Skepticism Over The Treasury Plan

I don't want to pretend I know what you're thinking when it comes to the government's plan to address the mess in the financial system. It may be something like this though:

Thank goodness someone has a plan. Don't bother me with the details, just do what it takes to fix it and let's get on with our busy daily lives.

That's pretty much how I reacted when I learned we had termites in our walls.

When the bill ranges in the billions of dollars, though, we probably should bother to stop, learn a little bit more, and ask a few questions before plunging ahead.

First, a summary of the problem via Paul Krugman:

1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.

2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.

3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.

4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”

Next, a summary of the Treasury's proposal to address it. The Treasury would be legally empowered by an Act of Congress to purchase troubled assets to promote market stability and "unclog" our financial markets. The limit on this authority would be set at $700 billion. The assets are "intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans." The government would sell off the assets once they regained some value.

One big question will be "how much will the government pay?" As law professor Hal Scott notes, pay too much and the public will be outraged. Pay too little, though, and we'll fail to accomplish our objective. Another is whether this is even the right model. Some, such as Krugman, have suggested that the Fannie Mae bailout from a few weeks ago is a better model, with the government actually taking ownership.

I'd like to think that there's a little time for rationale discussion and that the markets, knowing that help is on the way in one form or another remain calm. Otherwise, we'll just need to buckle in.

Quote of the Day

"When normal Americans know who the Secretary of the Treasury is, that's not good."

-Wil Durst, political satirist

Normally, we're all for people know more, rather than less, about key government policy makers, but there's a more than a grain of truth to the above. At right is Andrew Mellon, who was Treasury Secretary during the stock market crash of 1929. Mellon would have been decidedly opposed to the Federal Government's proposal to purchase assets from financial institutions (or "cash for trash" as Paul Krugman has dubbed it).

Don't Leave Town for the Weekend...

is the recent lesson I've learned.

A few weeks ago, I came back into town to learn that the Federal Government had taken over Fannie Mae and Freddie Mac.

On Monday, the Wall Street Journal reported that Wall Street as we knew it was over, as the two largest remaining investment banks had opted to convert to bank holding companies:

With Goldman Sachs and Morgan Stanley becoming commercial banks, and the other three big investment banks/brokerage houses being acquired by commercial banks, politicians and the press won't have Wall Street to kick around anymore. Headlines now shout about a $700 billion "Bailout for Wall Street." Yet strictly speaking, Wall Street as we knew it no longer exists. (emphasis added)

You know, you go out to the country to pick some pumpkins and buy some cider, and Wall Street goes out of business. This is becoming all too typical. What's next perhaps? The Onion gives us a clue in the photo above.

A good laugh...

is what we could use right now rather than a civics lesson. This is a personal favorite from The Politico.

What Might a McCain Presidency Look Like?

Last month, John Fortier of the American Enterprise Institute asked an important question. How would John McCain govern?

He noted a few McCain character traits:

McCain’s governing style displays a healthy balance between loyal insiders and outside advice. McCain has attracted loyal long-term staffers, such as chief of staff and co-author of his best-selling books, Mark Salter, but he also seeks counsel from a wide range of advisers inside and outside his campaign...

This is important because one of the chief failings of the current administration, in my view, has been insularity. People from inside Bush World were given key posts, even when not suitable. Outsiders who were tapped really didn't wield real power. Compare that to Ronald Reagan who made his chief GOP rival's campaign manager his Chief of Staff. A good leader will reach out and hire the best people, regardless of their past affilations.

With McCain’s emphasis on fiscal responsibility, lower spending and cutting congressional pork, a McCain presidency would likely see vetoes of appropriations bills and budget showdowns with Democrats. On this front, McCain would probably find strong backing from his Republican colleagues, who while in the minority would support fiscal restraint wholeheartedly.

As a Republican President with a strong record of fiscal restraint dealing with a Democratic Congress, McCain would likely do a fairly good job keeping spending in line. That's a big advantage he's got in my view over Senator Obama, who likely will go along with Congressional spending wishes because he's got some ambitious plans of his own, e.g., health care.

Fortier surmises that McCain's record of bi-partisanship and independence from his own party's line means that he'd work better with a Democratic Congress than any of his GOP rivals would have, which I find to be a reasonable assertion.

What Might an Obama President Look Like?

In his Politico column Wednesday, American Enterprise Institute scholar John Fortier asked what an Obama Presidency might look like. Given the current trend back toward Obama in most of the polls, this is a question many may be pondering between election day and January 20th, 2009.

Specifically, Fortier considers what is likely to be the political dynamic in 2009 (a strongly Democratic, fairly unified Congress) in conjunction with Obama's political record to date.

Obama’s legislative career has been spent mostly in the minority (ed: thus making it harder to accomplish goals)...He has modest but bipartisan accomplishments (italics added)...[as a state Senator] he championed a measure to expand health care, state legislative ethics reform and an anti-racial profiling bill that won unanimous support. In the U.S. Senate he worked on anti-nuclear proliferation efforts with Sen. Dick Lugar (R-Ind.) and on government accountability measures with Sen. Tom Coburn (R-Okla.), a conservative stalwart.

In this regard, he is similar to Senator McCain. Whereas McCain is quick to rub his bi-partisanship in his party's eye, though, Obama does so in a lower key manner that doesn't ruffle his party's feathers, says Fortier.

Another key "tell" for Fortier is that the Obama campaign has been very professional. It's been cohesive, lacking the leaks and backbiting that mark many presdiential campaigns. This bodes well for a smooth executive branch under President Obama.

As a President with liberal majorities in both Houses of Congress, Obama won't need to work very hard to reach out to Republicans. In fact, his biggest critics may be some in his own party who feel he doesn't go far enough:

But Obama would face some difficulties. He has bipartisan instincts, but political circumstances point neither to him courting GOP lawmakers nor at Republicans reciprocating. His chief difficulty is raised expectations. An Obama win, combined with strong congressional gains in 2006 and 2008, would embolden Democratic activists to push for an ambitious agenda. But the cost and complexity of health care reform, continuing costs of keeping troops in Afghanistan and even Iraq, and the reality that only a few agenda items can be tackled in the first year may frustrate the base or perhaps cause Obama to push for too much, only to disappoint. Managed correctly, a plan that gets 75 percent of what Obama wants on health care or energy would be a major victory, even if some see it as unambitious.

This is something I have thought for a while. There's so much excitement around the Obama campaign, and so much expectation, that if he is seen as failing to deliver quickly on key promises such as bringing US troops home from Iraq, he may find his strongest supporters becoming his biggest critics.

Tomorrow, we'll look at Fortier's take on a McCain presidency.

Reality and the Next President

Whoever the next President is must accept that much of his agenda will need to be set aside given today's new realities.

George Bush did not come into office talking about fighting a war on terrorism. Nor did he plan to take over large segments of the US financial sector. Don Rumsfeld went to the Pentagon to downsize and retool our fighting forces away from those suited to a large ground war towards a lighter, more agile force concerned with containing small outbreaks at a moment's notice.

Then came 9/11, Iraq, the financial crisis, and the rest is history.

Similarly, Franklin Roosevelt was elected to fight the Depression and wound up fighting World War II. The ability to change with conditions was what historian Doris Kearns Godwin labeled as the 4th trait of great Presidents.

Neither Senator Obama nor Senator McCain are particularly well equipped to handle the situation Wall Street finds itself in, nor the threat it poses to the economy.

Let's admit that up front.

Obama's strong point is social policy, e.g. health care and McCain's is foreign policy and defense. McCain once famously admitted to not knowing much about economics, and Obama was simply politically saavy enough not to admit the same.

In today's Wall Street Journal, political veteran David Seib notes that the new reality will impose serious limits on the politcal agendas of both candidates:

The domestic agenda of the next president is shrinking. Nobody, anywhere, knows how much of a financial burden the federal government has taken on in the past few weeks, but the cost of bailing out Fannie Mae, Freddie Mac and American International Group Inc. -- to say nothing of the potential cost of riding to the rescue of American auto makers, which looks increasingly likely -- could conceivably run into the hundreds of billions...

Tax increases will be harder to sell. Sen. McCain is right: A period of a shaky economy is a bad time to talk about increasing taxes. And the economy as well as the markets figure to still be shaking in January from the shocks delivered. That's a problem for Sen. Obama's proposal to increase the capital gains tax.

But tax cuts get problematic as well in this environment. Though tax cuts to juice up a lagging economy make a lot of sense, the amount of tax revenue the feds bring in also will be a bigger issue -- especially if the Chinese and world financial institutions grow leery of continuing to loan money to finance American spending. Can the government afford to both bail out financial giants and take the big hit to its own revenues that would come from, say, eliminating the alternative minimum tax, as Sen. McCain proposes? Or are the government's needs for money now just too great? Either way, the next president's path on taxes is getting more complicated.

Instead of spending billions on a national health care system or anything else, we'll need to have a debate on the role of government in the economy:

The mega question -- what is the role of the U.S. government in the nation's economy? -- isn't just on the table, but at the center of the table. The next administration will have to decide not just what financial firms the government ought to own and run, but how heavy the government's hand should be. These are questions the country faced in the Great Depression, and to a lesser extent during the savings-and-loan crisis of the 1980s, but they are back with exclamation points, and will be dumped in the lap of the new president.

Whoever the next President is must accept that much of his agenda will need to be set aside to deal with these questions, as unprepared as they are to deal with them.