If a bank collapses, the only ones who lose money are investors. If the bank that holds your mortgage collapses, it isn't as if they can come and kick you out of your house. The worst case scenario is that you'll get a letter advising you that your lender is defunct, your loan has been purchased by another bank, and would you please send your future loan payments to a new address?

Link goes to my suggestions for how bring people around to our point of view.

[Francisco Torres]

Supporters of "do nothing" have to make the case that the crisis is not a crisis. I am not convinced that the crisis is a crisis and I am a moderate.

It is a crisis. The laissez faire approach does not stem from the premise that there is not a crisis, just one where an intervention from the State will make things worse.

[PC]

"Doing nothing" amounts to a bailout, the FDIC will bail out accounts up to 100,000. "Doing something" is nothing but a transfer of wealth, the negative effect will be spread to all via inflation while those who would have beared the brunt will be saved and will benefit by selling their crap to the taxpayer above market value. This is theft. The people holding these garbage bundles are looking around for a sucker to buy it because they don't want to sell it for what its worth so they find the only sucker left, the idiot taxpayer who listens to what the banking community says without understanding the interest that the banking community has in this. Motive doesn't exist for the ignorant. And this is under duress as well, Bernanke and Paulson by panicing and crying can make things worse just by what they say, so they are basically putting a gun to our heads. They should be tarred and feathered and paraded up and down Wall Street with no bailout period. This isn't necessary, this is theft.

[Pro Libertate]

It appears to be a serious crisis that could well lead us into a year of deepish recession. Maybe. Does that require further expanding government intervention in the economy and continuing the trend of mortgaging our future for political reasons today? I'm not convinced that any major intervention is necessary at all, and I keep wondering why something more restrained hasn't been suggested by Congress.

I keep thinking about Japan. They meddled and propped up their financial services industry, and look what that got 'em--ten years of major recession, and a downturn they're still not completely out of.

[Neu Mejican]

It is a crisis. The laissez faire approach does not stem from the premise that there is not a crisis, just one where an intervention from the State will make things worse.

That case can be made, but it requires a fatalistic world view that few hold. The idea that all and every option available to the government will make things worse is, actually, logically incorrect. The government is already involved in the market, so government action can include removing itself, disentangling itself, reducing its involvement, removing barriers, reducing taxes, eliminating oversight, etc...

So "do nothing" is actually a defense of the current government regime. If the current regime was working, then their wouldn't be a crisis (if there is one).

[PC]

If I could potentially be up for 700 billion, I'd try to scare and swindle you to the best of my ability too. Those people who think these guys are doing it because they think its best for the country should have their assets seized and put in mental assylums because they are endangering the rest of us at this moment...or they should be euthanized.

[Pro Libertate]

Neu Mejican,

If I were calling the shots, I'd be deregulating, so I'm all for an unbailout.

Back to what's actually happening--a trillion dollar bailout--maybe we should expect the industry to actually pay us taxpayers back at some point?

[Paul]

Som what's our next step now that our politicians have tossed that outmoded Evolution thing to the winds, and fully embraced "Intelligent Market Design".

There's a slogan here, somewhere. I can feel it.

[Neu Mejican]

Pro Liberate,

Being the moderate that I am, my guess is that the most effective plan would include a combination of removing some regulations, adding some new ones, providing some support to some players (certainly not on the scale proposed), and tweaking the collection of data for oversight to prevent similar crisis level situations from developing in the future.

But again, it seems all of those need to be aimed not at the effects of the crisis, but the causes of the crisis.

[JW]

The government is already involved in the market, so government action can include removing itself, disentangling itself, reducing its involvement, removing barriers, reducing taxes, eliminating oversight, etc...

C'mon seriously, do you actually expect for any of those options to be on the table? And when, exactly, has the current regime untangled itself from *anything,* other than taking the blame for its incompetency?

[Neu Mejican]

JW,

the current regime untangled itself from *anything,*

The current regime does not refer to the individuals (GWB et al) but the the systems of governance currently in place. These are, in part, the result of previous moves toward deregulation that were not well thought out (see RC Dean's comment above, for instance, regarding Fannie and Freddie).

[Francisco Torres]

Being the moderate that I am, my guess is that the most effective plan would include a combination of removing some regulations, adding some new ones, providing some support to some players (certainly not on the scale proposed), and tweaking the collection of data for oversight to prevent similar crisis level situations from developing in the future.

Still sounds too much like central planning.

[Pro Libertate]

Neu Mejican,

Libertarian than I am, a plan that made some sense and didn't sound like it was made up in a two-hour meeting would beat the current nonsense. I just ranted in another thread about how this situation proves that our government shouldn't be so deeply interventionist.

[JW]

The current regime does not refer to the individuals (GWB et al) but the the systems of governance currently in place.

Ah, gotcha. I hear 'regime' and....

"Do nothing" and deregulation are not the same thing. "Do nothing" has the elegant beauty of being the all purpose option, no matter what apocalypse is upon us.

Deruglation can be done very poorly, as was the case for the California and Maryland electrical markets. It can be worse than the actual regulating. "Do nothing" just implies that I have no faith in any of the players to do the right thing. IOW,to not screw things up even more.

Taking on $700 billion+++ in debt (plus interest!) is not the right thing. Failure is a better teacher than Big Mama making everything all better.

[GG]

This was just posted on the RCP Blog:

Barr Wanted In, Got Shut Out

[Francisco Torres]

The government is already involved in the market, so government action can include removing itself, disentangling itself, reducing its involvement, removing barriers, reducing taxes, eliminating oversight, etc...

So "do nothing" is actually a defense of the current government regime.

Not so much; since central planning necessarily requires a constant fiddling of the system, a "do nothing" approach is actually contrary to such process. "Do Nothing" means don't tweak, don't oversee, don't regulate, don't tax... don't do anything.

What I believe you're thinking is "keep the status quo", which would actually include a bailout, since, the same as the scorpion in Aesop's tale, that is what meddling governments do: bail out their well-connected friends.

[Francisco Torres]

In a statement released on Wednesday, Barr said a vote for the bailout package, "in whatever form it comes in, is a vote against the American taxpayer, and a vote against the free market."

Amen.

Barr also condemned McCain's call for more regulation and oversight, saying such regulation is government seeking to micro-manage the U.S. economy. "Capitalism involves losses as well as profits," Barr explains. "When government tries to insulate businesses and investors from paying for their mistakes, we all lose. In a Barr administration, there would be no more corporate bailouts or takeovers."

I wish that were true, but that would require abolishing the Federal Reserve Act, of which Congress is too fond.

[JW]

Oh, and "do nothing" is in no way implying that we should not reform the system in place. However, I have little faith that anything will be done that won't be stuffed to the rafters with favors for donors and constituents, as we're seeing already. I just don't think we should be worrying about whether or not these companies survive.

To quote our fabulous J sub, "fuck 'em."

[H man]

This is one of the better solutions to pricing the MBS that I've seen

Go to

http://www.arthurdevany.com

for the rest of the article.

As William Goldman famously said of movies, nobody knows anything when it comes to predicting what a movie will earn when it finally reaches the market. I showed in my book, Hollywood Economics, that the way to solve the problem of unpredictable results is to set the price later when you do know. How is that done? Well, to use the movies as an example, you make contingent contracts that pay based on the revenues a movie earns after it is released. Virtually all the industry's contracts follow this principle, which I call the Option Principle. Designing option-like contracts lets you pay when you do know.

[JW]

Being the moderate that I am, my guess is that the most effective plan would include a combination of removing some regulations, adding some new ones, providing some support to some players (certainly not on the scale proposed), and tweaking the collection of data for oversight to prevent similar crisis level situations from developing in the future.

Neu--I would also add that, despite having all of this wonderful economic and financial data available to the powers-that-be already, they were still caught flat-footed by the unwinding events. Monkeying up the system with more bells and whistles, but leaving the same dopes in charge, is not a recipe for change or improvement.

It's just more buzzers going off and people running around with a wild look in their eye because they don't know which of the millions of buttons to press first.

[St. V]

This averages out to, what, $5,000 per working person? Just give us the damn money. Those who can't pay their mortgages can use the cash to either pay the bills, or find a new place to live.

Then I can use my 5k to pay off a large portion of my car! Or guns! Or clones! Or (whatever else was in the reason news)!

Woooo!

[Francisco Torres]

Monkeying up the system with more bells and whistles, but leaving the same dopes in charge, is not a recipe for change or improvement.

JW, we could go even further and argue that, even if we had veritable geniuses in charge of the centrally-planned economy, the system would still fail, because there is not enough processing power in the brain to control a complex system like the market, driven by purposeful (i.e. unpredictable) action.

[James Butler]

@Pro Libertate - Your thought about "paying taxpayers back at some point" reflects Obama's recent statements. Interestingly, a majority of people polled by ABC News who were asked about making a "taxpayer investment" for this expenditure were in favor of it, but when asked about making a "bailout", a majority were against.

At this point, though, shouldn't the biggest question be: Where the hell is this $700B coming from? We sure don't have it lying around, so it will be in the form of new debt. The discussions about this bailout imply that we have sources lined up to loan the money, but today the South China Morning Post reported that China has given the order to all of its banks to halt all lending to American institutions until the threat of this crisis recedes. Current reporting from China indicates backpedaling on this (Reuters update), but it certainly wouldn't surprise me if foreign lenders were extremely hesitant to lend more, particularly when their own finances are probably in no small part tied up in all of this. It's a small world, after all.

[prolefeed]

But to do nothing-that really threatens a massive expansion of government.

OK, this has got to go on the "Unconvincing Quote of the Week" for the Friday Political Thread.

Talk about destroying the last shreds of credibility the Republican party had on economic matters.

[Mike Laursen]

...even if we had veritable geniuses in charge of the centrally-planned economy, the system would still fail, because there is not enough processing power in the brain to control a complex system...

Francisco, go to the head of the class!

[Some Guy]

I just got done yelling it all of my Republican friends. Each one loves to talk about how the free market must never be tampered with. Each one says we have to do that bailout. They better never call themselves capitalists again while I am in earshot.

[JW]

even if we had veritable geniuses in charge of the centrally-planned economy, the system would still fail, because there is not enough processing power in the brain to control a complex system like the market, driven by purposeful (i.e. unpredictable) action.

Bingo!

[Paul]

the system would still fail, because there is not enough processing power in the brain to control a complex system like the market, driven by purposeful (i.e. unpredictable) action.

The only problem I have with this problem is it leave an 'in' for pols to declare that if they put 'enough' brains on the problem, the voila! Solution!

Centrally planned economies failed because regardless of processing power, you just can't know what the cost of everything is. But regulars here know that. Make a sentence with the following words:

Sense A No Beating Horse Dead In There's

[Paul]

Anyhoo, by the syntax in my previous post, it's clear I'm overtired. I was up late beating this dead horse right here on H&R. I need a break. Plus, I gotta get ready for the rubber hose that is this government plan.

[Amakudari]

Great, it looks like a whole bunch of economists signed a letter disparaging the bailout. That's how you know it will ultimately receive broad support.

[Mike Laursen]

They better never call themselves capitalists again while I am in earshot.

Let go of the term, capitalist. Better to disassociate yourself from it. It is now commonly understood to mean people like Paulson and Bush. It was Marx' term, anyway.

We are free marketers.

[Theresa K]

Our only hope is to make this plan as bad a deal as possible for the banks that buy into it, so as to minimize the number who choose to participate.

That means joinging forces with the Democrats to make sure the asset price we pay is as low as possible and it comes with all sorts of pay caps and punitive measures for corporate executives and shareholders.

[Neu Mejican]

JW, we could go even further and argue that, even if we had veritable geniuses in charge of the centrally-planned economy, the system would still fail, because there is not enough processing power in the brain to control a complex system like the market, driven by purposeful (i.e. unpredictable) action.

We could but that would require ignoring what we know about successful adaptive systems. They always contain a combination of bottom-up and top-down decision processes. Breakdowns in the system can result from too much top-down control, but they can also result from too little. The economy is no different in this sense than any other complex system.

In the brain too little top-down control results in disorders like ADHD and Epilepsy. If the current crisis is a real crisis, it would take a bit more reflection to determine whether it results from too much, too little, or the wrong type of top-down control.

What is certain is that no top-down control will result in poorer results over the long run than appropriately tuned top-down controls.

This means that the comment about constant tweaking above is, imho, particularly off the mark.

[Theresa Klein]

Let me add to that:

We can also help by backing Democratic proposals to spend this money on (just about) anything else.

When all else fails, throw sand in their eyes.

[gao xia en]

But this system is the best of all for the banks and insurance companies. It's "Heads I win, tails you lose".

[JW]

In the brain too little top-down control results in disorders like ADHD and Epilepsy. If the current crisis is a real crisis, it would take a bit more reflection to determine whether it results from too much, too little, or the wrong type of top-down control.

In the economy, a financial organ failing from its poor performance is generally a good thing. In the body, an organ, such as the liver, failing from poor performance, not so much of a good thing.

Fortunately for us, the Big Brain is not in charge of the economy. It would find all that giga-tasking tiresome.

[Eric Dondero]

Libertarians are split, as well. Not all libertarians are extremists like Weigel, who want absolutely no government intervention under any circumstances.

There's political reality to consider, as well.

But of course, the Reasonoids like Weigel could care less about politics. Better to lose elections and stand on principle they'd shout.

We've seen where that line has gotten the libertarian movement over the years.

[Alan]

RE: As the Republicans spoke, a few cameramen snickered audibly. When Bachmann called the bailout "the enslavement of the American people," the snickering reached its loudest pitch.

Where have I heard that "enslavement" line before? Taxes in general, public education, social security, the right of racial and enthnic minorities to be free of public humiliation, etc., etc. are all cast by the libertarian extreamists as "enslavement".

The result: the "libertarian movement" is largly, and rightly, considered a joke.

Eric, I think you express a good point about Reasonoids who could care less about politics. But perhaps it is not politics, but people that the Reasonoids could care less about.

Extreamist insistence on one social value, like liberty, to the exclusion of others leads to an inhumain and impoverished society.