House Republicans Drop the Ball

I understand the case for the bailout, I really do.  Tim Peach and Dave Fitzgerald have done a very good job explaining it here, and John Mauldin explains it in much greater detail (and argues that it’s not really a bailout at all because the taxpayers will profit) here.  (Note:  The Mauldin piece is free, but you need to give him an e-mail address before it shows up on your screen.)  Because of all the bad things that would happen to the economy as a whole in the absence of the bailout, it’s no surprise that a deal has been reached.  Apparently there is no official text yet, but the Washington Post has a pretty concise rundown of the major points, and the stories in the New York Times and Wall Street Journal seem to be in accord.  What caught my eye, though, was what the House Republicans managed to get in return for ending their holdout.  From the Post story:

Meanwhile, House Republicans won a major victory, persuading negotiators to include a provision that would require the Treasury Department to create a federal insurance program that would guarantee banks and other firms against loss from any troubled asset, the official said.

That’s a major victory?  A new federal insurance program to guarantee banks and other firms against loss from any troubled asset? I guess that’s a major victory for the banks and the firms, but it seems to me it further attenuates the extent to which the risk-takers at banks and firms have to suffer the consequences when they bet wrong.

And this victory for House Republicans just gets better the more you read about it.  According to the Times,

Officials said they had also agreed to include a proposal by House Republicans that gives the Treasury secretary an additional option of issuing government insurance for troubled financial instruments as a way of reducing the amount of taxpayer money spent up front on the rescue effort.

The Treasury would be required to create the insurance program, officials said, but not necessarily to use it. Mr. Paulson had expressed little interest in that plan, and initial cost projections suggested it would be enormously expensive. But final details were not immediately available.

So what was the point of the holdout again?  Certainly not free-market economics, because it places another great big federal safety net beneath the high-wire artists on Wall Street.  Certainly not taxpayer protection because Treasury doesn’t even have to implement the program.

This is popularly referred to as a subprime mortgage crisis, but from everything I’ve been able to learn, it’s mostly about dangerous levels of debt and only accidentally about mortgages.  As Mauldin writes,

The second part of the problem is a little more complex. Because we were running a huge trade deficit, countries all over the world were selling us goods and taking our dollars. They in turn invested those excess dollars in US bonds, helping to drive down interest rates. It became easy to borrow money at low rates. Banks, and what Paul McCulley properly called the Shadow Banking System, used that ability to borrow and dramatically leverage up those bad loans (when everyone thought they were good), as it seemed like easy money. They created off-balance-sheet vehicles called Structured Investment Vehicles (SIVs) and put loans and other debt into them. They then borrowed money on the short-term commercial paper market to fund the SIVs and made as profit the difference between the low short-term rates of commercial paper and the higher long-term rates on the loans in the SIV. And if a little leverage was good, why not use a lot of leverage and make even more money? Everyone knew these were AAA-rated securities.

And then the music stopped. It became evident that some of these SIVs contained subprime debt and other risky loans. Investors stopped buying the commercial paper of these SIVs. Large banks were basically forced to take the loans and other debt in the SIVs back onto their balance sheets last summer as the credit crisis started. Because of a new accounting rule (called FASB 157), banks had to mark their illiquid investments to the most recent market price of a similar security that actually had a trade. Over $500 billion has been written off so far, with credible estimates that there might be another $500 billion to go. That means these large banks have to get more capital, and it also means they have less to lend. (More on the nature of these investments in a few paragraphs.)

Banks can lend to consumers and investors about 12 times their capital base. If they have to write off 20% of their capital because of losses, that means they either have to sell more equity or reduce their loan portfolios. As an example, for every $1,000 of capital, a bank can loan $12,000 (more or less). If they have to write off 20% ($200), they either have to sell stock to raise their capital back to $1,000 or reduce their loan portfolio by $2,400. Add some zeroes to that number and it gets to be huge.

So we’re definitely going to raise reserve requirements to deal with that leverage, right?  Not now, perhaps, but soon?  And we’ll take steps to address our trade deficit, or at least show that we recognize the importance of getting our economy back to the point where we’re exporting real manufactured goods rather than just derivatives?  And surely we’re going to do something about market concentration, so that we don’t wind up with a gun to our head because of imprudent risks at firms that are too big to fail?  And what better opportunity could there possibly be to decide as a nation that we have to get our loose fiscal policies under control and stop borrowing from abroad?  For $700 billion, when it looks like the We the People are the only ones who can stop global financial meltdown, it’s surely fair to ask for an actual long-term solution, isn’t it?

Apparently not.  I don’t know what kind of game the House Republicans were playing here, but the party’s intellectual bankruptcy has never been clearer to me than at this moment.


7 Responses to “House Republicans Drop the Ball”

  1. Mark Esswein Says:

    I thought the Mauldin piece was excellent. Unfortunately, it is still above the heads of most of the electorate.

    I’ve realized in the last couple of days that, unless you work in the finance industry, the real story hasn’t been readily available. I didn’t fully grasp the implications of the situation until I happened to hear a story on “Marketplace” that went into depth about the money market problem. Was I not paying attention or did the media completely drop the ball?

    As for the House Republicans, when I heard that Cantor (could have been any Va. Republican – they are all idiots) was involved, I just thought “’nuff said”.

  2. Mark Grannis Says:

    I just saw the House GOP leadership on CNBC, and they’re blaming an excessively partisan tone in a floor speech by Speaker Pelosi.

    I’m slack-jawed by this. There are all kinds of reasons to oppose the bailout, and I agree with many of them. But to oppose it because of a speech?

  3. David Fitzgerald Says:

    Game on. Let’s see how this plays out netween now and the election. This is what elections are supposed to be about.

  4. Timothy Peach Says:

    Let’s just pray that today’s selloff is enough to scare these candy asses back to the table.

    Thanks, Congress. We hired you to listen to angry callers and hide behind the furniture when we really needed you. You delivered and more.

  5. Mark Grannis Says:

    Someone claiming to be John Boehner has posted an edited version of Pelosi’s speech on Youtube. These are apparently the most offensive excerpts. I remain mystified by the claim that this influenced the vote total.

    I’m not sorry the bailout failed today, because to me it keeps a couple of potentially positive developments alive. For example, the first of the month could come and go with moderate losses in the stock market and no serious dislocations outside of lower Manhattan, in which case we might conclude that we really didn’t need the bailout. Alternatively, the Republicans — or (less plausibly) recalcitrant Democrats — could hold out for something really worthwhile, like an across-the-board cut in discretionary spending. Either of those things would be great. But to claim you’re voting no because of a speech?

  6. Mark Grannis Says:

    I should not neglect this House Republican who voted no for the right reasons:

  7. Timothy Peach Says:

    Partisans have taken advantage of the naivete of the American public on matters of modern finance to create the possibility of a total systemic collapse.

    We lost over a trillion dollars in market value today in US stocks alone, with a lot of that value coming out of pension funds and 401(k) plans.

    Unfortunately, if something dramatic doesn’t happen shortly, the pain inflicted on ordinary Americans will be multiples of that.

    Ron Paul is a crackpot, as are his brethren in the House, and history will treat them very poorly if they don’t come to their sense very quickly. They voted no because they want to stay in the House of Representatives, putting their personal interests ahead of the common good. Today was a seminar in that kind of behavior, on both sides of the aisle.

    Those of you here are about to be subjected, along with the rest of us, to a brutal “proof by demonstration”. The Asian markets are going to get absolutely obliterated overnight, and if we have no news in the morning, the markets are going to plummet again.

    What fucking good is wisdom if it profiteth not the wise?

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