LFTC - Letter From The Capitol

Index 9/30/08

5 posts: (1) Pelosi's Pre-Vote Provocation--The Home Front; (2) The Bailout: Big Mac's Ace of Trumps; Democrat Deuces; Wild Cards--The Home Front; (3) Meltdown: The Fed Acts--"It's the Earth Stupid!; (4) Friday's Debate: Mac Wins My Vote; Loses Public's--The Home Front; (5) Sunset of The Sun: Death of a Great Paper--The Home Front.  Special 10:30 AM added posting: In unpleasant times, recall a happier Sept. 30: 1927, when Babe Ruth hit his 60th homerun (1:10), breaking his 1921 record of 59; the new mark lasted until 1961, when Roger Maris hit 61 HRs.

Pelosi's Pre-Vote Provocation

House Minority Leader John Boehner (R-OH), Minority Whip Roy Blount (R-MO, and Eric Cantor (R-VA) all explained the 228 - 205 House bailout vote failure as caused explicitly by the highly partisan comments (5:31) Nancy Pelosi made on the floor of the House just before the vote, in the same vein as when she announced the deal on Sunday.  Along with 133 Rs, 95 Ds voted against the deal.  65 Rs voted for the proposal, along with 140 Ds.  Thus, Ds supported the bill 60-40 while Rs opposed it 60-40.  Five Democratic Committee chairmen, plus pals of Pelosi, voted against the bill.  TAS Prowler says Ds wanted to have Rs put the bill over the top, and did not whip their members; top leader Rahm Emanuel was, BTW, a former board member of Freddie Mac.

In 30 years in Washington, I have never seen any leader of any party use the occasion of announcing the reaching of a difficult compromise, as the moment to bash the other party.  Always the praise has been for both sides working to reach a compromise. The Wall Street Journal editors chide GOP Members who switched their vote due to Pelosi's grandstanding, but the practical reality is that at times when a bitter pill is offered, real leaders hold their tongues.

The Dow Jones Industrial Average plunged 777.68 points, to 10,365.45, a numerical record (though at 7 percent about 1/3 the 22.6 percent plunge on the Black Monday Oct. 19 Crash of 1987).  The plunge wiped out $1.2 trillion.

NANCY, TAKE A BOW.

The Bailout: Big Mac's Ace of Trumps; Democrat Deuces; Wild Cards

Ace of Trumps.  House Minority Leader John Boehner (R-OH) explained how John McCain's intervention at the White House gave House GOP dissenters a seat at the bargaining table.  Without Big Mac's intercession, said Boehner, "They (the White House) would have run over me like a freight train."  The administration basically bargained with Democrats in Congress, ignoring its GOP base.  It is a characteristic of administrations that lose their vision and policy compass to bypass their base in striking major deals.

Deuces.  On the contrary side, check out this astonishing 2004 House video (8:37) of Barney Frank, Black Caucus lefties and Franklin Raines defending Fannie & Freddie.  This video rebuts Speaker Pelosi's absurd, partisan finger-pointing Sunday when she announced the bailout deal.  Even Bill Clinton acknowledges the culpability of Congressional Democrats at the end of the video, which also features Raines calling Fannie & Freddie "practically riskless."  NRO pundit Jonah Goldberg blames all Beltway types for failing to pass what Boehner called a "crap sandwich"; crapola, it seems, reigns inside the Beltway while the world economy burns.  Stanley Kurtz describes how thugs deployed by activist groups like ACORN harass banks and executives to force them to push more bad loans out to poor borrowers, undermining the credit system; his must-read article details how a top Obama ally who runs Chicago's chapter of ACORN deployed extortionist tactics against local banks, including contesting merger applications based upon lack of community "investing" required by the Community Reinvestment Act, the Carter law expanded by Clinton.  Pundit David Brooks styles the 228 "no" votes in the House as "nihilists" who jeopardize the world economy, while Bush & Paulson cannot exert needed crisis leadership.

Wild Cards.  Here is an academic paper by a Harvard professor suggesting four inter-related elements:

• No overpaying for troubled assets: The Treasury’s authority to
purchase troubled assets should be limited to doing so at fair
market value. 
• Addressing undercapitalization problems directly: Because the
purchase of troubled assets at fair market value may leave
financial firms severely under-capitalized, the Treasury’s
authority should be expanded to allow purchasing, again at fair
market value, new securities issued by financial institutions in
need of additional capital. 
• Market-based discipline: to ensure that purchases are made at
fair market value, the Treasury should conduct them through
multi-buyer competitive processes with appropriate incentives. 
• Inducing infusion of private capital: to further expand the
capital available to the financial sector, and to reduce the use of
public funds for this purpose, financial firms should be
required or induced to raise their existing shareholders.   

Economist John Makin urges Treasury to lift the $100,000 FDIC insurance ceiling on bank deposits.  Writer Matthew Continetti cites two chilling propositions from a financial author: (1) globalization makes economies less, not more, transparent; (2) governments no longer have the power to control economies that are vaster in size than can be controlled by any government, alone or even in concert with others.  Manhattan D.A. Robert Morgenthau fingers $3.4 trillion of fugitive capital secretly sloshing around in five financial havens as a source of world economic instability.  The Wall Street Journal Europe editors suggest that Europeans prepare their own bailout plans, and stop wallowing in schadenfreude at American hubris--in stark contrast to their self-perceived virtue.

MarketWatch chief economist Irwin Kellner explains why the Great Depression was much worse and this is not a bailout.  He needs to explain this to Main Street, not the folks who read his column.  UK Times columnist Geraard Baker fears a global economic Hurricane Katrina is inevitable, causing misery and, if governments do not do more, catastrophe.  One remedy may be to use the Citigroup - Wachovia deal as a model, with Citi bearing the first $42B of risk on Wachovia's balance sheet and FDIC the rest; FDIC got $12B in preferred stock & warrants in return for extending an insurance guarantee..

Perhaps the ultimate wild card this fall: Mona Charen recounts how ACORN was caught in massive voter fraud in Washington State: Their minions went to a Seattle public library and registered 1,800 names, all but 6--yes, 6--fraudulent.  They do this stuff all over the country.  In a close race they could steal the election for their political ally, Barack Obama.  She quotes a Fox News report on ACORN:

"The ACORN workers told state investigators that they went to the Seattle public library, sat at a table and filled out the voter registration forms. They made up names, addresses, and Social Security numbers and in some cases plucked names from the phone book. One worker said it was a lot of hard work making up all those names and another said he would sit at home, smoke marijuana and fill out the forms."

Stay tuned, fasten your seat belts and above all, hold on to your wallets.

Meltdown: The Fed Acts

Bloomberg News reports that the Federal Reserve injected $630 billion into the global financial system, including (a) increasing currency swaps with foreign central banks from $330 to $620 billion, and (b) increasing the Term Auction Facility from $300 to $450 billion.  One global index of 23 developed world stock exchanges fell 6 percent, close to the 7 percent drop in the Dow Jones Industrials.  Steve Forbes warns (5:51) that unless some form of bailout is enacted, we will see a replay of 1933 and what followed it..the Great Depression.  Economics scholar Judy Shelton explains how reliance on "fiat money" administered by mandarins at central banks--including the Fed--cannot bring stability to the world economy.  She calls for a gold standard restoration.  Well worth a read.

Friday's Debate: Mac Wins My Vote; Loses Public's

Public Verdict.  A CBS News poll showed 39% of viewers gave Obama the nod,24% gave Mac the win & 37% called it a draw.  Perhaps more significantly, Obama's favorable rating as ready to lead jumped 16 points, from 44% to 60%.  If these results are replicated in other polls. then Obama was the winner.  In political terms, this is all that matters.  Below is my own take, which gave Mac the nod.  I infer from this two propositions: (1) the public wanted an emotional connection with their candidate that Obama provided more of; (2) the public dismissed Mac's experience & judgment argument re foreign policy.  As I note below, polls that include voters who have heard about the bailout agreement reached early Sunday morning and blown up Monday afternoon will likely be skewed by such knowledge.

My Overall Assessment.  Friday's debate (transcript & video posted by NY Times) was the finest presidential debate since the 1960 Kennedy - Nixon debates, which were special because they were the first series, and thus repetitive verbal jousting over such mini-crises as Chairman Mao shelling two islands (Quemoy and Matsu) off the coast of Mainland China were tolerated.  Obama came out quickly, with sharper answers on the financial meltdown issues.  Mac picked up with substantive knowledge when pure foreign policy issues were discussed, and then finished strongly with experience arguments.

Economy.  Obama's strongest point was on spending freeze; he called Mac's freeze votes "using a hatchet when you need a scalpel."  Mac made an effective point on fighting wasteful defense spending, and added: "I'm afraid Senator Obama doesn't understand the difference between a tactic and a strategy."  Mac scored on veterans' benefits, an issue that, with his life story, is his against anyone.

Pakistan.  Obama blamed America backing dictators for our troubles in Pakistan.  Mac said--correctly--that we walked away from the country after the end of the Soviet - Afghan War.  The full story, told by neither candidate: We left Pakistan in the economic lurch, by walking away, not helping them cope with several million afghan refugees in camps on Pakistan's northwest frontier area, by keeping some $700 million in funds sent for F-16s, but not delivering them.  Our reason: to punish Pakistan for pursuing a nuclear program in violation of the Nuclear non-Proliferation Treaty (NPT).

Iraq.  Mac scored solid, emphasizing his support for a surge Obama declines, even now, to admit he was wrong about.  Also, Mac connected Iraq to Afghanistan and Iran.  Mac noted that both Generals Petraeus & Osama bin Laden called Iraq "the central front" in the war.

Afghanistan.  Mac explained the need for a new strategy, while Obama dwelled on the "we missed bin Laden" standard position.  Mac cited his many trips to Afghanistan, and his knowledge of why the current strategy is foundering.

Iran. Obama said he would seek the support of Russia & China, a goal almost certainly not achievable.  Mac cited the "negotiations without preconditions" original stance of Obama--which Obama has since modified to low-level negotiations, versus his original stance of presidential negotiations without conditions.  (An exchange over what Henry Kissinger advocated as to direct negotiations, whether they should be at the presidential or lower level, was resolved after the debate by HK himself, in favor of Mac.  Younger voters, to be sure, have no idea who Henry the K is.)  For his part, Obama, re his earlier stated willingness to meet Iran's leaders, stated that he regarded other leaders in Iran as more important than President Ahmadinejad.

Russia.  Mac scored by pointing out that Obama's first stance when Russia rolled into Georgia that "both sides should show restraint."  Mac used his "I looked into Putin's eyes and saw K-G-B" quip to separate himself from President Bush, who famously peered into Putin's "soul" (which Putin utterly lacks) and saw a good person.  The problem: With the average voter 44 (the same age as Michelle Obama & Sarah Palin), many have no idea what the KGB was, i.e., the secret police and intelligence service in the former Soviet Union.  This is a problem with all historical references Mac made.

Missile Defense.  Obama endorsed a shield against Iran, something I do not recall him doing before; indeed, I recall he was against it.  Obama referred to the threat of a terror "suitcase nuke"--a weapon that does not exist, as footlocker size is the smallest Russia has achieved.  He dismissed the nuclear missile threat from the likes of Iran, which ignores the threat posed by an EMP (electromagnetic pulse--see my recent LFTC entry on this danger) attack from a single high-altitude nuclear detonation over Kansas, that could knock out most of America's electric grid and communications infrastructure.

Demeanor + Soundbites.  Both candidates acquitted themselves well.  Obama's demeanor faltered here and there, not as hesitation but as grimaces and shaking his head.  But nothing major was done.  The Focus Group assembled by GOP pollster Frank Luntz gave Obama the nod, due to his seeming to care for everyone in America.  The FG dismissed experience arguments as past history.  There were neither super-gaffes nor memorable sound bites.  NRO's Byron York notes that Obama said "Senator McCain is absolutely right" no less than 8 times during the 90 minutes.  Odd, but will voters see that as giving in, or being nice?

Friday Bottom Line.  The format proved crisper than earlier years, with direct exchanges and without the canned opening and closing statements.  Jim Lehrer, as always, was the perfect moderator, asking straight questions without the media wiseacre grandstanding that helped ruin debates in the 1970s, 1980s & 1990s.  Mac finished strong, and won the foreign policy segment by more than Obama's superior start won the economic part.  I do not think Obama "closed the deal" Friday night. but I do not expect a major move in the polls in either direction.  Tuesday's 3-day presidential tracking polls will give the first all-post debate sample result.  The best debate contrast between the two was drawn by Washington Post columnist David Ignatius, who called the debate one between a prime minster & head of government (Obama) and a president & head of state (Mac); the former stresses programs, the latter, themes.  Another contrast, between styles, is drawn by Fred Barnes: the Warrior (like FDR) versus the Priest (like Woodrow Wilson).  Myrna Blyth captures a key factor favoring Obama: the ignorance many Americans have of history, and the disdain for its lessons.

One more thing: The transformation of Barack Obama from "new" politics to the "old" is now formally complete.  There was none of the magic carpet "change we can believe in" stuff last night.  Just two pols slugging it out for 15 rounds, punching & counter-punching from the opening bell to the closing bell.

Post-Debate Polls.  Today's tracking polls are the first 3-day polls taken entirely since the conclusion of Friday's debate.  Their results, however, are surely conflated with public reaction to the Bailout mess.  Thus any assessment of the Friday debate's impact is necessarily far more conjectural than usual.  Thursday's vice=presidential debate offers the first relatively clean glimpse into how the debates may sway public perceptions, and how such voter attitudes may affect the two tickets.  Scott Rasmussen's latest presidential tracking poll number shows Obama leading McCain 50-45.

Future Debates.  The closeness of this debate puts an unusually high premium on the Thursday, Oct. 2 vice-presidential candidate debate.  Palin must get at least a draw with Biden, who will be solidly favored and must pay special attention to his demeanor vis-a-vis Palin.  Biden is a decent sort, and should manage this.  Mac, for his part, can learn from his sub-par economy performance, to prepare better for the Oct. 15 domestic policy presidential debate, when the will be no foreign policy segment to enable him to recover from a shaky start.

Campaign Politics:  Main Street & Wall Street Decoupled.  Fortune pundit Nina Easton sees a populist fury sweeping Middle America, laced by skepticism that the bailout is necessary to rescue Main Street.  Rather, Main Street sees Wall Street moguls bailing out their friends, and asking the taxpayer to help out.  John McCain should be worried.

Sunset of The Sun: Death of a Great Paper

The economic meltdown has claimed a valuable national resource: The New York Sun ceased publication today, unable to raise sufficient capital to continue, after 6 great years.  It is simply irreplaceable.  A Wall Street Journal editorial salutes a local--and national--asset lost.

Index 9/29/08

3 posts:(1) Financial 9/11: Bailout Discussion Draft--"It's the Earth Stupid!"; (2) Financial 9/11: A Brief Securities Primer--"It's the Earth Stupid!; (3) Merrill's Bad Assets: My Bad Entry--OOPS!

N.B., Due to the tentative resolution of the financial meltdown, my assessment of the Friday presidential debate will run on LFTC tomorrow, instead of today.  A collateral benefit of the delay is that Tuesday will bring the first 3-day presidential tracking polls taken with all 3 days polling done after the debate.

Financial 9/11: Bailout Discussion Draft

Public Policy Quote of the Century?  Jay Leno said on his Sept. 23 show: "See, you know the way a bailout works? Here's the way a bailout works. A failed president and a failed Congress invest $700 billion of your money in failed businesses. Believe me, this can't fail."

The Agreement.  The First Discussion Draft (FDD: 106 pages) of the Emergency Economic Stabilization Act of 2008 (EESA) was released Sunday afternoon.  Within hours a Second Discussion Draft (SDD: 110 pages) was released; not having it, I use the 106-page version for this posting.  The one major change that I noticed was elimination of the slush fund for community activists.  One technical change of note was a bunch of extra pages detailing tax treatment.  The rest seems essentially the same.

The Agreement's 8 Points in Broad Outline:

(1) commits up to $700 billion (more than the current estimated direct $650B cost of the Iraq War) from the federal Treasury to shore up the financial system, in three stages), by buying stakes--in the form of warrants to buy non-voting common stock, in firms loaded with distressed mortgage-backed securities (MBS) as assets on their balance sheets.  The $700B incorporates (a) an immediate Treasury commitment of $250B; (b) another $100B if needed, upon a report by the president submitted to the Congress; and (c) the remaining $350B upon presidential decision, with Congress given 15 days to vote its disapproval, else the funds are authorized for disbursement.

(2) commits the government to take stronger action than taken so far, to prevent foreclosures on homes covered by MBS assets purchased by the government, but bars bankruptcy judges from taking such action.

(3) limits pay for executives at failed firms, especially as to golden parachutes, and denies tax exemptions for amounts paid that exceed $400,000 (the salary of the President of the United States) at failed firms.

(4) imposes stringent conflict-of-interest rules on those administering the plan.

(5) imposes stronger oversight by Congress than contemplated in the Paulson Plan.

(6) requires the President to propose a fee on financial services firms to cover any losses incurred by the government that remain after five years.

(7) requires the government to create a federal insurance program to guarantee troubled assets at banks & financial firms.

(8) defers to the next administration & Congress the issue of how to pay for losses incurred by the government arising out of purchase & resale of distressed assets.

The administration gave in on terms of staging the outlay of up to $700B, plus (3), (5), (6) & (7).  (2) saw both sides give, with the GOP accepting foreclosure authority for the administration.  Democrats gave on two demands: (1) a slush fund for community activists; (2) that bankruptcy judges be empowered to adjust mortgage foreclosures. Points (4) & (8) were agreed o without reports of concessions attributable to a given side.

The Agreement: Highlighted Details.  There are three Titles in the Draft: Title I establishes a Troubled Assets Relief Program; Title II sets Budget-Related Provisions; Title III provides Tax Treatment Rules.  The purposes of the law: (1) restore liquidity and stability of the financial system; (2) protect the value of homes, college funds, retirement accounts & life savings; (3) preserve home-ownership; (4) promote jobs & economic growth; (5) maximizes overall returns to the American taxpayer; (6) provide public accountability for the exercise of such authority.

What follows are noteworthy sections based upon my rapid review of the Draft; I left out many technical procedural and reporting matters I deemed not of sufficient import to write up--especially on short notice.

Assets Covered.  Sec. 101 establishes a Troubled Assets Relief Program (TARP); sec. 101(e) empowers the Treasury Secretary (TS) to take action the TS deems "necessary to prevent unjust enrichment of financial institutions...including by preventing the resale of a troubled asset...at a higher price than what the seller paid to purchased the asset."  Exceptions: assets per merger or acquisition, in conservatorship or receivership (the former includes Bear Stearns & AIG) or where bankruptcy proceedings are underway.  Under sec. 102, Troubled Asset (TA) insurance guarantee coverage applies  to TAS issued prior to March 18, 2008.  Under 102(c) the TS sets insurance premiums paid by applying firms for the feds insuring TAs.

Community Activist Slush Funds.  Sec. 103 gives as one consideration the TS is to take into account in running the TRAP the needs of "financial institutions, including those serving low- and moderate-income populations and other underserved communities, and that have assets less than $1 billion, and that were well or adequately capitalized as of June 330, 2008 [that suffered assets class losses due to Fannie & Freddie going into conservatorship]."

Sec. 106(d) of the First Discussion Draft provided that up to 20 percent of profits realized from sales of TAs shall be deposited in two funds: 65 percent into the Housing Trust Fund and 35 percent into the Capital Magnet Fund.  These funds support "affordable housing."  This provision was stripped from the Second Discussion Draft.  Sec. 116(a)(1)(H) sets as one criterion for "the efficacy of contracting procedures "..."contracting to the maximum extent possible of minorities, women, and minority-owned and women-owned businesses."  In other words, affirmative action rules apply to the TARP.  This provision survived in the SDD, and may accomplish indirectly what the FDD's slush fund was aimed at doing.  Slush fund payments empower activists--this TAS piece details how they operate--that push a radical left-wing agenda.

Executive Compensation.  Existing arrangements are grandfathered.  (This appears required by U.S. Constitution, Art. I, sec. 10, which, in pertinent part, that no State shall pass any law "impairing...the Obligation of Contracts.")  CEOs, CFOs *Chief Financial Officers) & certain other key employees are covered.

Foreign Investors Covered.  Sec. 112 directs the TS to coordinate with foreign "financial authorities" in buying or insuring TAs in U.S. institutions held by foreign investors.

Costs & Benefits to U.S. Taxpayers.  Sec. 112 generally directs--no surprise--that the TS maximize returns & minimize costs to the taxpayer.  Any TA purchase must give the TS warrants to receive non-voting common stock, or preferred stock, or a senior debt instrument, depending upon the kind of financial institution.  Warrants can be converted to senior debt if the common stock of a financial firm seeking protection is no longer traded publicly.  Warrants may not be diluted in financial value by a financial firm seeking protection, by virtue of any changes to the firm's capital structure (stocks & bonds, etc.).

Market Transparency.  Sec. 114 requires posting transactions on the Internet within 2 days of exercise.

Timing of Funding.  Sec. 115 allows, as noted above, the $250B, $100B & $350B stages for the $700B total potential outlay under the TARP.

Leveraging & Deleveraging.  The Comptroller General must issue a study of the impact of leveraging & deleveraging, by June 1, 2009.

Judicial Review.  Sec. 119 contains detailed provisions for judicial review of actions taken by the TS that are unlawful and can be set aside if found by a court to be "arbitrary, capricious, an abuse of discretion, or not in accordance with law."  Expedited legal proceedings are required.

Termination.  Sec. 120 provides for December 31, 2009, unless a two-year extension is requested and granted.

Mark To Market (MTM).  Sec. 131 allows the Securities and Exchange Commission (SEC) t0 suspend MTM rules at SEC discretion.  Sec. 133 calls for the SEC to issue an MTM study of the market impact of MTM rules within 90 days of the effective date of enactment of EESA.

Tax Treatment.  Under Sec. 310, transactions under the TARP post-Dec. 31, 2007 are treated as ordinary income.

The Agreement is, as typical of such high-stakes negotiation under time pressure, a hastily cobbled-together fix, driven by intense outside political and media pressure, with staffers pulling a college-student all-nighter to draft suitable language.  In all, agreement took 10 days from announcement of the Paulson Plan.  A House vote is expected Monday; the Senate will vote later, possibly as late as Wednesday.  Treasury officials privately said that if the deal falls through the stock market might lose 1/3 of its value.  By comparison, the 1929 stock market crash wiped out 25% in two days and 40% in two months ($100B in value), but the market did not bottom out until July 1932, with the Dow Jones Industrial Average at 41.22, down 89.2% from its 381.17 value before the 1929 Crash.  The Crash of 1987 wiped out 22.6% ($500B in value), the biggest single-day loss in stock market history (which dates back to 1790).

Was It a Good Deal?  Bill Kristol wrote Saturday that he received calls from two prominent economists, only one of whom--Larry Lindsey, former Chairman of the Council of Economic Advisers under Bush 43--saying that Fortis, a huge European bank, might fail, and that Wachovia (which has $812 billion in assets) might also fail.  Hence, immediate action was necessary to avert global financial panic, one that could trigger successive bank defaults, depositor runs, liquidity crises and massive stock market sell-offs.  Such knowledge surely reached negotiators.  The two economists told Kristol that two actions need immediately be taken: (1) guarantee 100% under FDIC for all bank transaction deposits; (2) use Treasury's Exchange Stabilization Fund to provide unlimited credit to money market funds.

Turn now to another executive pig-out: the payments made by Washington Mutual S&L to new CEO Alan Fishman.  On Sept. 7, WaMu paid a $7.5M "signing bonus" to their new CEO.  On Sept. 25--just 18 days later--as WaMu went belly up in what is the largest bank failure ($1.9B) in American history, Fishman walked away with a golden parachute of $6.15M, per his severance agreement.  $13.65M for 18 calendar days on the job--let's assume that with WaMu tottering the new CEO worked 7-day weeks--is equal to $758,000 per day.  If he worked only 5-day weeks?  It would be $1,062,000 per work day.

Per Ira Gershwin's lyrics, that is "nice work if you can get it, and you can get it if you try...."  (What one has to try to do to get a contract that sweet is to cozy up to clubhouse pals sitting on some corporate board who would sign a financial looting like that over to you.)  Let The Wall Street Journal's Pepper & Salt Saturday cartoon encapsulate perfectly the spirit of executive pig-outs & non-performance.

Michael Barone sees an historic return to socialized government not seen since FDR's New Deal + LBJ's Great Society, reversing the Reagan Revolution of 1981.

Economics and the Agreement.  A Wall Street Journal article alerts readers to imminent economic bad news, none of it dissipated by the agreement: (1) while foreclosures continue to prop up existing home sales, they may be discouraging new housing starts; (2) durable goods orders dropped sharply last month; (3) jobless claims are rising, with 7% unemployment anticipated by the Spring of 2009; (4) 3Q08 is likely to see the first quarterly drop in consumer spending--which drives 70% of GDP -- in 17 years; (5) GDP growth for 2Q08 is expected to be revised downward to 2.8% from 3.5%.

A real estate executive warned that because the $200 billion commercial mortgage-backed securities (CMBS) market is frozen, the next casualty had the government failed to act decisively (or, if the government's measures fail to stem the meltdown) is the commercial real estate market, despite a default rate of 0.47% on CMBS loans and a default rate of 0.3% on life insurance company-owned commercial mortgages.  The exec details the impact of real estate on the economy, with a direct and indirect impact of nearly $3 trillion on our !4T GDP:

The stakes for the economy are enormous. Overall, real estate directly and indirectly generates economic activity equivalent to about 20% of GDP. It encompasses an estimated $20 trillion in owner-occupied housing, and approximately $5 trillion in income-producing commercial property. It creates some nine million jobs and generates billions of dollars in federal, regional and local tax revenue. Local governments, especially, depend on this revenue (approximately 70 cents of every local budget dollar) to pay for public services such as education, road construction, law enforcement, and emergency planning and response.

Manhattan Institute scholar Nicole Gelinas raises troubling questions, in anticipation of the bailout deal being consummated, as in fact happened a day later.  Central to her arguments is that the reputation of America's securitization business model is severely damaged, and hence investors will be chary of further purchases--at least, at current prices.  Should the Treasury purchase credit default swaps--the complex financial derivatives at the root of Wall Street's woes--it may face liabilities under those contracts extending many years into the future.  Also, Treasury does not know how to value these, so finding a purchase prices at which the Treasury can make money will be very hard.

Politics and the Agreement.  Unforgivably, in her public statement after release of the Discussion Draft, House Speaker Nancy Pelosi blamed the administrations exclusively, for deregulation plus lack of regulatory oversight.  In refreshing contrast, Treasury Secretary Hank Paulson praised those in both parties who worked with the administration to produce the Discussion Draft.

GOP negotiators failed to keep out of the final deal a Democratic proposal, euphemistically referring to "affordable housing," that amounted to a second pig-out: a public trough for community activist groups like ACORN (an Obama favorite), whose pushing for more loans to the poor helped create the fix we are now in (and who are the prime engines of massive urban vote fraud to help Democrats in elections).  These groups were to get at least 20 percent of any profit the government makes of the bailout--despite having taken zero financial risk.  They would have drawn this before--yes, BEFORE--any profits went to the taxpayers, who are paying for the bailout and thus assuming the risk.

Here is the sec. 106 language confirming this hijacking:

"Deposits. Not less than 20% of any profit realized on the sale of each troubled asset purchased under this Act shall be deposited as provided in paragraph (2).

"Use of Deposits. 65% shall be deposited into the Housing Trust Fund established under section 1338 of the Federal Housing Enterprises Regulatory Reform Act . . . ; and 35% shall be deposited into the Capital Magnet Fund . . .

"Remainder Deposited in the Treasury. All amounts remaining after payments under paragraph (1) shall be paid into the General Fund of the Treasury for reduction of the public debt."

ACORN (Assn. of Community Organizations for Reform Now) is a monster umbrella group of 160 subsidiaries whose annual budget totals $110 million--mostly inhaled via the public trough, in an activist group racket started by LBJ's Great Society 40 years ago.  Radical, left-wing, at times violent, ACORN is at Ground Zero of the subprime loan catastrophe, working with community organizers such as...Barack Obama.  Their home page has a Big Lie re the Friday debate, blaming deregulation and asserting that ACORN pushed for sound lending standards.  In fact, they pushed every bad loan out the door that they could foist off on Fannie & Freddie.

Bill O'Reilly pinpoints what may be the Achilles heel of any bailout: the financial meltdown caused a loss of confidence, not only in Wall Street, but in Washington's ability to police the financial system.  He writes that Obama's universal health care & Mac's tax cuts are history due to the financial hole in the federal budget.  that former should be, the latter shouldn't be, but in times of perceived emergency politics trumps economics every time.  This impelled conservatives like the Wall Street Journal editors support the Paulson Plan, despite its flaws, over the "insurance" model proposed by House GOP members.

As for the candidates, Wes Pruden captures the biggest difference between Obama & Big Mac on this: Obama stayed back, above all trying to avoid making a big mistake; Mac charged forward, suspending his campaign and plunging into negotiations that Democrats had no intention of allowing to make Mac look good.  It is the difference between a lawyer who "talks the talk" and a fighter jock who "walks the walk."

Bottom Line.  The key to credit recovery is price discovery--harder today, as the WSJ editors recount in a telling of how J.P. Morgan single-handedly rescued the country from the Panic of 1907 (which led to the 1913 creation of the Federal Reserve).  Merrill Lynch's sale of $30B of bad assets for $7B suggests a steep decline in asset value.  The Second Discussion Draft has serious defects:

--  (1) It is incomplete, because it fails to address bank run risks.

--  (2) It fails to protect taxpayer equity investments in failed firms, because it provides non-voting common stock rights, rather than giving the government voting stock in exchange for investing.

3) It partially cures the defect by allowing the government to invest in preferred stock, but does not specify voting rights for such securities, which normally do not carry voting rights, but should in this extraordinary case, because of the financial risk taxpayers assume in buying bad assets.

-- (4) The assets being purchased are complex, opaque and thus impossible to value by any existing valuation yardstick, and thus the government is likely to overpay.

-- (5) The reverse auction process, by which a buyer seeks the lowest from among several sellers, does not protect against sales at higher than normal prices, as sellers may have better knowledge of what they are selling than the government does of what it is buying.

-- (6) It fails to assure recoupment of executive pay excesses in full, a moral essential to justify taxpayer bailout of failed firms, and to deter future "clubhouse" looting of financial firms.  Legislation is needed to amend the "business judgment rule" to establish a presumption against big payouts as being against the interest of failing firms, and to deny the defense of standard industry practice to executives drawing large bonuses and parachutes from failed firms.  What is "excessive" or "large" should be decided by caselaw.  The Clubhouse is not capitalism; it is looting.

-- (7) By allowing judicial review of decisions by the Treasury Secretary, it empowers litigants from a gaggle of activist groups to tie up every decision in court proceedings, albeit expedited ones.  The proper remedy for "arbitrary and capricious" rulings should be petitions to elected officials and the ballot box, not resort to unelected judges.  A single wayward judge could tie the process up in knots while markets gyrate.

Despite these serious defects, in the absence of ability to agree on something better, this bill probably deserves to pass.  Parties deeply divided by ideology, bargaining in the heat of a momentous election season, can hardly be expected to produce a canvas by Rembrandt.  The financial markets, in the event, care more about balance sheet restoration than about Rembrandt.  Indeed, balance sheet restoration will be needed to enable more financial wizards who do care about Rembrandt to afford his paintings.

Financial 9/11: A Brief Securities Primer

Talking about financial meltdowns and options for fixing them inevitably involves jargon.  LFTC readers have at times indicated that more definitional groundwork needs to be laid.  Herewith a few of the gazillion terms tossed around on the news programs:

Common Stock - A security that gives the holder an equity ownership interest in a company.  Stockholders (shareholders) can receive dividends paid by the corporation.  In event a company is liquidated, stockholders stand last in terms of reviewing assets, after holders of senior securities are paid off.

Bond - a security representing a loan arrangement between lender (bondholder) and borrower (company or unit of government).  A bond carries a coupon, paid annually in the form of interest.  If held to maturity the holder is entitled to payment of face (par) value--100 percent of the face value of the bond.  In event of liquidation, senior bond issues come first, and if there are not enough assets to satisfy, bondholders not yet paid off get less than 100 cents on the dollar, and stockholders get nothing.

Warrants - a security in the form of an exercisable "right" that is convertible into stock at the option of the holder, at a given "exercise price."

Preferred Stock - a hybrid security that combines the features of common stock--ownership equity, with that of a bond--payment of an annual interest rate.  In event of company liquidation, preferred stock holders are junior in credit status to bondholders but senior to common stock holders.  Preferred securities rarely carry voting rights given equity holders.

 Numerous forms of hybrids exist.  Perhaps most common are "convertible bonds": bonds that can, at a "conversion price," by converted to stock, at the option of the holder.

Deciding what kind of investment stake the federal government should have if it invests in financial firms as part of a bailout involves weighing the various considerations as to the risks & rewards of ownership versus those of debt.  Specialized hybrid instruments can be created to give the government superior interests that combine advantages of both and minimize risks of both.  A practical consideration, however, is that if the government takes all the good stuff, it risks "crowding out" private investment that might otherwise take place.

Merrill's Bad Assets: My Bad Entry

I recently wrote in LFTC that Bank of America paid 22 cents on the dollar for that portion ($30B) of Merrill Lynch's portfolio that held troubled assets.  The actual buyer of the bad stuff was Lone Star Fund (of Texas).

Index 9/26/08

4 posts: (1) Financial 9/11: America Embraces Social Capitalism--The Home Front; (2) The Debates: A Preview--The Home Front; (3) Big Mac's Progress: Palin-Powered--The Home Front; (4) Palin Watch: Michelle's Miscue, Rangel's Rip & Media Mugging--The Home Front.

Financial 9/11: America Embraces Social Capitalism

George Will frames the power sought by Hank Paulson under his Plan as as America's financial socialism successor to Lenin's "commanding heights" socialism and Great Britain's post-World War II industrial socialism.  Read Will at his astringent best.  Animating that plan is yesterday's largest bank failure ever in America, the $1.9 billion S&L Washington Mutual, taken over by JP Morgan Chase.  Fox News documents repeated attempts by the Bush administration to get Congress to act on Fannie & Freddie, all stymied by the Democrats.  Tallying trillions available for investment--$.4T in money market funds and nearly $6T in time deposits--the NY Post editors call for private investors to step in.

Steve Forbes fingers mark-to-market (MTM) and a weak dollar as the main obstacles to recovery, and notes that there is $56T in household assets to ride out the storm.  Two former top regulators defend MTM as a guard against accounting chicanery.  That is true, but MTM works well only for assets whose value is readily and repeatedly determined by actual marketplace transactions; it works poorly for assets like complex derivatives, whose value is rarely tested.

But such facts are O.B.E.  Aeschylus quipped that "In war, truth is the first casualty."  Ditto for financial meltdowns.

Writing in Manhattan Institute City Journal, John Avlon rejects the Paulson Plan:

While a sense of crisis is often the only way large-scale legislation is passed in Congress, it’s also how epic mistakes are made. In our panic and desire for protection, we are in danger of forgetting that it’s both right and reasonable to question King Henry—especially with the looming threat of saddling future generations with unprecedented debt. With every day marking a new economic milestone, it’s easy to overlook the fact that the scale of the bailout dwarfs anything in the history of printed money. Here’s a reality check: the current (conservative) $700 billion price tag is larger than those of the federal departments of defense, homeland security, and justice—combined.

What is clear is that taxpayers will be left to foot the bill for decades to come as Main Street bails out Wall Street—all while the nation is at war, facing record deficits, and preparing for a demographic tsunami of rising entitlements with the approaching retirement of the baby boomers. The S&L bailout of 20 years ago pales in comparison, not only because of its comparatively modest taxpayer price tag ($124 billion), but also because in that case the U.S. retained companywide assets that were later auctioned off. In this case, taxpayers are being asked to assume all of the risk and none of the positive underlying assets. It’s a lose-lose deal.

Avlon offers a better way:

Those better ways include making secure loans to the afflicted organizations, protecting taxpayers, and holding firms’ management accountable for their mistakes. This will stop the asset run and require the companies to sell their remaining assets at market prices, instead of holding out for a better payday at taxpayer expense. And reasonable restrictions are needed to ensure that not one cent of taxpayer money goes to executives at the companies we are bailing out in the form of bonuses or any other type of compensation. Their greed or mismanagement drove these companies into the ground, and American taxpayers should not subsidize their newest house in the Hamptons.

Make no mistake: the fiscal crisis is broad and real and needs to be addressed comprehensively. Paulson might yet prove to be one of the greatest Treasury secretaries in American history—the right man at the right time. But rushing to enact the wrong bailout plan will compound the problem and restrict government’s ability to deal with the looming recession. A blank-check bailout will be quickly characterized as a lifeline for billionaires. Deliberation is not the same thing as delay, and dissent is not disloyal.

James V. DeLong of TCS Daily presents a solid case in support of the Paulson Plan.  It fails to persuade me, but is worth a read.  Andy Kessler, long with Forbes, defends the Plan, asserting it could net $1 trillion to $2.2 trillion for the Treasury.

Martin Wolf urges alternative plans that do not make the government the owner of dicey securities, including forced recapitalization of banks, government investment in special class preferred securities free of toxic taint; the details of his alternatives merit a read.  Investment firm chieftain John Paulson (related to Hank?) calls for government to follow Warren Buffet, and invest $700 billion in the form of senior preferred stock + warrants in troubled institutions, rather than buying up their bad assets.  Noting that the Paulson Plan subsidizes the very firms that helped create the monster mess, and gives too much discretion to a single official, J. Paulson states of his Preferred Plan--which sounds like a far better investment vehicle than the Paulson Plan:

Shareholders had their dividends blocked and remain first in line to bear losses, as they should have been. Taxpayers came both first and last -- first to get paid back, as the new preferred stock is senior to all shareholders; and last in realizing losses, as common and other preferred equity would be extinguished before the taxpayers would be at risk.

This mechanism -- purchases of senior preferred stock with warrants in troubled institutions -- addresses the problems with the Treasury plan. The financial market is stabilized, companies get recapitalized, failures are avoided, debt securities are supported, and time is gained for illiquid assets to mature.

The institutions continue to function, their cost of funding will decline as equity capital increases, and innocent third parties like bank depositors, broker/dealer clients and insurance-policy holders are all protected. The only difference is that potential losses are kept with the shareholders where they belong.

The Treasury plan would also entail larger outlays than the Preferred plan. By allowing all banks to sell their worst assets to Treasury at inflated prices, taxpayers would be subsidizing healthy banks which have access to private capital (Goldman Sachs, J.P. Morgan, Wells Fargo, and Bank of America, for example) as well as banks that don't have a private alternative. But under a Preferred plan, only banks that don't have a private alternative will be given federal assistance. This would reduce the outlay otherwise required to solve the crisis.

Two top experts at the Bookings Institution provide guidelines for fixing the financial mess.  They note that in the summer of 2008 action was taken to adjust 500,000 residential mortgages, getting lenders and borrowers to agree to a 15 percent haircut to prevent foreclosure; in 2009, another 2 million home buyers are expected to face foreclosure.  The authors propose three guidelines for reform: (1) greater transparency; (2) less leveraged, more liquid financial institutions; (3) more aggressive oversight.

Senator Hillary Clinton proposes a new Home Owner's Loan Corporation (HOLC), modeled after FDR's 1933 institution of the same name.  It would assume the 2 million home ARMs facing foreclosure--valued at $3 trillion--and modify the terms so that homeowners can stay in their homes and work out their problems over time.  Also, if the Treasury antes up to buy bad assets, she says that it must share in any profits realized.

The architects of the Resolution Trust Corporation that engineered the S&L clean-up offer lessons from their experience.  Critical is that the RTC bought most assets from thrifts that had already failed--not to be the case here.  Problems of "fair value" pricing could thus easily lead the government to overpay.  Assets must be jettisoned quickly, lest an overhang depress prices.  Valuation entails numerous local factors, hard to assess.  Read their op-ed in full.

Former Bush 43 Chairman of the Council of Economic Advisers, Lawrence B. Lindsey, spots several flaws: (1) legislation was not ready when the plan was presented; (2) to prevent massive bankruptcies, the government must pay higher than market rates; (3) pricing is too opaque for the government to make it work, and thus too easily gamed by sharpies.  Lindsey suggests, in the spirit of Hillary, that instead the government bail out homeowners by allowing them to refinance at, say, 4 percent, with lenders as well as borrowers on the hook.  Those who wish to default may do so.  This separates the bad from the OK mortgages for which workouts may obviate the need for bailout.  This idea also seems vastly better than the Paulson Plan.  Monetary economist Alan Meltzer says that Paulson and Bernanke should be talking to bankers, not Members of Congress.

Bottom Line.  Economist Irwin Stelzer pinpoints the forces driving the death of Reagan capitalism: fear of systemic breakdown sending buccaneer firms into the government's arms, populist fury at executive salaries exempt from the market discipline everyday workers face, globalized trade causing socially disruptive labor shifts, all transforming the balance between economic growth and its collateral social effects towards the latter:

Instead we have a capitalism in which financial institutions trade freedom for the protection of access to the government's balance sheet (Goldman Sachs and Morgan Stanley). In which institutions under stress accept pervasive government regulation in return for insurance against failure. In which the advantages of free trade are sacrificed in the interests of preserving jobs in industries best left to adjust to the winds of change. In which regulation of executive salaries is seen as a necessary political price to pay for preventing systemic failure of the banking system. In which taxes on the "rich" and not-so-rich are seen as necessary to offset the inequities of the income distribution system created by capitalism as we have known it.

Can Horatio Alger--America's enterprise paragons such as Steven Jobs, Michael Dell and Sam Walton--survive the socialization of our market economy?  I fear we will see fewer in America's future.  The socialization of a major sector of America's economy--a goal that eluded Hillary with her 1993 health care plan--may become George Bush's signal domestic policy accomplishment.  That will be Wall Street's ultimate gift to the Democratic Party that the Masters of the Universe favored so lopsidedly with their donations that bought vast political influence.

Such a gift, alas, may be the ultimate "Greeks bearing gifts" Trojan Horse: socializing the American economy.

The Debates: A Preview

Here are details for the four debates, all of which begin at 9 PM EST and run 90 minutes.  Tonight is the first presidential debate (of three), and will focus on foreign policy, with PBS's Jim Lehrer as moderator.  Thursday, Oct. 2 is the vice-presidential debate, covering domestic & foreign policy, with PBS's Gwen Ifill as moderator.  Tuesday, Oct. 7, is the second presidential contest, in the form of a town meeting, with topics determined by the questioners (and, presumably, in part by those who screen the questions first), with NBC's Tom Brokaw as moderator.  The last presidential debate is Wednesday, Oct. 15, and is on domestic policy, with CBS's Bob Schieffer as moderator.

Notable are two changes from prior debate formats: (1) the town meeting debate adds questions fielded from the Internet to those taken from the audience in attendance; (2) the other three debates will be divided into 8 10-minute issue segments, leaving 5 minutes each for opening & closing statements.  A single moderator will conduct the three debates by interposing questions to facilitate exchanges between the candidates.  A further concord between the campaigns allows for more free-flow exchanges between the presidential candidates, while preserving a structured format, with no free-flow exchanges, between the vice-presidential candidates, given that Governor Palin has little debate experience.

The history of Presidential & VP debates offers clues on what to expect:

-- In 1960, JFK lost on points to Nixon on radio, but won on TV, with his movie-star looks & boyish charm.

-- In 1976, alter Mondale beat Bob Dole in the '76 (first-ever--thank God we were in 1960 spared an LBJ - Henry Cabot Lodge debate) VP debate, countering sarcasm ("Democrat wars") with steadiness, in the presidential debate Gerald Ford committed the gaffe of prematurely (by 13 years) liberating Poland.

-- In 1980, Ronald Reagan bested Jimmy Carter by reassuring voters that he would not start a nuclear war, while Carter promised to consult is pre-teen daughter Amy on nuclear proliferation (she probably had less-bad ideas than her dad).

-- In 1984, Reagan recovered from a meandering verbal drive down the San Bernadino Freeway at the end of the first debate, by hitting the age issue out of the park (Reagan was 73, Mondale 56): "I'm not going to use my opponent's age as an issue in this campaign!"  Even Mondale laughed.

-- In 1988, Lloyd Bentsen froze Dan Quayle with his "I served in Congress with Jack Kennedy, I knew Jack Kennedy, Jack Kennedy was a friend of mine and Senator, you're no Jack Kennedy!"  But Michael Dukakis gave his "chalk on a blackboard" answer to what he'd do--dispassionately leave matters to the law--were his wife raped & murdered (a reference to the GOP's Willie Horton ad about the murderer Dukakis furloughed, who then invaded a Maryland couple's home--though Al Gore has also raised the issue in the primaries).

-- In 1992 & 1996, the debates produced an avalanche of Sominex consumption.

-- In 2000, Al Gore's grotesque rudeness--rolling his eyes, shaking his head, waving his arms, walking in front of George Bush--convinced Americans that they did not want Al in their living rooms for the next four years.

-- In 2004, Dick Cheney & Joe Lieberman had perhaps the best, most civilized debate of all the debates over the years, a pleasant surprise to viewers cringing in anticipation of another boring 90 minutes.

I have watched nearly all the debates--see this debate history page at the Commission on Presidential Debates website--missing only several in 2000 while traveling in India & Bhutan (a lovely little country where the debates were not a hot topic)--I did see the first debate, one AM in Hong Kong.  They mattered in 1960, 1976, 1980 & 2000, probably deciding the elections.  Nothing in 1984, short of Reagan fainting on stage, could have saved Mondale.  Dukakis's gaffe topped Bentsen's prepared quip, and contributed to his defeat, though he could easily have lost anyway.  The 1992, 1996 & 2004 debates (Cheney - Lieberman excepted) proved that millions of viewers could endure "cruel & unusual punishment" within the meaning of the Eighth Amendment.

Karl Rove offers sage advice to both candidates, noting first that the first contest matters most, producing on average a 4.2 point swing to the perceived (by the public, not the pundits) winner: (1) avoid major mistakes; (2) counter-punch; (3) avoid canned or evasive answers; (4) use genuine humor & behave graciously

Bill Kristol thinks Big Mac should either transform a dull foreign policy debate--of lessened import to a country mesmerized by the financial meltdown--into a "leadership" debate, or send...Sarah Palin!  Bill Clinton gave McCain a pass on his decision to stop campaigning and his request that the first debate be delayed, noting that Big Mac had originally wanted more debates.

Big Mac's Progress: Palin-Powered

Team McCain is weighing a "nuclear option" ad featuring Obama's toxic pastor, in the tradition of the 1988 Willie Horton ad that helped propel George Bush senior to victory over Michael Dukakis.  (Horton was a black convict furloughed from prison--despite a sentence of life without parole--by Governor Dukakis, who drifted down to Maryland, invaded a home, tied up the husband and then beat & raped his wife in front of him when she returned home; more detail is in the Wiki entry on Horton.)  Team McCain can always point out that just as in 1988 Al Gore first used the Willie Horton issue in the Tennessee primary (albeit without the picture of Horton), so Hillary used the Jeremiah Wright issue in the primaries this time around.

A Wall Street Journal editorial details how Michigan may prove to be a toss-up state this fall, with economic trends no longer strongly favoring Democrats, and failed local governance and Sarah Palin's social appeal favoring the GOP.  Obama opposed a United Auto Workers deal that cut wages, to enable the Big Three automakers to survive against Asian competitors who had a $1,500 wage edge in selling cars.

Michael Barone sees voter trust in McCain rising, and notes Palin's impact on the tax issue:

The best argument against higher rates on high earners has come from Governor Palin in her acceptance speech, in a line obviously not written by her speechwriter.

"My sister Heather and her husband have just built a service station that's now opened for business — like millions of others who run small businesses. How are they going to be any better off if taxes go up?" Note that she doesn't say that Heather and her husband will be paying higher taxes themselves. She's arguing that higher taxes will hurt the economy and will hurt the little gal and guy.

Essayist Noemie Emery analyzes in depth (prints at 5 pages) "the Palin Effect."  A Wall Street Journal editorial adds that Palin makes Big Mac look younger and Obama go negative, undermining his "new politics" image.  Testament to her appeal is that on Sunday Palin drew a crowd of 60,000 near Orlando, Florida.  A Sept. 11 - 15 Quinnipiac poll gives dramatic evidence of Palin Power, in a shift of white women voters supporting the GOP in key states.  The RNC chairmen of the Senatorial and Congressional committees rhapsodize over how Palin has galvanized fund-raising and given a big boost to GOP efforts; everyone, they say, wants to take Sarah to the prom.

A Washington Post story examines the role Todd Palin is playing in Sarah's campaign + policy positions. 

Palin Watch: Michelle's Miscue, Rangel's Rip & Media Mugging

Michelle Obama slipped campaign mode discipline recently, saying to a supportive crowd that had been chanting "No Palin!"that voters should vote on the issues and not because "I like that guy" or, "she's cute."  Michelle, called on her quip, denied targeting Palin.  She claimed she was referring to herself.  But Michelle is not on the ballot.  meanwhile, House Ways & Means Chairman Charles Rangel (D-NY), perhaps to take attention away from his his tax troubles, recently slimed Sarah Palin as "disabled" and refused to retract it when given two chances.  Savor this exchange in this CBS report:

In a CBS 2 HD exclusive interview, Rep. Rangel called Republican vice presidential candidate Sarah Palin "disabled."

The question was simple: Why are the Democrats so afraid of Palin and her popularity?

The answer was astonishing.

"You got to be kind to the disabled," Rangel said.

That's right. The chairman of the powerful House Ways & Means Committee called Palin disabled -- even when CBS 2 HD called him on it.

CBS 2 HD: "You got to be kind to the disabled?"

Rangel: "Yes."

CBS 2 HD: "She's disabled?"

Rangel: "There's no question about it politically. It's a nightmare to think that a person's foreign policy is based on their ability to look at Russia from where they live."

Comes now Alcee Hastings, African-American Congressman from Florida--who has the rare distinction of being on the select list of 6 of federal judges to have been impeached and removed from office (details will amuse)--telling Florida Jewish voters that Palin does not care about Jews & blacks because she hunts moose.  Logic has never been a strong point for Hastings.  Team Palin smartly answered it was "taking a pass."

But African-American liberals get a pass from mainstream media.  Let a white conservative say these things about a black, or even a white liberal....But there may be consequences: A Breitbart report cites an AP poll showing that 1/3 of white Democrats have reservations about voting for a black candidate (I use the report's wording):

The AP-Yahoo poll used the unique methodology of Knowledge Networks, a Menlo Park, Calif., firm that interviews people online after randomly selecting and screening them over telephone. Numerous studies have shown that people are more likely to report embarrassing behavior and unpopular opinions when answering questions on a computer rather than talking to a stranger.

Other techniques used in the poll included recording people's responses to black or white faces flashed on a computer screen, asking participants to rate how well certain adjectives apply to blacks, measuring whether people believe blacks' troubles are their own fault, and simply asking people how much they like or dislike blacks.

"We still don't like black people," said John Clouse, 57, reflecting the sentiments of his pals gathered at a coffee shop in Somerset, Ohio.

Given a choice of several positive and negative adjectives that might describe blacks, 20 percent of all whites said the word "violent" strongly applied. Among other words, 22 percent agreed with "boastful," 29 percent "complaining," 13 percent "lazy" and 11 percent "irresponsible." When asked about positive adjectives, whites were more likely to stay on the fence than give a strongly positive assessment.

Among white Democrats, one-third cited a negative adjective and, of those, 58 percent said they planned to back Obama.

The poll sought to measure latent prejudices among whites by asking about factors contributing to the state of black America. One finding: More than a quarter of white Democrats agree that "if blacks would only try harder, they could be just as well off as whites."

Those who agreed with that statement were much less likely to back Obama than those who didn't.

Among white independents, racial stereotyping is not uncommon. For example, while about 20 percent of independent voters called blacks "intelligent" or "smart," more than one third latched on the adjective "complaining" and 24 percent said blacks were "violent."

Nearly four in 10 white independents agreed that blacks would be better off if they "try harder."

Palin's foreign policy tour in NYC was a success.  Perhaps Democrats would have been well advised to heed advice from Bill Clinton, who knows a thing or two about politics: praise Mrs. Palin, recognize her wide appeal, and put the slime buckets aside.  Media in NYC mugged Palin, insisting that unless they could listen in on her interviews with heads of state they would not send in a camera.

One solid exception was Katie Couric, who interviewed Palin (2 parts, approx. 11 min. combined) in NYC.  Couric's questions were straightforward and, with one exception was fair.  The exception was asking Palin to provide examples from Mac's long Senate career, other than the much-cited 2005 effort re Fannie & Freddie, where Mac supported regulation instead of deregulation.  Palin could not reasonably be expected to know something like that, let alone, Couric's reference to Mac's having chaired the Senate Commerce Committee.  Palin told Couric that she would get back to her, which will entail--what else?--asking for other examples from the senator's staff. 

Did MSM impose similar constraints re photo ops on Barack Obama?  I do not so recall.  One intellectually honest, moderate Democratic pundit, Kirsten Powers, herself a former press secretary (to whom she doesn't say), counsels Palin to limit press access:

Every campaign has a duty to protect its candidate. Good staffers have to be reluctant to offer up their principal when they know the press will make no honest attempt to be fair - and the media's behavior upon the announcement of Palin's candidacy showed massive bias.

Powers goes on to cite several examples of the media favoring less liberal candidates in some races, but there are too many examples of liberal media bias so sustain her analysis.  She is, however, right re Palin.

Index 9/25/08

5 posts: (1) Financial 9/11: Fraud Probed, Fakery Finessed--The Home Front; (2) Did 1999 Deregulation Law Cause Asset Crash?--The Home Front; (3) Fannie & Freddie: Barney Frank Fibs on Live TV--The Home Front; (4) Biden Watch: FDR's 5th Term & TV Presidency--The Home Front; (5) Georgia: Eyewitness Tale; Hurricane Vladimir Hits Caribbean--Us v. Them.

N.B., President Bush's address last night, plus the meeting between Bush & the two presidential candidates, augurs for rapid settlement on a final rescue package, probably in time for Friday night's presidential debate.

Financial 9/11: Fraud Probed, Fakery Finessed

The New York Post reports good & bad news.  Good: The FBI is investigating Fannie, Freddie, Lehman Brothers & AIG for possible (probable?) fraud.  Bad: A Bloomberg/LA Times poll finds that the American public blames under-regulation (62%), Wall Street greed (32%) & President Bush (28%) for the financial meltdown.  MIA in the poll: CONGRESS, which over- (protecting Fannie & Freddie) and under -regulated (passing, then extending the Community Reinvestment Act, repealing Glass-Steagall).

Apropos of fraud, Manhattan Institute scholar Steven Malanga explains a politically incorrect point: Main Street is hardly without sin.  Massive, escalating fraud on subprime mortgages played a role.  Borrowers took slightly higher interest rates in return for not having to document their financial picture, so-called "liar loans."  Speculators flipped properties ISO instant profit, but were more likely to walk away if they guessed wrong.  Bubbles in California and Florida accounted for 58 percent of 2Q07 foreclosures on subprime ARMs (adjustable-rate mortgages); nationwide 2Q07 new foreclosures were 6.63% for subprime ARMs, versus 0.34% for traditional mortgages.

As for Chris Dodd, here is evidence of Dodd's prescience: Just this July--two, yes, two--months ago, Dodd was asked about the status of Fannie & Freddie.  Said the Connecticut Yankee King Congress's Court, the financial world's Fric & Frac were "fundamentally sound" and that there was no need to be "panicky" about F&F.

Now on the the Oracle of Omaha.  Check out the Jeff Matthews is not Making this Up blog and learn the following: (1) Buffet's $5B investment in Goldman Sachs yields 10 percent--a cool $500M annually--and gives him preferred stock, not tainted by any of Goldman's dodgy assets; (2) Buffet's own investment powerhouse, Berkshire Hathaway, sold S&P Index "put" options as of June 30, 2008 with a notional value just under $40 billion--which means he profits if the market rises; (3) if the Paulson mega-bailout plan passes muster, markets will indeed rise, though not as fast as the Treasury Department's liability.

A Fox News Special Report segment documents that prominent Democrats, including Barney Frank & Chuck Schumer, resisted Bush administration efforts to rein in Fannie & Freddie, ignoring Alan Greenspan.  A Wall Street Journal editorial condemns SEC Chairman Chris Cox for over-regulating short sales in response to political heat.

Let Washington Times pundit Wes Pruden sum up the impending $700 billion wager: Bonnie & Clyde had a tougher time.  Bailing out Wall Street means capitalism for the poor, socialism for the rich.

Did 1999 Deregulation Law Cause Asset Crash?

The NRO editors defend former Texas GOP Senator Phil Gramm, and the law abolishing the Glass-Steagall Act, thus allowing commercial and investment banks to merge, that Gramm co-sponsored.  NRO's folks make a credible, if not fully convincing, case against Glass-Steagall, but their defense of Gramm is simply beside the point, for two reasons: the 1999 law was overwhelmingly passed in both houses, and in the event Gramm's recent remarks about a "nation of whiners" make his presence anywhere politically toxic for the GOP.  Rich Lowry adds his defense of Gramm, summing things up in three points.

One, Democrats in good standing supported the final bill. Robert Rubin and Larry Summers, Clinton Treasury officials whom Obama relies on for advice, supported it. Joe Biden voted for it, it passed the Senate with 90 votes, and President Clinton signed it. Heaven knows, Washington can make bipartisan mistakes, but if the bill were so obviously the road to financial perdition, presumably some of these Democrats much keener to regulate the economy than Gramm would have voted “no.”

Two, the bill was a foregone conclusion. Europe already had so-called universal banking in which financial institutions could undertake varied operations. U.S. banks were finding loopholes in the law to keep up with foreign competitors, and increasingly bumped up against the 60-year-old regulatory constraints. The Gramm bill just blessed the world as it was already evolving.

Three, the legislation appears to have alleviated the current crisis rather than making it worse. Big, diversified financial institutions have been weathering the crunch better than anyone else and have occasionally swooped in to lessen the pain. Bank of America acquired Merrill Lynch, which would have been impossible prior to Gramm’s deregulation. Otherwise, Merrill would either have gone under or been bailed out by the taxpayers. Similarly, J.P. Morgan wouldn’t have taken over Bear Stearns, and Barclays Bank wouldn’t be considering buying Lehman Brothers.

What of all this?  Start with Wiki's Glass-Steagall posting offering the pros and cons of GS:

The argument for preserving Glass-Steagall:
1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act
2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.
3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.
4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

The argument against preserving Glass-Steagall:
1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.
2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.
3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.
4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.

Personally, I find the conflict of interest argument most persuasive, and hence believe G-S should not have been repealed.  But as LFTC has noted over the past week, there are many other causes behind the financial meltdown.  One factor, noted in an NRO piece: With the exception of Merill Lynch, individual contributions from major Wall Street firms favored Democrats (PACs not included) by 2:1 & even 3:1.  Worst of all was Fannie Mae, where Obama leads McCain 13:1 in contributions.

Fannie & Freddie: Barney Frank Fibs on Live TV

Barney Frank took a minute of air time late yesterday to state about Fannie & Freddie & the Democrats that the GOP controlled both Houses until January 2007, and hence claims that the Democrats we not mainly at fault, etc.  re F&F.  TWO FRANK FIBS:

Senate: GOP Majority NEVER Had Control

Whereas the House of Representatives runs on the will of the majority, in which even a single-vote majority (218 - 217), if held together, enables the majority to run the institution, the Senate--a body in which no State can be deprived of "equal suffrage" (two votes) without its consent, per U.S. Const. Art. 5--runs on the consent of the minority, which can filibuster indefinitely given enough votes to defeat a "cloture" motion (to end debate and force a vote).  Until 1917 there was no limit on debate time in the Senate.  Senate Rule 22, adopted in 1917, required a 2/3 vote of Senators "present and voting" to cut off debate.  In 1975 a Democratic Senate reduced the cloture number to 60, but defined that number as the total number of Senators "duly chosen and sworn".  This is usually 60, but if there are vacancies, the number drops.  With 98 Senatorial seats duly filled--nearly always the case, it would be 59.  Merely being absent from the floor does not reduce the 60 number.

Even when the GOP had over 50 votes, its highest in recent years having been 56, it had some 6 senators who were liberal enough to often vote with the Democrats, depriving it of even a numerical, let alone working, majority.  Alternatively, these senators could bargain with the remainder of their party to force changes to their liking.

GOP Ran Policy in the Senate

In the event, in 2005 Democrats were able to prevent a Fannie & Freddie reform bill (co-sponsored by, among others, John McCain) from coming to a vote on the Senate floor.

Biden Watch: FDR's 5th Term & TV Presidency

Joe Biden is a smart guy.  He also talks lots.  Thus the law of averages frequently catches up with him.  It did once again.  Ben Smith's Politico.com airs the exact quote, but the gist is this: Answering a question from Katie Couric, Biden referred to FDR having, when the stock market crashed, gone on television to explain things to the public.

Except: (1) FDR did not take office until more than three years after the October 1929 market crash--on March 4, 1933 (the Jan. 20 inauguration date came with passage of the 20th amendment, with FDR's second inauguration, in 1937).  (2) FDR used radio, not television, to conduct his "Fireside Chats" with the American people.

Now, JB knows both of these facts.  But would John McCain get a break in the same situation, or would there be a media feeding frenzy over the Old Geezer flubbing Big Time?

Georgia: Eyewitness Tale; Hurricane Vladimir Hits Caribbean

Blogger Michael Totten, who sent back many great dispatches from Iraq, offers a credible narrative from Georgia in August, with photos.  Worth a look. Also, read historian Arthur Herman's warning about Russia's coming challenge to the Monroe Doctrine--and ask whether you wish John McCain or Barack Obama to decide how to meet it.

Index 9/24/08

4 posts: (1) Financial 9/11: Jane's Math Beats Ben & Hank--The Home Front; (2) A Conservative Case for Obama--The Home Front; (3) Abortion: If McCain Wins, Will Roe be Aborted?--The Home Front; (4) Bush's UN Valedictory Address--Turtle Bay Tortoise.

Financial 9/11: Jane's Math Beats Ben & Hank

Start with Fox's "Happening Now" co-hostess Jane Skinner observing that the Paulson Plan's estimated price tag of $700 billion is equal to $2,300 for each living American--which happens, anchorette Jane noted, to be equal to the maximum direct campaign contribution individuals can lawfully make to individual candidates in the general election.

Next, turn to Treasury Secretary Hank Paulson's Tuesday testimony before the Senate Banking Committee.  Federal Reserve Chairman Ben Bernanke defended in his testimony avoiding "fire sale" price transactions for illiquid, hard-to-value assets.  And they will apply "mark-to-market" (MTM) for accounting purposes, to keep "credibility."  It appears that the Treasury may pay close to full full "hold to maturity" prices, on the premise that there is no market; in fact, Merrill sold comparable assets at 22 cents on the dollar.  Senate Banking Committee Chris Dodd wants to ease bankruptcy rules to allow homeowners to avoid foreclosure, which would add to any bailout cost.

SEC Chairman Christopher Cox also gave testimony detailing SEC issues and actions.  The director of the newly-created Federal Housing & Finance Agency, Joseph Lockhart, also testified; the FHFA was created by the summer 2008 law putting Fannie Mae & Freddie Mac, the twin government-sponsored mortgage monsters, under conservatorship.  Ten GOP Members of Congress sent a Sept. 17 letter to Paulson & Bernanke.  Securities lawyer Harvey Pitt defends Cox's 3-year tenure at the SEC, noting that the SEC was denied by Congress the power to regulate derivatives.  (The abolition of the "net capital rule" that limited investment banks to a 12:1 leverage ratio came during the tenure of Cox's predecessor.)

Members of Congress grilling the witnesses raised four lines of argument re the Paulson Plan: (1) the need for more & better oversight; (2) limits on executive pay; (3) profit-sharing by the government when buying assets in a bailout; (4) mortgage modification.  Both candidates express strong opposition to the Paulson Plan, and Senate Banking Committee members were not persuaded by the presentations yesterday.  Mort Zuckerman offers a detailed portrait of the chain of disasters that led to catastrophe.

An investment maven states a cogent conservative case against the Paulson Plan.  Objections are also raised by a former Chairman of the Council of Economic Advisers, under President Bush the Younger, plus a pair of finance professors.  They offer three goals for a plan: (1) restore stability; (2) punish those who created the meltdown; (3) address the root cause--the residential mortgage collapse.  they find three flaws in the Paulson Plan: (1) it does not offer a clear way to price assets to be purchased; (2) it offers to buy too many assets, including those at solvent institutions, instead offsetting equity holders absorb such losses; (3) it costs too much, and could easily wind up costing more than $1 trillion.

A Wall Street Journal editorial explains why a pure private sector solution to the mortgage mess will not work:

The core of that sickness is a large capital hole in the financial system, and private capital alone can't fill it. A variety of mortgage securities are underpinned by housing assets that are falling in value. Those losses are real and will have to be written off eventually.

Private capital is vital but won't be forthcoming as long as no one knows what those assets are worth and which firms might fail. Public capital will be needed to refinance the banking system, whether through the FDIC or some other mechanism. Anyone who thinks otherwise doesn't understand the extent of this problem.

Treasury Secretary Paulson's plan would address the core sickness of those toxic securities. The point is to create a market when one doesn't exist, as well as a holding capacity and time to work out the assets. Real-estate securities are inherently sticky. Yet on bank balance sheets, they must either be written down or held like a ball and chain that inhibits other lending. The Treasury has the luxury of patience to buy and hold securities until they rise in price when home prices stabilize.

In that sense, the $700 billion isn't spending per se, like Medicare, but will instead be used to purchase these troubled assets. The risk to taxpayers is real, to be sure, especially because Mr. Paulson isn't telling anyone how Treasury intends to buy the assets. His concept of a "reverse auction" would let banks bid securities against a Treasury offer of cash -- say, $50 million. This is better than a flat-price purchase, but it still puts banks in a superior bargaining position based on what they know about the assets.

The better idea is an open auction. This would let private buyers join Treasury in bidding for bank securities. Taxpayers wouldn't have to buy all bad securities first, and, as the market develops, those that Treasury does buy would rise in price. Treasury could even make money on the resale.

As to MTM, the WSJ editors acknowledge it contributed to the problem, but caution against wholesale abandonment, lest we enter a "zombie" decade like Japan had in the 1990s.  The assets still must be disposed of to clear bank books.  Another tool is the Federal Deposit Insurance Improvement act of 1991, empowering the FDIC to intervene to prevent systemic risk; decisions to intervene are made by the President, the Secretary of the Treasury, and a 2/3 vote of the governors of the Federal Reserve Board.  (This is better than the Treasury Secretary deciding alone, per the Paulson Plan.)

Another Wall Street Journal editorial proposes a cleaner and quicker nostrum than the Paulson Plan: (1) the feds offer to buy mortgage derivatives on a "last-resort" basis, at 25 cents on the dollar; (2) homes in saturated markets--Florida & the Southwest--whose presence is depressing housing prices would be flattened, thereby boosting mortgage security prices and helping bank balance sheets--this involves thousands of homes, instead of millions of mortgages; (3) the gov't steps in otherwise only as circumstances dictate.  This seems far better than the Paulson Plan.  The 25-cent pricing tracks Merrill's 22 cents on the dollar sale of its troubled assets to Bank of America.

Bottom Line.  The Paulson Plan seems to cost far too much, and is far too interventionist.  A narrow, targeted plan minimizing taxpayer exposure seems a far superior--and fairer--course.

A Conservative Case for Barack Obama?

George Will makes the case for an Obama presidency as less of a gamble than a McCain one:

It is arguable that, because of his inexperience, Obama is not ready for the presidency. It is arguable that McCain, because of his boiling moralism and bottomless reservoir of certitudes, is not suited to the presidency. Unreadiness can be corrected, although perhaps at great cost, by experience. Can a dismaying temperament be fixed?

Herewith the Achilles' heel in Will's case: Who is ex-KGB thug now Tsar Vladimir Putin more likely to fear, and thus less likely to test by fire, a fighter jock or a lawyer cum community organizer?

Abortion: If McCain Wins, Wil Roe Be Aborted?

Stuart Taylor, the National Journal's ace legal eagle, crystal-ball gazes into 2009, and concludes: (a) Roe v. Wade will likely not be overturned; (b) if it were, state legislatures would pass abortion-rights laws.  Taylor is, as usual, right.  Start with the Supremes.  Their 1973 decision came when 16 states had already passed abortion liberalization laws.  The other 34 states were dragged into liberalization by the Court's judicial fiat, based upon highly creatively interpreting four provisions of the Bill of Rights that, in the majority's telling, created a "penumbra" of privacy from which "emanations" issued.  Justice White, dissenting, called the ruling an exercise of "raw judicial power."  Taylor opines that neither Justice Samuel Alito nor Chief Justice John Roberts are certain to overrule Roe.  On that he is right as well.

The Roe ruling came a generation ago. Since then Roe has been re-affirmed about 40 times.  It has become woven into the social fabric of America.  Testifying at his confirmation hearing, Alito said of stare decisis (legal lingo for "let the decision stand") that whether the rule is followed depends upon, among other things, how longstanding a precedent is, and how often it has been affirmed.  Thus, outliers like Plessy v. Ferguson, the 1896 separate-but-equal race ruling, and Dred Scott v. Sandiford, the 1857 pro-slavery ruling, are tossed.  But Miranda v. Arizona, the 1966 ruling creating interrogation rights for suspects in custody, was repeatedly re-affirmed over a generation, leading then-Chief Justice William Rehnquist to decline to vote in 2000 to overrule it.  A similar rationale leads me to agree with Taylor that neither Roberts nor Alito will vote to ditch Roe.

And if they did, every state would pass an abortion law within a year.  They would vary, but all would allow abortions in some measure.  Which is what federalism is.  And it was federalism that the Supreme Court majority contemptuously trashed in 1973, thus giving rise to the bitter abortion politics of the past generation.

Bush's UN Valedictory Address

President Bush spoke with predictable idealism in his farewell appearance at the UN.  Much of his address was the kind of diplomatic rhetoric--preaching idealism to the utterly cynical audience--that is a staple of American presidential speech-making at Turtle Bay.

One citation stood out, because it noted a concrete and substantial pair of achievements: (1) 5 years ago, only 50,000 sub-Saharan Africans with HIV were receiving treatment, a number that now stands at 1.7 million; (2) there are now 25 million Africans receiving protection against malaria, a continuing scourge.  Beyond question, this improvement is directly due to President Bush having pushed--hard and often--to make a major new commitment to help Africa.  Bush will, of course, get little credit for this from his critics--with the notable exception of a few liberals like the Irish rock star Bono.

Thus was idealism turned, in this one instance, into practical, successful remedial action.  Would that the president had been as successful versus Iran and North Korea.

Index 9/23/08

3 posts: Financial 9/11: Political & Money Winds--The Home Front; (2) Iran: Letter to its President; Ideas for US--Us v. Them; (3) Russian Bears Roll the Bear; Fidel Rolls US--Us v. Them.

Financial 9/11: Political & Money Winds

A New York Post story quotes two traders at financial firms saying that last Thursday the financial markets were 500 trades away from total meltdown--at least the 22 percent that marked the Crash of 1987, down to 8,300 on the Dow.  The $4 trillion money market fund (MMF) market (last Thursday's valuation) featured $500 billion in sell orders.  The previous week's $7.1 billion withdrawals from MMFs soared on Wednesday alone last week to $144.5 billion.  A key mutual fund, regarded as a bellwether for safe parking of money, the Reserve Primary Fund, fell below the $1 asset value level the market regards as magic.  Some Democrats have anonymously said that the bailout is their chance to play chicken with the financial meltdown, because it will hurt the GOP & not Obama to do so.  The New York Post headline article gives the numbers on market, oil, gold and dollar price swings yesterday, adding fuel to the Democratic blackmail.  David Brooks sees that an era of "Progressive Corporatism" has arrived, bringing with it a "long, gray" period of economic sluggishness.

Yet one market maven informs me that Treasury Secretary Hank Paulson still owns $600 million in Goldman Sachs stock.  David Frum defends the bailout neatly, but then says that tax cuts are off the table due to deficit growth.  At a time of economic weakness, a tax cut for all is what is needed.  Here is a witty savaging of the Paulson Plan, and defense of short sales.

Turn now to the folks at Lehman Brothers.  The London Independent reports that the failed firm pulled in $8 billion from its UK affiliate to NYC, partly to cover the final round of bonuses voted for top management, a vote taken in the final stretch, just before the firm collapsed.  The amount: a modest $2.5 billion.  That'll go over big in Washington and Main Street.  The concept is, of course, called chutzpah.

Chutzpah is what former Fannie Mae CEO Franklin Raines had in abundance.  As CEO of Fannie, Raines pushed dodgy mortgage loans that laid the foundation for the August 2007 crash of the $1.3 trillion subprime market.  Raines was paid $90 million during his 6-year (1998-2004) tenure.  WorldNetDaily reports that Raines is, at long last, getting a comeuppance of sorts: He agreed to settle a civil lawsuit by paying $24.7 million cash (including a $2 million fine) plus surrender Fannie options valued at $15.6 million.  This leaves him with about $50 million not yet recovered from his tenure.  The lawsuit charged fraud, because Fannie deliberately misstated earnings before Congress.  Why Raines does not also face criminal prosecution is beyond me.

Add this NRO piece on Barack Obama and convict financier Tony Rezko, who collaborated to shove out into the marketplace low-income subprime deals that went belly up in August 2007.  The NRO piece points to a Boston Globe article that details to the fullest Obama's machinations.  Meanwhile, a Wall Street Journal editorial notes that, incredibly, Joe Biden stands by his "paying higher taxes prove patriotism of the wealthy" statement made last week.  Biden added, re helping the poor: "Catholic social doctrine as I was taught it is, you take care of people who need the help the most."  The WSJ editors wryly note that over the past decade Mr. & Mrs. Biden allocated 0.2 percent of their combined personal income to charity, versus a national average of about 2 percent.  Thus, the typical taxpayer is ten times as personally charitable with income as are the Bidens; for many Beltway Democrats, charity begins at the public trough.

AEI scholar Kevin Hassett details how in 2005, when the GOP introduced a Senate bill (S.190), co-sponsored by, among others, John McCain, to rein in Fannie & Freddie it was blocked by senate Democrats, including Chris Dodd (CT), at $150,000 the largest recipient of largesse from F&F donations, Barack Obama (IL), at $125,000 in second place and Hillary Clinton (NY) at $75,000.  Democrats blocked the reform of F&F despite this warning from Alan Greenspan:

[If Fannie and Freddie] continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road....We are placing the total financial system of the future at a substantial risk.

Two AEI scholars detail how Fannie & Freddie destroyed the mortgage market--just as Greenspan foresaw, and how, on party lines, Democrats opposed & Republicans supported financial reform of Fannie & Freddie in 2005 & 2006, that might have substantially reduced the magnitude of the financial meltdown.  Newt Gingrich raises red flags on the bailout, plus proposes repealing the Sarbanes-Oxley accounting rules (adopted after the implosions of Enron & WorldCom, in 2001), which is killing start-ups, cutting the capital gains tax rate to zero, to encourage more investment.  Newt proposes more Congressional oversight to curb the discretion the Paulson Plan vests in the Secretary of the Treasury.  Economist Alan Reynolds offers an intelligent contrarian view on the mess, and is always worth a read.

A US News & World Report columnist sees three prospects: (1) Great Depression Lite; (2) Great Depression 2.0; (3) Bailout.  He runs calculations, estimating costs and foregone benefits, and concludes that even a $1.5 trillion bailout number is much better than the alternatives, which are far worse, by trillions.  Ron Paul, true to his laissez-faire school, says "let 'em all fail, and start over again."  True, this would end things faster, but no modern society can politically sustain such a course of action.  A long, slow workout, vastly more expensive than otherwise, is in the cards, one way or another.

Yesterday, John McCain proposed an oversight board of people like Mitt Romney, Michael Bloomberg, Warren Buffett, to oversee disbursement of taxpayer funds for bailout.  He smacked the Lehman Brothers pig-out.  McCain stated his respect for Hank Paulson, but said that with a trillion taxpayer dollars at stake, "trust me" is just not good enough.  He proposed online posting of details for public scrutiny of the plan in depth.  These are all solid ideas and pronouncements.  Most will be ignored.

A Wall Street Journal editorial sums up the consequences of the zapping of Masters of the Universe.

Iran: Letter to its President; Ideas for US

NRO's Michael Ledeen writes an open letter (prints at 5 pages) to Iran's President, Mahmoud Ahmadinejad.  Poetic in parts and riveting, it tells the hideous tale of how Iran sacrificed children in the war with Iraq in the 1980s, in stupefyingly barbaric fashion. 

Sarah Palin, disinvited from a high-profile anti-Iran rally in front of the UN, because Hillary canceled, having refused to appear alongside Palin, published the remarks she had intended to make at the event.  Most significant: Palin endorsed moving to impose sanctions on exporting refined oil to Iran, which exports crude oil but imports 60 percent of the refined oil it consumes, for want of refinery capacity.

Only by working together, across national, religious, and political differences, can we alter this regime's dangerous behavior. Iran has many vulnerabilities, including a regime weakened by sanctions and a population eager to embrace opportunities with the West. We must increase economic pressure to change Iran's behavior.....

We must rally the world to press for truly tough sanctions at the U.N. or with our allies if Iran's allies continue to block action in the U.N. We must start with restrictions on Iran's refined petroleum imports.

We must reduce our dependency on foreign oil to weaken Iran's economic influence.

We must target the regime's assets abroad; bank accounts, investments, and trading partners.

President Ahmadinejad should be held accountable for inciting genocide, a crime under international law.

We must sanction Iran's Central Bank and the Revolutionary Guard Corps — which no one should doubt is a terrorist organization.

Together, we can stop Iran's nuclear program.

Four former senior foreign policy officials warn yet again of the dangers posed by a nuclear Iran.  They note that Iran has been caught with traces of exotic elements useful only for making a nuclear weapon, floats on cheap oil & gas, that a nuclear Iran would ignite a regional nuclear arms race and threaten Iraq & the Straits of Hormuz.  They have formed a new group, United Against Nuclear Iran, to organize support against Iran's effort and to educate visitors to its home page.

Yet Wall Street Journal editor Bret Stephens sees "useful idiots" (Lenin's famous gibe) paving the way for a nuclear Iran.  Alas, he probably is right.

Russian Bears Roll the Bear; Fidel Rolls US

Russia's stock market is, a TAS article by national security maven George Wittman reports, reeling.  Problems began when Russia, in June, went after British Petroleum over its 50 percent stake in a Russian energy project.  Then came the invasion of Georgia in August.  Foreign investors got nervous, pulling out over $20 billion.  Moscow does have a $200 billion Sovereign Wealth Fund (SWF), but $142 billion is insurance against an oil-price drop.  If oil falls to below $70 per barrel, the Russian budget falls into deficit.  Add in money that props up Russia's sad-sack credit market, and the threshold for play money rises to $90 per barrel.  Putin either ponies up from his SWF to shore up the market, or must attract foreign investment.

Georgia's President, now visiting the US, explains how Russia fomented the faux August 2008 crisis by blocking negotiations with the separatists, then rushed in to invade at the first pretext.  His last sentence puts paid to the idea that Moscow has legitimate interests in re-annexing the nations on its borders: "The world must not permit Russia or others to assert spheres of influence and thus deny the right of free people to associate with like-minded nations."

Meanwhile, Wall Street Journal Latin America maven Mary Anastasia O'Grady punctures the case for opening foreign credit lines to Cuba after the island nation was devastated by Hurricanes Gustav & Ike.  The US offered $5 humanitarian aid anyway, which Castro refuses, in an effort to get the credit ban lifted.  As usual, we are helping anyway via private humanitarian groups.

Index 9/22/08

2 posts: (1) America's Financial 9/11: Summary--"It's the Earth Stupid!"; (2) America's Financial 9/11: Details--"It's the Earth Stupid!"

America's Financial 9/11: Summary

MARKET MELTDOWN: THE FINANCIAL WORLD WILL NEVER BE THE SAME

•    A meltdown of this magnitude has many and complex causes, covering public and private sectors, members of both political parties, including two presidents, two Federal Reserve chairmen, senior leaders and numerous members in both houses of Congress, reckless Wall Street and financial market CEOs, and lemming-like behavior from sophisticated investors.
•    A vast set of interlinked financial instruments were tied to housing prices that collapsed after the housing bubble burst.  Many were so complex that it is impossible to ascertain market values for them, and were highly leveraged on balance sheets of thousands of financial firms.  Their collapse caused catastrophic asset value losses at mega-firms whose failure plausibly posed systemic risk.
•    Markets failed to punish recklessness managers.  Regulation not only failed to impose outside discipline, it impeded efforts to punish unsound practices.
•    The resulting financial market turmoil, the world’s worst financial crisis since the Great Depression, caused banks and other lenders to freeze assets and refuse to make loans, thus imperiling both Wall and Main Streets.
•    It thus became imperative that the government act decisively, in concert with foreign governments, to forestall a total market panic that could have caused stock markets worldwide to implode, thus triggering global depression.
•    Because the web of interlinked transactions is so complex, and valuation of many arcane financial instruments unknown, the ultimate outcome of any remedial measures taken today will remain highly uncertain.
•    What has come to pass is not a crisis, as crises can be solved in a short period of time.  It is a meltdown that will dramatically alter how investors regard financial markets worldwide, and how markets are regulated.  Investors will be far more wary and regulators far more stringent, for generations.
•    Because taxpayers voted for politicians whose reckless, lobbyist-influenced actions contributed greatly to the market meltdown, it is not unreasonable to ask taxpayers to contribute financially to its resolution.
•    Critics say the plan makes the government an investor-insurer rather than a middleman offering bridge loans to distressed investors, thus exposing taxpayers to huge unnecessary financial risk.  But a major rescue was necessary.
•    Even if the market rescue succeeds, the United States has suffered a severe economic and political reversal that gravely weakens its position in world affairs.  America must still marshal resources to project power to defend its far-flung national security and geopolitical interests, and protect its homeland.  That task is immensely complicated by the financial meltdown.

America's Financial 9/11: Details

Considerations.  Begin with Thomas Sowell's column on political fads, and the quote he offers from the late French political philosopher, Jean-Francois Revel:

A human group transforms itself into a crowd when it suddenly responds to a suggestion rather than to reasoning, to an image rather than to an idea, to an affirmation rather than to proof, to the repetition of a phrase rather than to arguments, to prestige rather than to competence.

Revel's dictum is being sorely tested this week, as the government faces its gravest economic crisis in 70 years.  The Sage of Omaha, Warren Buffet, whose investment firm (Berkshire Hathaway) had returned $2,000 on the dollar invested in 1965 through 2002, predicted catastrophe in March 2003 in his letter to shareholders, calling complex derivatives "financial weapons of mass destruction."  Buffet called the developers of such instruments "madmen" and warned that firms could be pushed into "a spiral that can lead to a corporate meltdown." and lead to false accounting--partly honest optimism and partly "huge-scale fraud."  Buffet, ominously for the future, called derivatives markets "hell...easy to enter and almost impossible to exit."

Corporate takeover master Carl Icahn posted on Icahn Report his scathing assessment of the role of CEOs in creating the meltdown:

EBITDAT

The situation has gotten so egregious that we half-jokingly use a measure called EBITDAT when evaluating companies, i.e. earnings before interest, taxation, depreciation, amortization and theft. In my view, this theft is a measure of how much senior executives and boards of directors blithely take out of companies in lavish salaries, perks and benefits, even though they may be running their companies into the ground.

Icahn adds:

CREDIT EXCESS

The collapse of Fannie, Freddie, Lehman, AIG, Merrill and IndyMac and over a dozen regional banks is emblematic of the era of credit excess on the part of banks and abdication of government oversight in lending standards.

What we’ve really seen over the last three or four years is greed gone wild and now we’re paying the price for it in a monster hangover.

The fact is, we could end up in a major recession or even a depression with all the reckless lending that banks have done over the last few years, thanks to low interest rates, overabundant liquidity, lax lending standards and the wholesale offloading of risk to who knows where.

According to a financial maven I trust, there is $400 billion of vulture money in the market, for purchase of depressed assets.  The government should, in this view, be only a middleman offering bridging loans, and not an investor in risky assets.  Buying risky assets could cost taxpayers vast extra sums. Will panic drive taxpayers to support a more expensive bailout than necessary?

Confidence.  The White House--here is the President's statement made Saturday--and Congress are working on a $700 billion rescue package, on top of $800 billion already committed to various rescues, raising the federal debt limit from $10.6 trillion to $11.3 trillion.  The funds would be available for rescues on a case-specific basis, for two years.  Given a $14 trillion GDP, the debt ceiling will rise from 70 percent to 75 percent of GDP.  This New York Times Q&A explains the bailout details.  Here is the text of the administration's proposal.

N.B., a tally by the Peter G. Peterson Foundation--Peterson is a top financial mogul--puts the real national debt to date at $52.7 trillion: In addition to the $10.8 TR official debt--this is $200M higher than the figure above, for which I have no explanation--there are $1.1TR in contractual commitments such as loan guarantees, $6.7 TR in Social Security obligations + $34.1TR in Medicare obligations not yet covered by projected revenues.  But these projections are dubious, as they rely on projections of federal tax revenues decades ahead, when such numbers are often way off even in a given year.  Economic growth will determine the revenues available.

This Washington Post front-pager details who is advising the two presidential candidates on arcane financial matters about which neither has a clue--the good news being that they both seem to grasp that they need tutoring.  One yardstick for debt vulnerability: In the decade from 1Q1998 to 1Q2008, debt levels rose 128 percent in the financial sector; 97 percent for households, 65 percent for business, 61 percent for state & local governments, and 9 percent for the federal government.

N.B., The rescue plan does not involve the government immediately pumping out $700 billion to buy troubled assets; it contemplates case-by-case purchases of troubled assets, carrying them on the government's books, and selling them as market conditions permit, aiming for a profit.

Here is Treasury Secretary Hank Paulson's statement on emergency actions, including guaranty for MMF assets.  Here are (no pun intended) the money paragraphs from Paulson's statement:

The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy. When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans and investments that create jobs. As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy.

As we all know, lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing. This simply put too many families into mortgages they could not afford. We are seeing the impact on homeowners and neighborhoods, with 5 million homeowners now delinquent or in foreclosure. What began as a sub-prime lending problem has spread to other, less-risky mortgages, and contributed to excess home inventories that have pushed down home prices for responsible homeowners.

A similar scenario is playing out among the lenders who made those mortgages, the securitizers who bought, repackaged and resold them, and the investors who bought them. These troubled loans are now parked, or frozen, on the balance sheets of banks and other financial institutions, preventing them from financing productive loans. The inability to determine their worth has fostered uncertainty about mortgage assets, and even about the financial condition of the institutions that own them. The normal buying and selling of nearly all types of mortgage assets has become challenged.

These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions. As a result, Americans' personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted.

To restore confidence in our markets and our financial institutions, so they can fuel continued growth and prosperity, we must address the underlying problem.

The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.

The New York Times captures a close partnership that has developed between Paulson and Federal Reserve Chairman Ben Bernanke.  Bernanke summed up the prevailing Beltway mood, dismissing free market purism: "There are no atheists in foxholes and no ideologues in financial crises."

A Wall Street Journal online Sunday report details how "Black Wednesday" forced Paulson's hand.  Put simply, on Wednesday banks hoarded cash and stopped lending, in order to have reserves sufficient to meet anticipated depositor demands; banks, who normally hold $2 billion in cash on hand, held $190 billion as of Wednesday.  For their part, depositors invested cash in Treasury bills, driving yields to zero--in effect parking their cash in a security that paid no interest whatsoever, accepting a negative investment return as the face value of the bond is eroded by inflation.  The signal that triggered Paulson's action was sharp spikes in interbank lending rates--banks raised rates to discourage borrowing by other banks.  The $1.7 trillion commercial paper market, by which corporations raise capital directly from investors, was frozen.  It remains unclear how many of the 7,200 commercial banks and 1,200 thrift institutions will be allowed to park their assets with the government.

Consequences.  Economist Irwin Stelzer writes that: (a) the financial markets will never be the same again; and (b) that there is grave danger arising out of political pressure for instant reform, in that reform can make matters worse if made with incomplete information.  Stelzer shows that management matters: comparing the ratio of bad loans to total capital, Merrill stood at 6:1 and Lehman 3.4:1; Goldman's was 2.5:1, but it cut that to 1:1, anticipating hard times to come.  Stelzer is optimistic that in the end things will work out for the better.  But what follows offers reason to doubt sunny views.  A New York Times front-pager reports on why Merill Lynch and Lehman had different fates.  A London Financial Times editorial spells out two criteria for the bailout to work: (1) capital infusions to support firms whose failure poses systemic risk; (2) a price floor to give investors confidence to buy in a risky environment.  Liz Moyer of Forbes poses 10 questions the bailout must address.

A New York Times front-pager reports that Sunday night Morgan Stanley and Goldman Sachs, Wall Street's last remaining independent investment banks, agreed with the feds to transform themselves into bank holding firms, enabling them to gain access to the Federal Reserve discount lending window but subjecting themselves to layers of bank regulation more stringent than the rules they now follow.  Symbolic of the end of buccaneer capitalism are these asset-to-capital ratios (not to be confused with the ratios for bad loans given in the preceding paragraph): Morgan Stanley, 30:1; Goldman Sachs, 22:1; Bank of America, 11:1.

Equity maven Jeremy Siegel calls for underwriting the entire $3.5 trillion money market fund (MMF) industry, plus the $6.5 trillion held by the public in the form of bank deposits.  The Treasury, Siegel writes, can simply convert MMF and bank deposit assets into $10 trillion in Treasury bills, without inflating, while reassuring nervous investors.  A Wall Street Journal editorial praises the feds for stopping a global panic, but cautions that rules must be carefully framed to get incentives and risks right.

The New York Times Financial Turmoil Blog Q&A yields two nuggets: (1) Bob McTeer, former Federal Reserve Bank of Dallas president, said as to possible hyperinflation that the Fed has been neutralizing its lending by selling Treasury bills--the very policy capital maven John Rutledge decries as denying needed liquidity--but financial consultant Bert Ely, who predicted the 1980s S&L collapse, says that because Fed money pumped out would be immediately reinvested in interest-bearing government debt, hyperinflation won't happen; (2) McTeer explains that banks used to make mortgage loans and hold them, giving them the incentive to enforce strict lending standards, but "securitization" led banks to sell the loans in the form of mortgage-backed securities to holders who had less incentive to police loans.

Larry Kudlow proposes revival of the Securities & Exchange Commission (SEC) net-capital rule of 12:1 for debt leveraging by banks.  Home foreclosures of 3 percent--versus 50 percent during the Great Depression--and a decline of 10 to 20 percent in house prices--leaving them still 50 percent above what they were in 2000--forced highly leveraged firms into insolvency.  Great Depression historian Amity Shlaes warns that taking revenge on the rich can backfire very badly, and draws eerie parallels between the remedies tried by FDR, and those being readied today.

 The $9 billion the Reconstruction Finance Corporation bailout is equal to $135 billion today; the RFC terminated its operation in 1953, leaving in place only the Federal Deposit Insurance Corporation (FDIC).  The S&L bailout, financed by the original Resolution Trust Corporation (RTC) from 1989 - 1995, started with $50 billion and ultimately spent $160 billion, to clean up 747 thrifts carrying $394 billion in troubled loans.

Culprits.  A Wall Street Journal editorial counsels against believing political fables about how noble regulators tried to stop runaway capitalist greed.  Politicians listened to the lobbyists who supported them, and promoted home mortgages for poor borrowers despite their likely inability to pay.  One major villain: the Community Reinvestment Act, enacted under Jimmy Carter in 1977 and expanded in 1995 under Bill Clinton.  In essence, the 1995 rules imposed performance standards as to bank loans to residents in "under-served" communities, forcing lenders to make loans to borrowers they would otherwise deem not credit-worthy; the laws were buttressed by lawsuits filed by "community organizers."  These loans were, beginning in 1997, "securitized" into "subprime" mortgages, creating the $1.3 trillion market whose collapse in August 2007 began the massive financial market meltdown.

Another major law was the Glass-Steagall Act of 1933, barring commercial banks from engaging in investment banking.  This law was repealed in 1999, with wide bipartisan support, during President Clinton's second term.  The move was strongly opposed by Paul Volcker but supported equally strongly by his successor at the Fed, Alan Greenspan.  One of the 1999 repeal's strongest supporters was, the New York Sun reports today, New York Senator Charles Schumer, who also opposed attempts to rein in Fannie & Freddie. (Schumer also single-handedly triggered a run on a California bank, IndyMac, in June, by publicly speculating that the bank was in trouble, contrary to opinions held by bank regulators; depositors rushed into claim their money, thus causing it to fail.)

In a similar vein, NRO editor Rich Lowry captures in a few paragraphs many of the culprits for the mess:

Wall Street is experiencing one of its most wrenching periods since traders began gathering around a tree there in the 1790s, beset by a terrible reckoning: No, interest rates can’t be held at unsustainably low rates — 1 percent in 2003 —  without stoking wasteful investments; no, housing prices won’t always go up; no, home loans can’t be extended to people with shaky credit histories on scandalously easy terms (no money down!) with the expectation that they’ll be paid back; no, fancy financial instruments and computer models can’t eliminate risk; no, firms can’t exist on massive debt — now-bankrupt Lehman Brothers had debts 35 times its capital — without courting disaster.

It’s a sign of how fragile the entire financial edifice had become that a decline in housing prices of about 20 percent could precipitate the current near-meltdown. It’s easy to blame greed, as John McCain is doing at every opportunity, since it’s a given. Greed is endemic to the human condition, even if it is most visible on Wall Street. Lehman Brothers CEO Dick Fuld made $22 million last year, leading his firm toward the abyss, while Wall Street doled out $23.9 billion in bonuses in 2006. But everyone else joined in the wide-ranging bonanza.

As financial guru Ric Edelman writes, “The insurers got rich selling policies with fat premiums, brokerages got rich selling new securities, lenders got rich selling more loans than ever, builders, real estate agents, title settlement companies, appraisers, inspectors — everyone got rich from the ensuing real estate boom.”

He could have included the politicians who enabled the irresponsible lending of Fannie Mae and Freddie Mac because they knew these “government-sponsored enterprises” — since bailed out by the government at a potential cost of $200 billion to taxpayers — would line their campaign coffers. Fannie and Freddie were the “patient zero” of the financial contagion, encouraging and blessing the “subprime” loans that were a toxin spread throughout the financial system. Many Republicans, including McCain, wanted Fannie and Freddie reformed. As a largely Democratic cash cow, it was protected by Democrats, enamored of its mission of extending homeownership to those who — it turns out — couldn’t afford homes.

NRO Online editor Jonah Goldberg nails one especially appalling villain, Fannie ex-CEO Franklin Raines, who made pushing shaky loans to the poor his top priority, and aided by Democratic Senators Chris Dodd (CT) &--yes, Barack Obama (IL)--and House Member Barney Frank (MA), blocked efforts by President Bush and John McCain to rein Fannie's excesses in:

The self-proclaimed angels in Washington will tell you they’ve been working tirelessly to expand the American dream of homeownership by making mortgages available to people unable to plunk down 20 percent on a house. Franklin Raines, the Clinton-appointed former head of Fannie Mae from 1998 to 2004, made it his top priority to make mortgages easier to get for people with poor credit, few assets and little money for a down payment.

The fine print to this noble intent was an ill-conceived loosening of standards. For instance, the Clinton administration reinterpreted the Jimmy Carter-era Community Reinvestment Act to politicize lending practices. Under the CRA, the government forced banks to prove they weren’t “redlining” — i.e., discriminating against minorities — by approving loans to minorities and various left-wing “community group” shakedown artists whether they were bad risks or not. (A young Barack Obama got his start with exactly these sorts of groups.) Sen. Phil Gramm called it a vast extortion scheme against America’s banks. Still, the banks were perfectly happy to pass the risky loans to Raines’ Fannie Mae, which was happy to buy them up

That’s because Raines was transforming Fannie Mae from a boring but stable financial institution dedicated to making homes more affordable into a risky venture that abused its special status as a “Government Sponsored Enterprise” (GSE) for Raines’ personal profit. Fannie bought the bad loans and bundled them together with good ones. Wall Street was glad to buy up these mortgage securities because Fannie Mae was deemed a government-insured behemoth “too big to fail.” And others followed Fannie’s lead.

The current financial crisis stems in large part from the fact that people who shouldn’t have been buying a home, or who bought more home than they could afford, now can’t pay their bills. Their bad mortgages are mixed up with the good mortgages. And thanks in part to new accounting rules set up after Enron, the bad mortgages have contaminated the whole pile, reducing the value of even stable mortgages.

A Wall Street Journal editorial argues that short-selling rules were not a factor in the crisis, pointing out that "naked" short sales are once again illegal.  They were legalized by the SEC in September 2005, but only to aid market liquidity and not to drive down prices.  Naked shorts are short sales made without first borrowing the stock to deliver to the buyer.  Another short-sale limit, the "uptick" rule, was crafted in 1938, after the market break of 1937, to stop "bear raids"--sellers driving down share prices of thinly-capitalized firms; stock manipulators like Joseph (father of JFK, etc.) Kennedy used the tactic, often spreading false rumors to drive a stock's price down, after they had shorted it, then selling more shares short to trigger other sales by panicky investors, then finally buying the shares back at the lower price to lock in a profit before the original false rumors were dispelled.  The SEC abolished the rule on July 5, 2007 (having modified it on July 28, 2004 to study the impact on market liquidity).  Short sales of any kind were banned last week for 799 financial companies, to prevent downward pressure or a ceiling on potential upward price moves.  One financial firm CEO opposes the short sale ban as based upon rumor, not fact, about short sales.  He points out that short positions make up 4 percent of the New York Stock Exchange share value, and that only a small fraction of the $2 trillion manged by private investment firms are short positions.  Most short sales are in fact hedged by sophisticated investment hedging strategies that entail a parallel position taken against the short sale.

One key culprit is "mark to the market" (MTM) accounting, but, ironically, Hank Paulson supports this.  For frequently traded securities this is fine, but for rarely traded securities it is bad.  A trade-off for exempting assets from MTM should be limiting the size of non-MTM assets in a financial firm's asset portfolio.  Financial Accounting Standards Board (FASB) Rule 157 provides, in part, as to valuing assets:

Definition Of Fair Value
Fair value is defined in SFAS 157 as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market which would be the most advantageous for the asset or liability." Notably, this definition focuses on exit values, e.g. the value when an asset is sold, rather than entrance values.

Fair Value Hierarchy
SFAS 157 identifies a fair value hierarchy to rank the reliability of inputs used in a valuation approach. The first – and highest – level refers to quoted prices for identical assets or liabilities in an active market. When those prices are not available, the second – or middle – level will base fair value estimates on observable inputs that a market participant would use. If observable inputs are not available, the third – and lowest – level will require the use of unobservable inputs. However, the objective of fair value remains the same and thus even unobservable inputs will need to incorporate the assumptions a market participant would use in developing an exit price. The reporting entity's own data may be used to develop unobservable inputs, provided that information which shows that market participants would use different assumptions is not readily available with undue cost and effort.  (Emphasis added.)

Complications.  Former Chairman of the Council of Economic Advisers Lawrence Lindsey's superb analysis begins by noting that we are nowhere near 1929, when the US per capita GDP was that of people in the Balkans today; instead, it is five times higher.  In 2006 mortgage buyers were paying 3 percent down, and the old rules for lending were chucked in favor of recent default experience, times when prices were inflating in a massive bubble.  Financial firms lent 90 cents on the dollar to home buyers whose homes are worth 75 yo 80 cents per dollar.  "Counterparty risk" (the parties to financial contracts are called "counterparties") arising out of massive swaps interlock firms so that those with real-estate backed assets drag healthier firms into the vortex.  Lindsey finds both parties "clueless" about what to do.  He suggests lifting the $100,000 ceiling on federal deposit insurance, and that bailouts will be necessary to forestall a financial market implosion.  Lindsey fears that the mess "has probably permanently impaired the attractiveness of U.S. financial markets"--" a price we are going to pay for decades to come."  Central to the problem, said Don Marron, CEO of Lightyear Capital, is that the bond market is 2 or 3 times the size of the stock market.

A key component are financial derivatives whose unwinding in a declining mortgage market destroyed balance sheets at major financial firms.  A "derivative" is a secondary financial instrument whose value is tied to an underlying primary financial instrument.  Take a home mortgage issued by Fannie Mae or Freddie Mac (the two GSEs--Government Sponsored Enterprises) to a homeowner.  Fannie or Freddie sells the mortgage to a financial firm, say, Lehman Brothers.  Lehman packages bundles of many mortgages into a "securitized" instrument that is a derivative of the original mortgage contract.  Packaging many loans, even those made under lenient terms to buyers of poor creditworthiness, was judged by Wall Street Masters of the Universe to spread the risk--making, as it were, the proverbial silk purse of out many sows' ears.

But when the housing bubble burst in 2006, the value of homes plummeted--at least 20 percent.  This caused a far steeper than 20 percent decline in the value of the securitized derivative instruments, due to leverage: Financial firms used $1 of assets to buy as much as $30 to $40 dollars of derivatives.  As a result, even a small decline in the value of mortgages caused a vastly greater drop in portfolio value.  At 10:1 leverage, a 10 percent decline in the underlying security wipes out the asset value of the leveraged derivative security.  Thus, the decline of 20 percent in the value of home mortgages destroyed the balance sheets of Fannie, Freddie and top Wall Street financial firms.

The size of the derivatives market is staggering: about $600 trillion--nine times estimated world gross domestic product.  According to the Bank for International Settlements (a consortium of 55 country central banks discussed below), as of December 2007, the $596 trillion in derivatives outstanding is 66 percent ($400 trillion) interest rate contracts, 10 percent ($60 trillion) credit default swaps (see next paragraph), 9 percent ($54 trillion) foreign exchange contracts, 2 percent ($12 trillion) commodity contracts, 1 ($6 trillion) percent equity contracts and 12 percent ($144 trillion) other types of instruments.

Credit Default Swaps (CDS) are a special class of financial instrument encompassing three elements: (1) a buyer or fixed-rate payer; (2) a seller or floating-rate payer; (3) a third-party "reference utility."  The buyer pays periodic sums to the seller, in return a right to reclaim the value of the CDS in event of default on the underlying instrument.  A seller repays either the par value of the instrument, or auctions it for its cash market value, when the buyer delivers the instrument or the cash proceeds.  Put simply, when mortgage values declined as the housing bubble burst, the value of leveraged CDS portfolios plummeted by far more than the actual percentage decline in home values.  Thus were financial firm balance sheets, loaded with CDS instruments, ravaged, and the nation's financial system ground to a halt.  CDS instruments totaled only $6.4 trillion in December 2004, and soared nearly ten-fold within three years, riding the housing bubble's final phase up, and than the ride downward.  This London Financial Times article cites Alan Greenspan's 1998 rebuff of a plea from the head of the Commodity Futures Trading Commission to regulate more closely financial derivatives.

Herewith an analysis of financial derivatives from the Angry Bear (a reference to the Wall Street term "bear" that denotes market pessimists) blog, further clarifying the preceding paragraphs:

As the world financial markets head into complete meltdown, it is worth taking a moment to look back to see where much of this began. A significant portion of the current crisis stems from the shadow banking system's dependence upon the explosive growth in derivatives market. Put simply, these complex financial instruments are meant to monetize risk of default. Futures contracts, options, swaps, and many others allow one party to insure money is exchanged, but the outcome of the contract depend upon many underlying factors that make up the terms of the contract. Though many forms of derivatives are traded in exchanges, many are not necessarily.

Derivatives that not necessarily traded on market floors are known as "over-the-counter" derivatives. They are usually bilateral contracts between investment banks and a customer and can be generated simply over the phone or over the internet. This form of contracting is largely unregulated. The OTC market has been monitored by the Bank for International Settlements since at 1998, and they publish detailed information on various forms of OTC derivatives every six months. The most recent data can be found here.

This market was very big in 1998, but it has exploded since then. I've generated a figure of the amounts outstanding of OTC derivatives since 1998 broken down into their various types.

You should note that the Y-axis is in billions of dollars. Yes, billions. That means, as of Dec 2007 (for which BIS has the most recent data), the total OTC derivative market was almost $600 trillion. With a T. Thus, in 10 years it has gown 826%.

The growth is even more shocking if you look at some of the subcategories of OTC derivatives. Below is a figure illustrating the percentage of amount of outstanding contracts relative to the amount outstanding in June 1998 for interest rate contracts, commodity contracts, and credit default swaps.

Though commodity contracts still make up only a small proportion of the total OTC contracts outstanding (1.5%), its growth has been astronomical, increasing over 2,000% since June of 1998. Even interest rate contracts, which make up the largest portion (66%) of all OTC derivatives, increased over 900% in 10 years. And most troubling of all is the credit default swap market. These are contracts that are activated in the event of a default.

This market has increased 905% in just three and a half years since BIS starting monitoring this form of derivative. It was a mere $6.4 trillion in Dec 2004; In Dec of 2007 this market ballooned to $57.9 trillion. Just think of the unwinding of credit default swaps that is involved when big investment banks like Lehman Bros. go under.

Of course, all of it is very complicated, because derivatives are essentially a "zero-sum" instrument. The way derivatives are supposed to function is that money is exchanged depending on the outcome. Nothing is lost, at least in an ideal environment; it is only exchanged hands. One side wins, the other loses. So it isn't exactly clear what will happen as these contracts are unwound. But what happens when one party of the contract can't pay?

I think we're going to see that many times over very soon…

Here is a set of tables compiled by the Bank for International Settlements (BIS--see Wiki BIS entry for description).  Here is a discussion of Frequently Asked Questions on the Lehman & AIG deals.  Here is more detail on the market mess in the form of comment from assorted experts.  A $180 billion foreign central bank contribution reflects huge financial stakes foreign investors hold in the US market: $400 billion from China, and large sums from Japan and other Asian countries with substantial monetary reserves.

Now, take the estimate for 2006 World Gross Domestic Product: $65.6 trillion.  A $600 trillion swap aggregate means swaps are 11 times world GDP--the equivalent of a global reserve of nine percent against this class of liabilities alone, let alone other outstanding liabilities.  If these unwind asymmetrically....

The final number surely will be in the trillions, dwarfing the Fed's puny $500 billion still not committed and the Bank for International Settlements's $400 billion reserves.  David Brooks cautions that regulators face political pressures that impede sound regulation, offering a classic political example from Atlantic Monthly writer Megan McArdle:

We’re also going to need regulators who can overcome politics and human nature. As McArdle notes, cracking down on subprime loans just when they were getting frothy would have meant issuing an edict that effectively said: “Don’t lend money to poor people.” Good luck with that.

Can--or Should--the Paulson Plan Safely Be Opposed? Bill Kristol is one of the few prominent conservatives who thinks the plan not only flawed, for want of sufficient transparency, accountability and administrative practicality, but politically survivable, possibly, for John McCain to oppose.  He notes that some conservatives wish to add a delicious provision to the Paulson Plan, limiting the salary of any CEO whose firms ask the Treasury to bail out his firm to a salary no higher than the $400 grand paid the President (a salary most Wall Street CEOs would consider modest for even one week's work).  The New York Times reports that on Sunday Democrats set conditions for consenting to the rescue plan: (1) greater legislative oversight of implementation of the plan; (2) more direct aid to homeowners; (3) limits on financial firm executive pay--including a "claw-back" provision enabling Treasury recoupment of executive pay from CEOs who departed with platinum parachutes from firms seeking Treasury help (which Paulson opposes, fearing firms will thus decline to participate in the program--if true, an indictment of the CEOs who put personal enrichment above saving their firms).

Pundit Roger Cohen argues that as the US in past world financial messes has been asked to help, that foreign countries should be asked tor return the favor this time.  But Europe is not listening.  Niall Ferguson, British historian, argues that the China lends, America spends model of economic growth has ended, but also notes that while America's stock market is down 18 percent in 2008, China's is down 48 percent and Russia's 55 percent, so that alternate economic models do not look so good either.  The Los Angeles Times reports widespread schadenfreude (the wonderful German word meaning "malicious glee") all over Europe, at Wall Street's, and America's, woes.  They should remember that when America, 20 percent of the global economy, sneezes, the world economy catches a cold.  When America catches financial cancer, necessitating protracted treatment with uncertain outcome, Europe catches....Europeans, laugh at will, but beware.

Bottom  Line.  Be afraid.  Be very afraid.

Index 9/19/08

5 posts: (1) Reforming the Beltway: One Weapon May Work--The Home Front; (2) Wall Street: The Donald's Take & Biden's Blooper--"It's the Earth Stupid!"; (3) Polls 2008: Rove Reads Tea Leaves--The Home Front; (4) Leverage: A Double Whammy--"It's the Earth Stupid!"; (5) Culture Hits the Beltway Bandits--Class & Crass.

Reforming the Beltway: One Weapon May Work

Dan Henninger nails the single best help Sarah Palin can offer to John McCain: her gubernatorial record of casting hundreds of line-item vetoes.  A line-item veto is one that vetoes one or more specified budget items in a bill, letting the rest pass.  Under current law this cannot be done: a President either signs or vetoes the entire package, which seriously impairs budget control.  DH says that Big Mac should campaign on a platform of seeking a line-item veto law from Congress, promising that if he does not get it he will support only candidates in 2010 elections who sign on.

Come October 15, Big Mac can take to the country, during the domestic policy presidential debate, his proposal: call for passage of a line-item veto, and work to throw out anyone in the 2010 cycle who votes either against it or, like Barack voted often in Illinois, "present.

George Will suggests that Big Mac promise in advance to wield his veto pen to stop efforts by a Democratic Congress to strip workers of their right to decline to join a union, and to reinstate the "Fairness Doctrine"; the latter, abolished in 1987 by the Federal Communications Commission (FCC), would if revived enable liberals at the FCC to silence conservative talk radio.  Will sees a public whose opinion of the Democratic Congress is even lower than their view of the President, and thus receptive to a message of keeping government divided.  He cites a study from the CATO Institute that shows federal spending rising 5.26 percent during periods when one party controlled both the White House and Congress, versus 1.73 percent when the two branches were controlled by different parties.  Thus, the rate of spending triples when the executive and legislative branches of government are united.

Wall Street: The Donald's Take & Biden's Blooper

Watch this Donald Trump video (5:10) with Neil Cavuto.  The Donald thinks it will take 1 to 2 years to even start getting better, and that it will take through 2011 to see a full workout.  AEI scholar Desmond Lachman pinpoints Alan Greenspan as the major pusher of the housing and credit bubbles, by keeping interest rates too low and abysmally failing to provide proper regulatory oversight.  Perhaps most worrisome of all is this Bloomberg News report that foreign investors have lost confidence in the United States as an investment destination.  Sovereign Wealth Funds invested $28.5 billion in 4Q07, $19.7B in 1Q08, $6.43B in 2Q08 & just $900 million--yes, million--in 3Q08, which ends in a fortnight.  Estimates for the total cost of the workout range from $1 to $4 trillion.  The Bloomberg piece is excellent, except ignore the nonsense about Iraq and the American federal budget deficit. AEI scholar & former Federal Reserve director of monetary affairs Vincent Reinhart says that Hank Paulson's AIG deal obliterated the sharp line against bailouts he drew 48 hours earlier.

Meanwhile Joe Biden called upon wealthy Americans to to the patriotic thing: "It's time to be patriotic ... time to jump in, time to be part of the deal, time to help get America out of the rut."

To which Sarah Palin retorted that to many Americans higher taxes means "killing jobs, hurting small businesses and making things worse."  Point to Sarah.  Joe, go back to partitioning foreign countries.

Polls 2008: Rove Reads Tea Leaves

Polling data gets curiouser and curiouser, and Karl Rove serves up intriguing data that readers may parse, that support why John McCain has turned the tables on Obama: negative campaigning hurts "new politics" Barack more than it hurts Big Mac.  Note this nugget at the end of Rove's op-ed:

In a revealing slip in an interview with ABC recently, Mr. Obama said, "If we're going to ask questions about who has been promulgating negative ads that are completely unrelated to the issues at hand, I think I win that contest pretty handily." That he is in fact winning the contest for the most negative campaign could well spell his defeat.

Leverage: A Double Whammy

An LFTC reader asked me to explain the concept of leverage with more clarity than I have done to date.  So:

Leverage = the ability to invest or lend larger sums than one actually puts up in advance.  Banks have $1 held in reserve for every $16 to lend.  This is one form of leverage.  Buying a stock on margin of 50 percent is another form of leverage: you put up $1,000 and buy $2,000 worth of stock.  If the stock doubles you make $3,000 but must pay off the $1,000 you borrowed, leaving a net profit of $2,000.  You made $2,000 by putting up only $1,000, instead of putting up $2,000 at the outset.  But you always had $2,000 at risk; you simply did not have to put all the money up in advance.

The danger of leverage is this: If the stock price falls to zero, you have lost not $1,000, but $2,000, and must then come up with the additional grand.  If you do not have it in cash, you must sell or pledge as collateral an asset to raise money and pay off the debt.  If you have no assets to sell, you are bankrupt.  If a bank lends $16 billion against $1 billion of reserves, it is betting, based upon business experience, that depositors will not show up and ask for more than $1 billion.  If there is a run on the bank, in times of financial panic, this can happen, and then the bank is bankrupt.

The danger now is that banks doubled down on their leverage, lending to highly leveraged enterprises, especially with mortgage-backed securities (MBS) and complex financial instruments.  MBS value is based upon housing prices.  When the housing bubble collapsed, banks saw the value of their assets decline, under accounting “mark to the market” (MTM) rules.  MTM rules make sense in normal times, for assets whose valuation is constantly verified in marketplace transactions.  But MTM rules, in times of decline or with hard-to-value assets, can spur balance sheet disaster by pushing bank reserves below the 16:1 benchmark, forcing the bank to reel in loans or declare bankruptcy.  The current mortgage market risk is that no one knows when the housing market will recover, ending the downward slide.  With complex instruments, because no one knows from market trading what their true value is, conservative accounting principles dictate an artificial MTM value on the low side of valuation estimates, which radically exacerbates the problem of declining assets.

Leverage is a joyride on the way up, and Hell on the way down.  Like riding a kite in a hurricane, you can really soar on the way up, but beware of the descent.

Culture Hits the Beltway Bandits

Little known outside the Beltway is that Washington DC, in its better aspect, it a culturally rich environment.  From an example, here is a clip of "La Traviata" (2:24) from opening night. The exquisite coloratura soprano in the title role of Violetta is opera superstar Elizabeth Futral.

Index 9/18/08

4 posts: (1) Oval Office Job Resumes: Barack v. Big Mac--The Home Front; (2) Financial Meltdown: More Ideas--"It's the Economy Stupid!"; (3) Cyber-War Politics--The Home Front; (4) Famous Spy Case Closed, 55 Years Later--The Home Front.

Oval Office Job Resumes: Barack v. Big Mac

Community organizer, law student, lawyer, state legislator, US Senator....carrier-based fighter-bomber pilot, survived torture in captivity, commanded postwar stateside squadron, naval liaison to Capitol Hill, Congressman, Senator.

Let's go beyond that.  A New York Times op-ed describes in a few paragraphs the awesome responsibilities carrier pilots carry, and their qualities of character: flying a plane catapulted off a moving deck, braving combat, landing on a pitching deck, having your performance constantly publicly graded against that of your fellow pilots, carrying the responsibility of decisions that can have life or death impact.

Now, on the other hard, Barack Obama served 143 days when the Senate was in session, in his first term, before he announced the formation of an exploratory committee to consider seeking the presidency--in reality, he had decided then to seek it, but now sought backing--people + money--to launch a formal campaign.  143 days of experience, it seems, is not sufficient to get a new hire at McDonald's promoted to district manager.

Take your pick.

Financial Meltdown: More Ideas

A Wall Street Journal editorial sums up perfectly the confusion in both campaigns: Barack & Big Mack know more about Mars than they do about finance.  Great.  Another WSJ editorial questions the AIG bailout, which AIG founder Hank Greenberg defends as not a bailout, but a bridging loan extended to an otherwise sound enterprise.  The indispensable WSJ throws in darts aimed at DC's most deserving target, Massachusetts Congressman Barney Frank, who guarded Fannie & Freddie even as the financial mess got worse.  WSJ columnist Holman Jenkins wonders if the AIG bailout sends the federal government closer to the "out of cash" cliff.  Economist Alan Reynolds argues that "panicky interventions" add a "capricious element" that protects bondholder at the expense of equity holders.  Reynolds sums up the AIG move:

As it is, the US government is charging AIG an interest rate above 11 percent for a well-secured two-year loan of $85 billion. That rate properly includes a fat risk premium above the Treasury's two-year borrowing cost (about 2.2 percent) - but the government is also greatly diluting AIG stockholder equity by taking a 79.9 percent stake in the company.

The nation's largest insurance company has been virtually nationalized, surely a draconian solution.

Reynolds continues:

Owners of common stock are supposed to be last in line during an actual bankruptcy, getting leftover scraps after creditors pick a firm's assets to the bone. But in anything short of that, patient stockholders stand a decent chance of eventually seeing some recovery in the share price, if and when the firm gets back on its feet.

And in the recent crises, bankruptcy was involved only in the case of Lehman - the one time the feds kept their hands off.

From Treasury Secretary Hank Paulson and Fed chief Ben Bernanke on down, top officials have shown too little confidence in markets and too much confidence in themselves. As a result, anyone who's still holding stock in a financial firm now faces a big new risk premium - because these companies are now subject to compulsory mergers on unfavorable terms (as with Bear Stearns, where the feds initially tried to force stockholders to take just $2 a share) or quasi-nationalization.

Reynolds warns about two regulatory tools: (1) the Basel standards for capital, that presume to know how to assess the relative risk level of complex financial instruments; (2) mark-to-market rules, which artificially depress assets values for complex securities whose market value is unknown.  The danger here is pushing firms that could potentially work out their problems over time, into premature liquidation for temporary insolvency.

The New York Sun (a paper the without capital infusion dies at the end of September, a huge prospective loss to the news scene) reports that a former Securities and Exchange Commission official blames a 2004 rule change for hyper-leveraging.  The 2004 rule allowed the Big Five Wall Street firms--only two of which survive independently now: Goldman Sachs and Morgan Stanley--to double their leveraging and take assets off the books to avoid marking them down.  The Sun sums up the "net capital" rule, originally created in 1975 but loosened in 2004:

The so-called net capital rule was created in 1975 to allow the SEC to oversee broker-dealers, or companies that trade securities for customers as well as their own accounts. It requires that firms value all of their tradable assets at market prices, and then it applies a haircut, or a discount, to account for the assets' market risk. So equities, for example, have a haircut of 15%, while a 30-year Treasury bill, because it is less risky, has a 6% haircut.

The net capital rule also requires that broker dealers limit their debt-to-net capital ratio to 12-to-1, although they must issue an early warning if they begin approaching this limit, and are forced to stop trading if they exceed it, so broker dealers often keep their debt-to-net capital ratios much lower.

In 2004, the European Union passed a rule allowing the SEC's European counterpart to manage the risk both of broker dealers and their investment banking holding companies. In response, the SEC instituted a similar, voluntary program for broker dealers with capital of at least $5 billion, enabling the agency to oversee both the broker dealers and the holding companies.

The former official, who created the 1975 rule, calls this the sole cause of our problems.  This is piffle.  Fannie & Freddie is a Beltway disaster minted in Congress, both parties going along, albeit the Democrats more eager and pushing harder for F&F.  The subpirme crisis was also created in Congress by liberals pushing for more loans to poor borrowers, on lenient terms--especially, at the risk of being politically incorrect--to minority borrowers, to avoid what pols like to call "redlining" of poor neighborhoods.

Another mess is credit default swap arrangements, which amount to swapping complex credit derivatives (whose value derives from the credit risk on an underlying financial instrument) among institutions.  Wiki explains the hazard:

A credit default swap resembles an insurance policy, as it can be used by a debt holder to hedge, or insure against a default under the debt instrument. However, because there is no requirement to actually hold any asset or suffer a loss, a credit default swap can also be used for speculative purposes and is not generally considered insurance for regulatory purposes.

One equity maven blames bad regulation that forces artificially low valuations on assets which may temporarily be down 20 percent, thus destroying 100 percent of their value, which otherwise would, over time, rebound.  Another expert explains in detail:

Here are the key events: Two investment banks, categorized as non deposit-taking financial intuitions (NDFIs), were in difficulty. One fire-sold itself to a bank (Merrill). The other went bust (Lehman). In the case of AIG, another NDFI, the government has imposed a controlled bankruptcy through nationalization.

The collapse of these NDFIs ought to have been expected. Why? They have much less capital than banks to support losses and far riskier assets. They borrow and lend money using securities (often pledged by their clients) as collateral. As financial markets fall their gearing ratios (i.e., the value of their debt relative to their assets) rise. To maintain a constant gearing ratio, the NDFI has to liquidate assets and pay down loans. This causes financial asset-prices to fall and the NDFI gearing ratio to rise again.

Then the process begins again.

The points to bear in mind from this are that NDFI balance sheets are notoriously cyclical, far more so than banks, which have much more stable loans. Last November, my firm put the ultimate losses that banks and NDFIs would suffer as a result of the coming credit crisis at about $1.3 trillion (this included losses in the credit insurance industry, specifically singling out AIG). Of those potential losses, approximately half were marked down to NDFIs and the rest to banks. But up to Black Sunday, the NDFIs have admitted losses of only $250 billion, compared to the banks' $510 billion.

He continues:

Bank lending cannot escape the process forever. The current level of losses in the financial system is ultimately consistent with a 4%-6% contraction of credit. That is quite something when you consider that the global economy needs a 10%-15% expansion of credit to grow by 3% in real terms.

When bank credit does contract, the impact on the real economy will be more marked than we have seen thus far. The reason is that most bank credit is the sort of money that gets spent in shops and garages, or is used by the corporate sector to invest in real assets. NDFI money is used to invest in financial markets, causing security prices to rise and fall, which only indirectly affects the real economy by changing the value of wealth.

So, the outcome will be a long gray, global recession -- not unlike what Japan experienced after the bursting of its "bubble economy" -- in which policy measures (low interest rates, huge liquidity injections and fiscal spending) will attempt to keep it from developing into a deflationary collapse while the credit system adjusts.

Another equity maven argues that the deeper the downturn, the quicker the recovery.  Really?  So let's go all the way to zero tomorrow?  Then we will all be gazillionaires in a week?

Three top finance mavens call for a reincarnation of the Resolution Trust Corporation, used originally in the S&L workout two decades ago.  Finance mogul Steven Rattner argues that we need batter capitalized institutions:

So what will Wall Street look like after it goes back to the future? For now, the market is loudly signaling that it wants larger, better-capitalized financial institutions. Even the vaunted Goldman Sachs and the venerable Morgan Stanley may prove too small to remain independent.

For those which emerge, both management and oversight will need to be far tighter. That will be reinforced by a dramatically changed business model. Instead of highly leveraged banks providing a commodity -- money -- at razor thin margins, we will have less leveraged institutions providing a scarce resource -- money -- at more profitable pricing.

Former Bush Jr. Council of Economic Advisers Chairman Lawrence Lindsey writes that deposit insurance rules must be loosened.  Herewith the key paragraph:

The place where we absolutely must build a firewall is around the payments system. It is hubris to assume that the health of our commercial banking system will be untouched by recent events, and that we have built good-enough safety nets in the last 70 years that we need not worry. Nearly 40% of the assets in the banking system are not protected by FDIC insurance because they are in accounts that exceed the $100,000 insurance limit. Most of these are not "investments" in the usual sense of the word. They are often the transaction accounts of businesses that have to meet payrolls and pay vendors. If you have to make a biweekly payroll for 50 people, it is sheer folly to expect the paychecks to be drawn on accounts in three or four separate banks. Sometimes individuals who would normally keep a balance well under $100,000 might be over the limit to make a downpayment on a house, purchase a car, or pay quarterly taxes.

Financial maven John Rutledge says the Fed is blowing it, by transferring funds from healthy banks to failing ones.  The Fed is, on one hand, pouring its own capital into failing institutions to bail them out.  But it is also selling more Treasury bills on the open market, thus taking capital out of the economy to replenish its own reserves:

As I have been screaming for a year, the U.S. crisis is a capital market event, not a GDP or CPI event. Investors lost confidence that they were able to understand the cash flows they would receive as security owners. They simply refused to own bonds, which shut down the mortgage market. The capital market has been frozen like a fly in amber, with prices no longer a reflection of the value of the underlying cash flow streams.

Rutledge continues:

The Fed’s job is to provide liquidity. Instead, they diverted their energies to propping up troubled banks and investment banks by extending massive loans to institutions that were never eligible before. At the same time, they adopted procedures to sterilize the resulting reserve increases by selling T-bills in the open market to suck the additional reserves back out of the market. The net result was simply to shift bank reserves from healthy banks who were making loans to their customers to the sick ones. Total reserves did not go up at all. The monetary base has not grown in the past year. The Fed’s balance sheet has imploded.

The upshot of all this is the Fed has provided no liquidity whatsoever and we have had one crisis after another.

Rutledge says that the pols focused on consumer spending with the rebate stimulus package, which predictably failed to help a capital and credit problem.  Do not raise anyone's taxes, he warns.  Until the credit markets are unlocked, nothing good will happen.  Obama's plan to raise taxes on the 5 percent of federal income taxpayers who pay 71 percent of federal income taxes is suicidal: These taxpayers have the most skin in the investment community, and if they are hammered they will invest less and take liquidity out of the market.

The Fed, it seems, must also be divested of its second responsibility, after protecting the dollar and liquidity: the Employment Act of 1946 tasked the Fed with ameliorating unemployment, a job no other central bank in the world has.  It creates a rationale for the Fed debasing the currency in an effort to goose the economy, instead of the pols cutting taxes and spending in order to do so.

The Wall Street Journal editors tally the Fed's commitments as $380 billion out of the Fed's $888 billion--about 43 percent of the Fed's total balance sheet--with more to come, as the Fed, the WSJ writes, shoots from the hip based upon Hank Paulson's judgment as to which firms pose systemic risk and which do not.  Paulson's guess is a better one than the 4 candidates have, or anyone on Capitol Hill, but neither he nor anyone really knows enough to do this job consistently well.

Bottom Line.  The economic and financial mess we are in will take years to work through.  Politicians promising quick results will only make things worse.  More regulation is a certainty, and if bad, as is likely, will delay the workout process.  Stay tuned, and protect capital.

Cyber-War Politics

The latest campaign development: hackers--most of whom are left-wingers--hacked into Sarah Palin's personal e-mail account and posted it on the World Wide Web for all to see.  The contents seem innocuous, but the message to targets of cyber-war cannot be more clear.  GOP candidates, you have been warned: Anything you have in an e-mail account is fair game for friends of the Democrats and their media allies.  You are well advised to establish alias accounts under names that hackers cannot find.  Then build trusted networks who will not divulge the alias.  Sarah Palin could, for example, use "Pit Bull" or "Lipstick" or "Hockey Mom."  These are, of course, too obvious.  But some security precautions must become standard for GOP candidates

What makes this more important is that, as Manhattan Institute scholar Peter Huber argues with his customary persuasiveness, the Web is assuming an increasingly important role in politics.  Whether, as Huber asserts, they are already dominant is unclear, but eventually the Web probably will dominate.  Which makes the hacking episode ominous for future campaigns.

Famous Spy Case Closed, 55 Years Later

Ronald Radosh, co-author of The Rosenberg Files, reports that, at long last, the guilt of Julius & Ethel Rosenberg on the charge of spying for the Soviet Union has been conclusively established.  Co-defendant Morton Sobell confessed last week, at age 91; the two sons of the Rosenbergs, who have been fighting to clear their parents' names for a generation, have conceded the issue.  The case was kept alive by leftists all this time, and presiding trial judge Irving R. Kaufman excoriated for sentencing the Rosenbergs to the electric chair.  Case, at long last, closed.

Index 9/17/08

4 posts: (1) Trans-Asian Tides: Afghanistan, Pakistan, Iraq, Georgia--Wobble Watch; (2) Health Care: Comparing the Candidates--The Home Front;  (3) Wall Street: Sour Apple--The Ap & the Cap; (4) CIA = Cover Intelligence A$^&s!--The Home Front.

Trans-Asian Tides: Afghanistan, Pakistan, Iraq, Georgia

Author-pundit Anne Applebaum describes a complex tapestry inside Afghanistan, where more military, civilian and financial resources are needed, if victory is to have a chance.  A Washington Post front-pager recounts an encounter at the border where Pakistani troops fired warning shots to prevent American forces from crossing the Afghan boundary.  The episode proves anew the wisdom of Sarah Palin having sidestepped Charles Gibson's pressing here--three times--to say whether she advocated entering Pakistan without the government's consent.  It also places in stark relief the foolishness of Barack Obama's summer 2007 comment that he would invade Pakistan to go after bin Laden.  Underscoring the sensitivity of these matterrs, the Washington Post reports that Admiral Mike Mullen, Chairman of the Joint Chiefs of Staff, flew to Pakistan to confer with senior leaders in the aftermath of the confrontation.

Frederick Kagan, co-architect of the Iraq surge plan, informs us of how three Democratic senators blocked a deal the Iraqis were ready to sign with five western oil companies,  What passes for their rationale was their fear that the contract, absent a hydrocarbon law, would increase instability inside Iraq.  Apparently the three senators think their judgment better on the impact of events inside Iraq than the government over there.  So instead Iraq signed a deal with...China.  Herewith the three: Senators John Kerry (MA), Claire McCaskill (MO) & Chuck Schumer (NY).  On the more positive side, here is a report on progress in Baghdad with the Iraqi police, who are collaborating with American troops as did the Iraqi Army, during the transition.  Columnist David Ignatius salutes the spectacular 20-month tenure of Gen. David Petraeus as commander in Iraq, a tenure that will adorn history books for generations.

A New York Times story sifts through new evidence on the beginning of Russia's August invasion of Georgia.  Georgia released call intercepts showing that Russian troops had moved into South Ossetia on Aug. 7--the day before the official invasion began.  The Gray Lady reports:

Russia has not disputed the veracity of the phone calls, which were apparently made by Ossetian border guards on a private Georgian cellphone network. “Listen, has the armor arrived or what?” a supervisor at the South Ossetian border guard headquarters asked a guard at the tunnel with the surname Gassiev, according to a call that Georgia and the cellphone provider said was intercepted at 3:52 a.m. on Aug. 7.

“The armor and people,” the guard replied. Asked if they had gone through, he said, “Yes, 20 minutes ago; when I called you, they had already arrived.”

Shota Utiashvili, the director of the intelligence analysis team at Georgia’s Interior Ministry, said the calls pointed to a Russian incursion. “This whole conflict has been overshadowed by the debate over who started this war,” he said. “These intercepted recordings show that Russia moved first and that we were defending ourselves.”

The recordings, however, do not explicitly describe the quantity of armor or indicate that Russian forces were engaged in fighting at that time.

Armor was there 20 hours before the war began?  Western intelligence confirmed further that two battalions were moved into South Ossetia late Aug. 7 or early Aug. 8.  Moscow denies combat intent, but under a 2004 accord it was to move troops only in daylight and with one month notice.

Health Care: Comparing the Candidates

Hudson Institute economist Diana Furchtgott-Roth compares the McCain & Obama health care plans.  In a nutshell, Mac offers a refundable tax credit of $2,500 per individual and $5,000 per family, and health savings accounts--incentives + privatization.  McCain's plan would put employer-paid plans into the system and offset, for all but the highest-income taxpayers, the cost of the lost benefits via tax credits.  The shift would make all health plans portable as between jobs, a major problem now that accounts for most of the uninsured.  The credit is "refundable," meaning it is paid even if the amount exceeds taxes paid, with the surplus going into health accounts.

Obama offers a national health plan with cafeteria choices, supported by taxes paid in, a public sector plan.  It would raise taxes on some employers re their plans, and impose a regulatory scheme on public and private health plans alike.    D F-R believes that Obama's plan understates costs (socialized plans usually do).  Sounds like customer choice versus stealth HillaryCare Lite ("lite" because the cafeteria choice within Obama's plan offers some choice, unlike Hillary's 1993 monster).  D F-R's column is an excellent read.

Wall Street Sours the Big Apple

Economist Irwin Stelzer sees three consequences of the latest financial meltdown: (1) fewer, more risk-averse financial firms; (2) more financing of American business shifting overseas--notably to the Sovereign Wealth Funds in the Mideast; (3) decoupling of financial firm performance from that of Main Street.  Manhattan Institute scholar Nicole Gelinas warns that Wall Street's woes will spill over to the Big Apple.  After the Internet bubble burst and 9/11, 40,,000 of Wall street's  200,000 jobs left town.  Wall Street's losses were 1/6 of those for 2001- - 2003; a similar result could lead to NYC losing 10 percent of all its jobs this time around.  Wall Street paid over 1/3 off all wages paid in the City.  Losses in 2007 & 2008 were $33 billion--more than the record $21 billion the Street earned in 2006.  In the past 6 months, 3 of NYC's top 5 investment banks disappeared: Bear Stearns & Lehman bankrupt & Merrill Lynch acquired (by Bank of America).  Yawning budget gaps in NYC and NY State budgets can only grow as the Street continues to take water amidships.

CIA = Cover Intelligence A%^*s!

Michael Ledeen sees a totally dysfunctional intelligence agency that he thinks ought to be sundered in three: send the domestic spooks to the FBI, send the foreign policy types to State and send the overseas spooks to the military.  His usual crisp & witty writing, and well with three pages of reading. L. Gordon Crovitz of the Wall Street Journal chides the feds for lagging in distributing advanced information technology to those tracking terrorists; only 1/3 of FBI agents have Internet access at their desks.

Index 9/16/08

3 posts: (1) Obama's 2008 Foreign Policy: Keep US Troops in Iraq? --The Home Front; (2) Wall Street's Implosion: Lucky Luciano Was Right--"It's the Earth Stupid!"; (3) Obamanomics: A Tale of Six States; But Cui Bono?--The Home Front.