Ed Brayton is a journalist, commentator and speaker. He is the co-founder and president of 
Jack Balkin has the same misgivings about the provision in the Bush treasury department's proposal for a $700 billion fund to purchase mortgage assets that I do. It's not the bailout itself, which may or may not be a bad idea, it's the total lack of accountability. Long excerpt below the fold.
In the latest version of its plan, the Secretary of the Treasury is given authority to take 700 billion dollars (that's 700,000,000,000) from the federal budget and spend it pretty much however he likes, free from any oversight requirements or restrictions that apply to public contracts and especially free from any form of judicial review. (The technical term for this is "committed to agency discretion.").Oversight and regulations of public contracts are designed to prevent malfeasance, corruption, self-dealing and conflicts of interest in the distribution of federal monies. (Here is a brief history of the Bush Administration's sorry legacy of squandering taxpayer money.). The Administration wishes to dispense with all of these restraints and precautions, just as it sought to run the Iraq war on no-bid contracts. That was bad enough, but here the dangers of bad deals and conflicts of interest are staggering. The Secretary is asking for authority to bail out Wall Street and enter into negotiations with financiers who include important parts of the political and financial base of the Republican Party. Not only will the Secretary be figuring out appropriate compensation for these people, he will also to a certain extent be deputizing a number of them to carry out a wide range of functions for the government.
Put differently, the Administration wants the Secretary to take over a sizable chunk of the nation's capital and insurance markets, and run them as a firm. It is a merger of public power and private capital that would have made a 1930s advocate of state corporatism proud. And because the Secretary's power is effectively unreviewable, he can make sweetheart deals with any or all of the firms and financiers that got us into this mess, providing handsome compensation packages to outgoing executives or, in the alternative, bring these failures into the government to run the new grand public/private business enterprise.
As the Secretary collects and sells off properties and debts, he alone determines who will be the beneficiaries of these sales, under what terms and conditions, and how the profits accruing from these sales will be distributed. In essence, the government will be buying assets from a group of people (many of whom caused or contributed to the crisis in the first place) that will then administer these assets for the government and then sell them back to the same group of people and/or their business associates. The possibilities for malfeasance, incompetence, corruption and conflict of interest are virtually endless.I do not oppose emergency plans to preserve liquidity in markets and prevent a further crisis. What I do object to is plenary discretion in the executive in running the nation's financial markets, especially given the history of the past seven years, which has been a sorry parade of venality, incompetence, hubris and failure.
The modus operandi of the Bush Administration has been to use crisis to seize unreviewable power for the executive. Have we learned nothing from the last seven years? True, the face of our new Dear Leader is Mr. Paulson, and not Messrs. Bush and Cheney. But who, pray tell, do Mr. Paulson and his associates work for? If one truly credits the theory of the unitary executive so beloved by the Bush Administration, who, at the end of the day will these masters of the universe be taking orders from? And whose friends, business associates, and allies will stand to benefit from their deal making?
But there is more. The current secretary of the Treasury will soon be gone, replaced by the appointee of a new Administration, run either by McCain or by Obama. The next President-- and the next Secretary of the Treasury-- will face the very same temptations. If you think that the current Administration will behave itself appropriately-- a dubious proposition given its history-- do you have any guarantee that the next Administration will be equally well behaved? (As one commentator pointed out below, the Democrats have their share of friends and allies on Wall Street too. And don't even get me started about a McCain Administration advised by Phil Gramm.) We set a dangerous precedent by handing more and more unreviewable power to the president to nationalize large aspects of our economy and run them without effective oversight.
Hear, hear.
Politics
Comments
Here is what I believe is a superior argument than the President's: http://online.wsj.com/article/SB122238704668077137.html
If the plan I linked to above does not provide adequate liquidity given it's injecting less capital than the President's plan by purchasing assets closer to fair market value rather than booked minus some risk bogey, than the Treasury should inject capital into strong performing lenders who should have new and incremental demand for capital to cover new, incremental lending opportunities as their competitors fail. Why should the American taxpayer pay a premium for bad assets with a ton of risk? They shouldn't. The buyer should reap the reward of that risk by buying at today's prices, not what Investment Banks claim is the book value minus some abitrary risk factor, a book value that has never been accurately booked at purchase or adjusted over time (the reason top management reaped huge bonuses was because they kept their book value inflated above market prices).
The Bank of America CEO stated in a column in today's WSJ that they are already seeing an increase in loan applications given weaker banks can't write new loans. We can provide liquidity without over-paying. What business would do such a thing? None.
I also have a major concern about the position of ignorance even the policy makers seem to have on this issue. I have yet to see a metric that measures liquidity, where it stands today, where is the "fail" level and where are we relative to that level, how liquidity has been trending over time in terms of value and acceleration, and what leading indicators are predicting given certain sets of actions or inaction. They appear to be scrambling around in the dark, certainly the President and Congress are.
Posted by: Michael Heath | September 26, 2008 10:03 AM
No oversight + 700 billion dollars + Bush administration. Sounds pretty good!
Posted by: 386sx | September 26, 2008 10:29 AM
Can anyone explain whether the provision specifying the unreviewability (for lack of a better word) of the Secretary's decisions can be challenged in court? Because it seems to me that if this were a Constitutional provision, it would have been tried before. Hopefully those more knowledgeable can enlighten me.
Posted by: Jerry | September 26, 2008 11:12 AM
I believe CNBC is now reporting the changes Paulson has agreed to does add a list of oversight measures:
Seems like Bush has had to back off his initial ridiculous "we can do anything we want without interference" stance.
Posted by: tacitus | September 26, 2008 11:39 AM
Michael,
I read the article you linked to, but I think the basic problem is "Buy the troubled assets at fair market value." A major part of the problem is that no one has any idea what the assets are worth. "Fair market value" could be anything from zero to (apparently) $700 billion dollars. Or more. Or less. No one really knows.
Posted by: Jeff Hebert | September 26, 2008 11:58 AM
Jeff
The reason you have a multi-bidder auction process is to help establish a market. That market will almost certainly bear a price much less than the booked value Bush is promoting. The bulk of the distressed assets when looked at individually are solid assets assuming no economic meltdown, as the President stated in his speech. They therefore do have some worth if the government shows a tangible committment to keeping markets liquid, a market lever individual banks lack and why assets are illiquid. Buyers will come to an auction if they know what they are buying will be liquid and the government is committed to running a regulated market rather than a free market.
There are companies, countries, and other asset-holders that will participate given that the bulk of the assets are strong and we don't see a humongous drop in real estate values - that risk will be accounted for in the prices set at auction. Japan and its banks for example of have plenty of excess capital not earning a desired ROI.
I think the central challenge is not the government won't be able to get to a price, I'm convinced you can, it is that the sales of the currently illiquid CDOs at auction prices will most likely not inject a sufficient amount of capital into the banks selling these assets to bring the market back to liquidity. That is why Paulson is arguing to buy them at booked value minus some risk bogey. I argue a superior method to reach your capital target if you don't want a meltdown is to push capital infusions to the winners, who are already seeing increased demand.
As a developer I'm in touch with two regional banks, both are in great shape and getting an increased bump in demand for new loans, they'll quickly run out of capital to reserve against these new loans, therefore they have a strategic interest in diluting their current stock by raising more equity capital to capture this market share. That is where the Feds can help by either brokering deals with investors, or inject taxpayer funds as form of equity position, but into strong companies, not companies that deserve to go down. Even a small signal by the funds for these types of lenders should allow them to get more capital from private investors.
Jeff - I haven't seen you posting much lately, I always appreciate your insights.
Posted by: Michael Heath | September 26, 2008 12:27 PM
This is my problem. I haven't seen much in the way of good analysis that supports the idea that it will have that effect. I'm skeptical that a temporary propping up of what is obviously a broken market will have any sort of momentum given that the factors underlying the value of the bad paper haven't really changed.
Beyond that, I'm not really a fan of giving a financial God card to an office that has a ~50% chance of being filled by somebody who considers the author of Dow 36000 a good economic adviser.
Posted by: Troublesome Frog | September 26, 2008 1:36 PM
Jerry,
Article III of the U.S. Constitution says the federal courts shall have the power of appellate jurisdiction "with such Exceptions, and under such Regulations as the Congress shall make."
The scope of that clause is debated and has not been fully worked out in Court decisions. However my take is that it does in fact allow Congress to exempt legislation or executive action from judicial review--at least to some extent.
However IANAL, and in my grad classes on Con Law we never covered this issue. Kehrsam or some other well-educated folks here might have more to add, I hope.
Posted by: James Hanley | September 26, 2008 2:30 PM
Troublesome Frog - I may not have clear enough for you to get my point. Sorry 'bout that.
The Bush argument is that they'll inject plenty of capital into the market since they'll be immediately buying at close to book value. The Bush plan injects capital up front, not after a sale. Therefore their capital infusion should be sufficient and quick, I have a problem with how they are investing our money, I think it's a horrible investment when better options are available.
The problem I'm referring to in regards to insufficient capital in my quote above is if we went with an alternative plan not to purchase the assets at close to book, but instead broker a multi-bid auction, that should yield prices at market value, significantly less and probably insufficient to what is required to make the market liquid. That would require a step 1.b, which could be done immediately or in parallel, which is an infusion of capital beyond the capital invested in the CDO's into strong lenders, thereby providing them the reserves/capital needed to increase the amount of loans (assets) on their books, demand that is already appearing to at least three banks I am aware of.
Posted by: Michael Heath | September 26, 2008 2:58 PM
Hmm. I may be wrong about this, so if I am someone please correct me. Paulson and Bernanke believe that the assets in question are undervalued in the current market and that this undervaluing, because no one is actually sure of how much capital is based on the assets in question, and because past measures to alleviate the problem have had little effect, has reduced liquidity in capital markets, reducing the ability of banks to provide money to consumers and driving down the stock prices of companies, like Goldman Sachs, which aren't really in any danger from the price collapse in the debt derivatives and securities markets.
Their solution is the reverse auction, wherein they will determine a price for these assets pegged to the value they were accorded before the price collapse in the market for them (the book value), then use however much money is required, which Treasury has estimated to be $700 billion, to buy up these assets from whatever company wishes to participate.
So, unlike in our approach to AiG and the FM's, the Federal Government won't be buying stakes in the companies, just taking their rapidly devaluing assets of their hands, and then at some undefined later date when presumably the market for mortgage-backed securities and credit default swaps recovers, selling them back to the private sector for a profit, this profit (or the bet on this profit coming about in the future) being set aside to help refinance homes foreclosed on as a result of the adjustable rate mortgages.
Is this correct, or have I read faulty information/misunderstood?
Posted by: Julian | September 26, 2008 3:54 PM
"After initial signs they might be left out in the cold, most European and international banks holding substantial amounts of troubled U.S. mortgage debt now expect to be eligible for the $700 billion bailout plan..."
Is the American tax payer seriously expected to bail out the global market?
Posted by: pensy | September 26, 2008 4:02 PM
Thanks Michael, that's kind of you to say. Frankly the volume of comments here has gotten a bit overwhelming for me. By the time I get to a post and think of something to say, inevitably someone else has said it first and better. Not that that is a bad thing :-)
I don't really understand all of the finance stuff. I find myself falling back on primal emotions -- I don't trust anything the Bush Administration says, at all. I feel like I've been down this road before with the Iraq War buildup and the FISA fight and I fear I am about to get screwed over again. My rational brain knows that someone, somewhere, probably has a good idea of what we ought to do, but my reptile brain refuses to believe they'll get anywhere near the levers of power to actually implement anything.
Essentially my confidence in my government has fallen to such an abysmal nadir that I no longer have any faith in even the broad outlines of what they are telling me. I question whether there really is a crisis in the first place. I question whether there is any chance that the current custodians are in any way competent to solve it.
It's an odd position to be in; I feel like I ought to be grabbing a pitchfork and a torch and storming the castle in a rage at the monster I do not understand but fear nonetheless.
This concludes the "personal journey" portion of "Oprah on Brayton".
Posted by: Jeff Hebert | September 26, 2008 4:13 PM
What I really don't understand is why Paulson and Bernanke seem to have such a problem with getting equity in these companies as opposed to just buying their devalued assets.
It seems like a very obvious thing to do, something that has been done before (S&L crisis, Sweden crisis), pretty much a no-brainer. Thankfully the Dodd plan has included it and is most likely what will get passed at the end.
But did they ever come up with a real reason for their opposition to this? I mean now that they started making up reasons at all as opposed to just saying "give us the money, we'll fix it, trust us".
Posted by: Coriolis | September 26, 2008 4:14 PM
Michael Heath: I'm somewhat confused about the WSJ plan, likely owing to my own ignorance of banking and capital markets. What does Mr. Bebchuk mean by "the Treasury should buy [the assets] through multibuyer competitive processes with appropriate incentives"? Does he mean the different Fed bank branches should compete against each other to buy up the assets, or that the assets should be put up for public auction, and then the Fed should buy them off the companies who purchased the securities, or something else entirely? If all of the assets are going to the Treasury, then how can the process be multi-buyer?
Posted by: Julian | September 26, 2008 4:26 PM
Note: Dodd's proposal for equity warrants, which seems to be in all proposed versions of the bill except Paulson's and the lunancy McCain sorta-kinda-maybe backed, deals pretty neatly with the problem of overpayment.
Financial companies that overcharge the government for their assets give up equity at a 1.25 to 1 ratio -- meaning the more a financial company overcharges, the more stake (or senior debt, for a private concern) the government ends up with.
That sort of provision more or less makes ANY institution wanting a bailout to be desperate in order to accept at all, and highly encourages them to sell as few assets as possible for as close to the 'real' value as they can get.
Posted by: Morat | September 26, 2008 4:49 PM
Morat - while true regarding warrants; the bigger our loss on the warrants, the greater the chance the warrants are worthless.
Better the taxpayer only buy assets at a price the market can bear or invest in lenders with a reasonable expectation of providing some discipline to the underwriting process.
Dodds is putting lipstick on a pig.
Posted by: Michael Heath | September 26, 2008 4:57 PM
James Hanley is correct that the issue of stripping jurisdiction from the Supreme Court has never really been tested. An article on the issue from 2004 is available on the American Constitution Society's blog: http://www.acsblog.org/bill-of-rights-congress-attempts-to-strip-federal-courts-of-power.html
The issue was raised in the case Calcano-Martinez et al v. INS, but the Court sidestepped the issue, merely commenting (in dicta): "We agree with petitioners that leaving aliens without a forum for adjudicating claims such as those raised in this case would raise serious constitutional questions." They follow that by not identifying those questions or commenting on them.
So its the perfect situation for the Administration, claim a disputed power under cover of an emergency. I hope Washington will be under adult supervision the next four years, but I'm not counting on it, even if Obama wins. Is it just me, or does his campaign sound more and more like Bill Clinton every day?
Posted by: kehrsam | September 26, 2008 5:24 PM
Michael Heath:
I assume that when you say:
you mean that if we buy a lot of bad paper from firm X at well above market rates, we're likely to get "paid back" in equity in a bankrupt company when it all plays out. I don't necessarily see that as likely. It would certainly play out that way in a number of cases, but what is that loss compared to the loss of buying $700B worth of crap at well above market rates and eating the eventual loss?
It seems to me that Dodd's proposal works the same way as recapitalizing the lenders by investing in them, but without the drag of an immediate change in ownership or dilution. As you point out, it also comes without the additional discipline that we could enforce by being large shareholders immediately, but it seems that could be worked out by attaching the proper strings.
My issue is that we seem to have a choice between:
1) Having those assets go at market price, which tanks an unknown number of undercapitalized lenders. In fact, the whole problem is that market price on those assets is too low to keep people solvent.
2) Buying those assets well above market price, which is no different from just writing a check to every wiped out lender and saying, "There you go. Don't spend it all in one place. We'll see you when we do this again in a few years."
3) Taking an ownership stake and recapitalizing salvagable firms, by investing and dictating good behavior as shareholders (i.e. nationalizing them until they're stable again).
4) Something akin to Dodd's plan wherein we inject enough capital to keep them alive and let them deal with the dilution when the time comes instead of up front.
I'll take either 3 or 4 over 1 or 2 at this point. The main reason Dodd's plan sounds good to me is that the alternatives seem to be:
1) Letting everybody fail and eating it.
2) Writing a check to bad actors and rescuing them from their own stupidity with no meaningful strings attached.
3) Some sort of insane capital gains tax holiday that was apparently proposed by some congressmen who should go stand in the corner and be quiet.
If somebody in Congress wants to support bringing in the Red Hand of Communism and buying up lots of tanking lenders, I'll get behind them. My guess is it's a political non-starter, though.
This is not a happy week.
Posted by: Troublesome Frog | September 26, 2008 7:05 PM
Frog - nice synopsis.
However, there are additional choices.
I say have gov't broker an auction on your choice 1. The selling banks most likely go under, but they should anyway.
Don't nationalize struggling firms, instead invest in stronger firms that are capital limited, like Wells Fargo and Bank of America to increase their leverage.
Also, thanks for translating my quote, I was having Internet connection problems and didn't proof my work very well. I did mean to say the bigger the booked value of the warrant, the more likely it was worth zilch, which you appear to understand. It's a hedge to a bad plan, better we start with a good plan.
Julian - I agree that Bebchuk was unclear on this point. I believe he meant the asset managers the Treasury Dept. plans to hire to manage these assets would bid against each other and would get paid based on their rate of return after they resell what they purchase. I find that kinda weird as well they could compete for the same assets, driving up the price the taxpayer would have to pay and spend in interest carrying them and sell for a higher price to make a return.
I continue to prefer the government act as one bidder against other bidders, e.g., sovereign wealth funds, Japanese banks, BofA, some hedge funds, etc. The key to bringing buyers to the table is the promise by the gov't to bring liquidity in whatever form as long as their cash enters the credit market, so why buy high?
Rep. Barney Franks was on Hardball just now and says he gets this and is working to incorporate some of this into his bill, I heard just the tail end of it so I might be wrong on Frank's perspective.
Posted by: Michael Heath | September 26, 2008 7:24 PM
Michael Heath: Thanks for clearing that up. From what I've heard so far, your idea of putting the markets up in a limited market so as to keep banks from grabbing potentially more bad debt while using the proceeds to recapitalize smaller, solvent lenders, and (unfortunately from a moral hazard perspective) nationalizing the assets in question for a limited period (either through seizure or Baker's plan of taking any asset off a companies hands at no or little charge in exchange for an equal percentage of company ownership) seem to be the only 2 palatable ideas being bandied about.
Speaking of Congressman Franks, I just watched him give a joint interview with Mike Pence on the Newshour. I am a rather partisan individual, but Mr. Pence's performance sealed in my mind the House Republican's desire to make this an election issue regardless of the economic impact of doing so. It's up on the Newshour site under recent programs if you want greater clarification on Franks' views.
Posted by: Julian | September 26, 2008 8:11 PM
After posting that, I realize the partisan comment might not be clear. I mean by it that I have a long history of supporting the Democratic Party and that this may have colored Rep. Pence's performance in my eyes. Having said that, I'd rather their be consensus on this issue than a hastily passed and poorly constructed plan.
Posted by: Julian | September 26, 2008 8:22 PM
*facepalm* That should be "there", obviously. I really must start using the preview function. :/
Posted by: Julian | September 26, 2008 8:24 PM
Michael Heath:
If I thought that we could allow the insolvent or near-insolvent players to go under in an orderly way, I'd be all for it. My concern is that there may be too many firms out there with too many liabilities to allow it to go that direction. We're in a very fragile state, and I'm inclined to go with the more traditional and low-risk solution of temporarily nationalizing and rehabilitating those firms and wiping out the shareholders in the process.
BTW, there's a great video discussion from some of the Princeton economics department here.
Posted by: Troublesome Frog | September 28, 2008 12:12 AM