They write letters

A friend cc:ed me on a letter to his Congressman, and I think he's basically right about the Wall Street bailout. He writes Congress:

Please say NO. The Bush Administration's proposed bailout plan is overly broad, vastly too expensive, and lacks oversight and control that is absolutely necessary. The plan should be rejected unless it is significantly modified.

Under terms of the plan the Secretary of the Treasury can do anything he wishes with $700-Billion. Anything. No restrictions, no oversight by Congress, no review by the courts. As dangerous as our financial situation is, giving absolute power to one cabinet secretary (and by extension one President) is vastly more dangerous.

Under provisions of the Paulson proposal, he can hire any contractor he desires, essentially deputizing anyone he designates to carry out the negotiation and spending of our money. No bids. No review. No oversight. No control. Since we know what happened when this administration was given blanket authority in Iraq and in the aftermath of Katrina (as two instances) – I refer here to no-bid, no-oversight contracts let to political cronies with no experience or ability and resulting in the squandering of billions of dollars that helped no one except the contractors – we can only assume this "bailout" plan will be used to reward political cronies who will be subject to no review by Congress, Courts or regulators. This is like putting money on the table to be stolen.

There are other reasons to be skeptical and wary of this plan – many reasons to study, revise and amend this proposal. One of the biggest is need to build in supervision, oversight, investigation and the opportunity for litigation to limit the possibility for fraud and abuse.

Sincerely, from your constituent,

I think that Congress would listen if they got enough of these letters. The problems facing the nation are enormous, and the bailout under discussion addresses few if any of them.

To review:

Upon taking the oath of office in 2001, George Bush faced an economy at the tail end of a tech bubble, and on the road to recession. He fumbled, and the resulting recession was exacerbated by the attacks of 9/11, and the debt-financed war in Iraq did nothing to boost the economy. To fight the recession, the Fed kept interest rates low. This encouraged people to buy expensive things like houses. It also meant that people with lots of money didn't put it in banks, because interest rates stunk. And they didn't put it in Treasury bills and notes, because the rates of return stank. The wizards on Wall Street set to work, and came up with a genius idea.

Mortgages are, as the British say, safe as houses. With careful review of financial records, you could work out which mortgages were safest, and you could bundle a bunch of safe mortgages together, then break that bunch of mortgages up into chunks (which Wall Street wizards call tranches). Then you promise that people who buy tranche 1 from the bank will get paid back first, followed by tranche 2, and so forth. Then you take the riskier tranches, and break them up into small subtranches, which can in turn be subdivided. Then you sell the uppermost tranches from each subgroup, treating them as low-risk. Then you bundle a bunch of different tranches together, and sell it as a mortgage-backed security (MBS).

All that money which people and institutions wanted to put into safe bonds, but which wouldn't earn any interest in a T-bill or a bank account, wound up getting poured into these securities. They were rated as very secure investments (based on past performance of mortgages), but paid high interest.

The problem is, there weren't enough mortgages to create enough MBSs to fulfill demand. So the Wall Street wizards pushed the mortgage brokers to issues more mortgages. This wasn't hard, since low interest rates meant a lot of people wanted to buy houses. And to let them do so, banks started reducing their requirements. Pretty soon you could apply for a mortgage (at high, variable interest) without showing any proof of your income. Dishonest brokers faked the numbers on applications, and dishonest buyers lied about their income. And the financial instruments created by Wall Street wizards obscured the problems with those mortgages, and bond rating firms treated them the same way they treated well-vetted mortgages, even though any sane person would've known better.

All along, the Bush administration could've stepped in. There were lots of worries that there was a housing bubble, and that the resulting crash would be worrisome. A friend was talking about how to protect against that crash back in 2004, and argued credibly that the Bush administration was juicing the market to get reelected. They kept juicing things, hoping to retain a Congressional majority in 2006. And then it all fell apart.

Juicing things meant looking the other way on regulation. It meant keeping interest rates low. It meant talking up the housing market, rather than sounding a public warning. Yes, those steps would've undermined the only part of the economy that wasn't stagnant, and we'd've hit a recession sooner rather than later. But that would've been better than what we have now.

Bubbles are odd things. It's one thing for the Dutch to go crazy over tulips, another for Americans to go mad for Pets.com, and yet a third for there to be a bubble in house prices. People who pay too much for a tulip bulb and who then lose everything when the market collapses are screwed, but most people are fine. The tech bubble of the '90s was troubling because a lot of people bought into it, and because stock prices in general rose and fell along with the tech market. But still, you bought stock in online pet stores at your own risk, and no one was forced to buy stocks or tulips.

Houses though, people have to live in. Sure, some bought houses as investments, but most houseowners are not speculators, they are people who hope to raise kids, build a tire swing, and one day, have grandkids rediscover that swing. The bubble created by speculators caught up a great many young families, people who thought that their dreams were finally possible. And in a rational market, they'd have been right. But the bubble low-interest-driven bubble meant they paid more than they should've, and the lax regulatory environment led mortgage companies to loan more than was sensible, and when things inevitably went to hell, there was a lot of debt left for someone to deal with.

The debt and the financial ruin can be placed in three basic places. First, we can blame the homeowners. If we do that, we let banks foreclose and pursue people for ever dime, even though the banks should've known that the house they (as mortgagee) were buying wasn't worth the price.

We can pass that debt to the banks, compelling them to eat the difference in price between what they paid and what the houses were worth on a fair market. One way or another, that debt would be passed on to the Wall Street wizards, and thus to the financial markets in general, and to a wide range of investors, some who are blameless in all of this.

The third path would be to place the debt on the public's shoulders. The government could bail out mortgagers, who would then pay the banks, who would then pay investors, and the world would be whole. Or we could bail out the banks, who would still foreclose the homeowners, but the markets would survive. Or we could bail out the Wall Street wizards. Banks would probably pull through, Wall Street would celebrate, and homeowners would still get foreclosed.

The Bush administration, ever mindful of the needs of their corporate cronies, have chosen the third path. I happen to be unconvinced that taxes I've paid need to be used that way, though I agree that ad hoc nationalization of major global corporations is probably not the solution, and Congress and the administration need to craft real policies to determine how to proceed going forward.

I just know that the bailout shouldn't be a blank check to the Bush administration to give money to corporate tycoons. As my correspondent points out, we've seen what happens when they do that, and I don't care to see them do to the world economy what they did to New Orleans and Iraq.

Kevin Drum explains one of the biggest risks in this system for unaccountably pouring our treasury into failing banks:

I'll make the standard disclaimer that there's no way for an ordinary layman to have enough information to truly judge what's going on behind all those closed doors in Washington. And I'll add further that as laymen go, I'm as ordinary as you can get. Nonetheless.

It's true that the Bernanke/Paulson bailout is aimed at illiquid debt instruments. And those instruments are illiquid largely because they contain lots of toxic mortgage securities and nobody knows how much this stuff is really worth. It's unlikely that the toxic sludge makes these instruments literally worth nothing, but who knows? The mere possibility that they're worthless means that anyone who owns them might be insolvent, and since everyone owns at least some of them, this in turn means that everyone might be insolvent. Result: no one is willing to loan money to anyone else, because who wants to loan money to a bank that might never pay it back?…

Now, there are obviously all sorts of problems here. How is the Treasury going to value all the sludge? If they value it too high, then we really are bailing out irresponsible bankers who made stupid loans, and the taxpayers will foot the bill when the sludge eventually gets sold off at a loss. Value it too low and the feds are acting as vultures, causing more bank failures than we really ought to have. Furthermore, once the sludge is off Wall Street's books and some big banks turn out to be involvent for certain, will they really be allowed to fail? Or will Bernanke and Paulson prop them up yet again?

And smart people have better ideas:

Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles.

Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.

I'd tend to favor the first, at least assuming that the sizes of those dividends can make a meaningful dent, and that a sale of new stock could generate meaningful amounts of revenue (given the chance that the stock would become worthless in short order). Otherwise, I rather like these suggestions, first from Robert Reich, the other again from Kevin Drum. Other good ideas undoubtedly exist, and Congress would do well to consider them before taking up the ill-considered Bush plan.

Reich suggests:

The government (i.e. taxpayers) [should get] an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.

Drum counters:

Instead of an equity stake, we offer ailing banks the following deal: the taxpayers will buy your toxic waste for 20 cents on the dollar. (Or 10 cents or 30 cents. Whatever.) We'll hold it for a maximum of 24 months, at which point you can buy it back from us at, say, a 10% premium, and then sell it off yourselves. If you choose not to buy it back, Uncle Sam will sell it off. If we sell it at a profit, we'll keep the upside. If we sell it at a loss, you guys will make up the difference. The payback terms will be, oh, let's say three points above LIBOR over five years.

And what control do the banks have over how much we sell this stuff for? None. They have to trust us to get the best possible price. To coin a term, they have to give us a blank check. Seems like a fair exchange.

Meanwhile, the Editors take the radical, yet entirely reasonable perspective, that:

the primary fault here lies with the institutions who wrote bad mortgages, then with the institutions who laundered these into ridiculously-overvalued securities, and finally with the financial geniuses who bought this nonsense and are now left holding big piles of shit. The sins range from poor risk assessment to professional malpractice to flat-out fucking lying. As this albatross-laundering scheme was carried out in what was at best (I gather) a regulatory gray area, it’s hard to see how the government holds any particular liability here, except for not adequately babysitting the private business transactions carried out by adults. As these under-regulated securities carried no FDIC-type guarantee, I can see no reason for the government to feel obliged to back them up. Which is to say: I am enough of a free marketeer that my prejudice is to let failing enterprises fail, and I’m sure that, were it anybody else’s ass in the fire, the good people who run these failed enterprises would be taking to the pages of the WSJ to editorialize in support of this view. Now, I am sympathetic to the argument that the overall consequences to the economy of letting Big Shitpile fall apart naturally would be too horrible; but, if that is the case, I would like my pound of flesh, please.

Which brings us, finally, to a proposal offered by Sadly, No!, a proposal which could and should be implemented alongside any of the other proposals above:

It’s times like these where I start getting pitchfork-and-torches angry. Make no mistake, this bailout plan will have a massive opportunity cost. National health care just became that much more difficult because we’re going to be spending $1 trillion to bail out a bunch of irresponsible Wall Street assholes. The sheer amount of shit that the American taxpayer is about to devour cannot be calculated. …

It’s time to bring back the pillory stocks, my friends. I want Bush, Paulson, Cox, Bernanke and the heads of AIG, Bear Stearns, Lehman Brothers and Fannie and Freddie locked up for years on end so that we may hurl vegetables and feces at them to our hearts’ content. Because hey, if we likely won’t have any Social Security money to retire on, we might as well get *something* out of the deal.

Until any of that happens, the best thing any of us can do is get ourselves out to a swing state, register new Democrats, and do all in our power to get Obama elected president, and kick as many corporatist Republican hacks out of DC as humanly possible. Alas that we aren't pitchforks and torches angry, but huzzah that we get to vote every now and then. Let's put this frustration to good use.