Our Unserious Politicians

Today the unserious House of Representatives punted on the administration’s plan to empower the US Treasury to buy toxic mortgage debt, get it off the market, and get the financial system going again.

It doesn’t really matter how it’s done.

This is not that hard to understand. When you have a bunch of debt floating around that’s under water—where the assets that provide collateral for the debt are worth less than the face value of the debt—then you have a problem. It’s like the game of musical chairs. Nobody wants to be left with the toxic debt when the music stops, so nobody gets up of their chairs at all.

It doesn’t matter who’s to blame for all this. It seems that there’s plenty of blame to go around, although it is important to realize that the banks, even the investment banks, are all regulated by the government.

We’ve got to get the toxic debt off the market, and these days that means the government.

A hundred years ago, before the Federal Reserve System, it was up to banker J.P. Morgan to direct operations during the Panic of 1907. And he did it. The key moment, as we have written here, was when the brokerage house of Moore & Schley was about to fail. Morgan engineered an asset swap to save Moore & Schley, got President Roosevelt’s approval, and the crisis was over.

If only we could do the same today. But the problem today is that the government has distorted the credit system in countless ways to support its various political agendas. That’s what the flap over Fannie/Freddie is all about. Congress decided to use Fannie/Freddie to boost homeownership in the inner cities. Great idea, and all that, but they didn’t want to pay for it. They wanted the banks to pay for it.

Well, now we are finding out the true cost of this stealth social program, and it ain’t going to be chump change.

March towards the Sound of Guns. Not.

Back in the good old days, when armies marched on their feet rather than Humvees, they had a simple saying: “March towards the sound of the guns.”

The reason is pretty simple. Under normal conditions, armies are scattered across the countryside. The key skill for an army commander is to get all his units to the battlefield before the other chap.

Of course, in real life there are units marching around, or camped, who haven’t got the word. But if they got to the battlefield then they could help. Indeed, they might make the decisive difference between victory and defeat.

So when Sen. Barack Obama (D-IL) declined to go to Washington DC to help in the final stages of putting the Great Mortgage Bailout Act together, he was violating this fundamental principle of conflict. Whaddya mean, call me if you want me?

A guy who wants to be president should be feeling: “I just can’t wait!” He should be foaming with impatience to get to work and solve the nation’s problems, to get into the room where critial decisions are being made.

But no. Sen. Obama elected to stay in Florida preparing for the presidential debate on foreign policy. Foreign policy? How about acting like the leader of your party and corralling senators and representatives together to get a solution to the nation’s economic crisis?

It goes deeper than that. Back to the military metaphor. Suppose you were a young, untested formation commander. You hear the sound of guns. What do you do? You march towards the sound of the guns. Here, at last is your chance to show the old buffers what you are made of. Here is the chance to deploy your troops and smash into the tired enemy troops that have been fighting all day. Here is your chance to show that you are made for greatness—and there may never be another chance.

If I were an Obama supporter, I would have a nasty feeling in my stomach today.

Mr Potter is Buying!

Remember the run on the Bailey Brother Building and Loan in It’s a Wonderful Life? Just as the panicky depositors were demanding their money back from George Bailey, Mr. Potter the evil banker called George in for a chat. You don’t really want that broken-down old Building and Loan, do you, George, he said, and all the bother involved?

Mr. Potter would buy it, he said, and George could have a nice job at Potter’s bank.

Don’t you realize! George yelled at the panicky depositors. Don’t you realize that while you are selling, Potter is buying?

Today, as John McCain suspended his campaign to get back to Washington DC to work on the bank bailout plan, Warren Buffett signed up for $5 billion of stock in Goldman Sachs.

Mr. Potter is buying.

Close-coupled Character

I was commenting on the financial meltdown of 1907 at the American Thinker today. It’s all about sound collateral, I argued. An alert reader complained about the loose ends lying around.

Back in 1907, you see we, had a major credit crunch with trust companies failing all over the place. J.P.Morgan solved it with a bit of asset swapping, so that a shaky Wall Street broker could have collateral that everyone could trust.

In the aftermath of the crisis Congress hauled banker Morgan up to testify so that they could convict the innocent and let the guilty go free. He rather surprised them by saying that the key thing in business is character. Very good. But I then muddled things up by talking about the danger of close-coupled systems. They are bound to break, sooner of later, and then where are you?

You are right where we are today.

Morgan also flummoxed his congressional interrogator by failing to explain why he would buy a stock like Equitable Life, which only yielded one-eighth of a percent.

The answer, I think is character. We can’t just have people running flat out everywhere, trying to get the last ounce of profit out of the economy. That goes for politicians like Barney Frank who want Fannie and Freddie to squeeze the last ounce of credit into “affordable” homes for Democrats. And it goes for Wall Street Masters of the Universe leveraged up to the eyeballs squeezing the last ounce of profit out of the latest hot stock or derivative.

What is needed is some men of substance around like Morgan who, from painful experience, are willing to provide a factor of safety for the economy. They buy a stock not for its immediate potential but because it needs a good home. They unwind their leverage because they don’t want to be wiped—or wipe others out—if they bet wrong.

With chaps like Morgan around, you hope to avoid the risks of the close-coupled system which, when it fails, fails big.

It’s a tricky thing to implement, because we all want more efficiency in the economy, and more efficient use of resources. But how much should we risk for that?

Dead Cat Bounce?

After two days soaring, stocks turned lower again today, with the Dow down 372.75 or 3.25 percent at the close. They say that the third day after a bounce is the key to a sustained rally, so it looks like there is more to come on the bad news front.

When things turn south, we read in the books, the key is to find a scapegoat and sacrifice it. That's how primitive humans did it back in the day according to Rene Girard in Violence and the Sacred.  Since all this bad stuff happened on Bush’s watch it goes without saying that he is to blame.

But since Bush will soon be out of office, it seems hardly satisfying to give him the entire blame for the mortgage meltdown and the Fannie/Freddie meltdown and the Wall Street investment bank meltdom and doubtless more meltdowns to come.

I know, let’s blame the Democrats! Kevin Hassett from the American Enterprise Institute has the goods on them.

Back in 2005 responsible Republicans introduced S.190 in the United States Senate. It would have curbed Fannie and Freddie and maybe averted the meltdown. But Democrats were united in opposition.

Of course it had nothing to do with the money that Democrats were getting from Fannie/Freddie. Oh no. Even though Hassett writes that Sen. Barack Obama (D-IL) was one of the prime beneficiaries of Fannie/Freddie money.

Throughout his political career, Obama has gotten more than $125,000 in campaign contributions from employees and political action committees of Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking Committee chairman, who received more than $165,000.

That’s right. Chairman Dodd. He was a mere ranking Democrat in 2005, but the Senate changed hands in 2006. Don’t expect much from Chairman Dodd on the Fannie/Freddie reform front, not unless Secretary Paulson puts a gun to his head. Especially since Dodd was a “Friend of Angelo” at Countrywide Financial.

But the larger issue is to think back over the years of Fannie/Freddie excess. Was it really doing their low-income homeowner constituents a favor for Democrats to sluice money at housing? Wouldn’t they be better off if there had been no subsidies and no big runup in home prices? Wouldn’t they be better off if house prices weren’t in free fall right now?

The tragedy is that Democrats still don’t seem to have learned their lesson. At least not Barney Frank, the counterpart to Dodd in the House, according to the Wall Street Journal.

Fan and Fred’s patrons on Capitol Hill didn’t care about the risks inherent in their combined trillion-dollar-plus mortgage portfolios, so long as they helped meet political goals on housing. Even after taxpayers have had to pick up a bailout tab that may grow as large as $200 billion, House Financial Services Chairman Barney Frank still won’t back a reduction in their mortgage portfolios.

It’s the trouble with the whole welfare state model. You think you are helping the poor by sluicing out subsidies. But you only end up wrecking their families, failing to educate their children, and enticing them into buying more house than they can afford.

But at least you get their votes.

It's the Debt Stupid

So here we are, we hope, at the selling climax of this bear market, with the big Wall Street investment firms going cap in hand to the Feds and to the banks for a handout. Last night there was talk that Morgan Stanley and Goldman Sachs might be the next to go.

As Robert Samuelson says, this is the end of Wall Street as we know it. It is the end of the Masters of the Universe and their leverage fueled “principal transactions.” In the old days, investment firms worked for their clients. But now they work for themselves.:

Now, most financial firms also invest for themselves. They use partners’ or shareholders’ money to place bets on stocks, bonds and other securities — so-called "principal transactions."

And most of this investing has been financed with a high level of borrowed money. Nothing wrong with that, of course, until things go south and the asset that is collateralizing the loan can no longer liquidate the loan.

The trouble with high-leverage investing is that it is taking money that is not really supposed to be risk capital—i.e., fixed-income debt—and then using it in high-risk transactions. The banks or individuals supplying the money for this activity are not hands-off investors. They are risk partners in the venture. Because if asset values go south, then they are out of the chips.

For too long, for far too long, government has allowed this high-octane, highly flammable business model to operate, when everyone should know the risks. People investing money in these high-risk ventures and people lending money to these high-risk ventures are, whether they like it or not, risk partners in the venture. They should be treated as such and rewarded as such.

When you are a partner in the risk, then you should be getting an equity stake in the venture, not you should not be lending money backed by collateral.

How hard is this? Well, I’ll tell you. If we enforced this rule, that risk=equity and should be capitalized as such, then the Masters of the Universe wouldn’t be making so much money in the good times. They would have to share the wealth with their equity partners.

But on the downside they wouldn’t be forcing fixed-income investors and taxpayers to pay for their stupid mistakes.

An Eight-point Economic Plan

With the distractions of Palin Power and the earthquake on Wall Street, some of us are losing the narrative. But the editors at National Review are not. They have an eight-point plan to remind us whose side they are on. Let’s review it.

1. No more bailouts. Actually, let’s make that a bit broader. No more subsidies. The trouble with subsidies, aside from the universal truth that subsidies are a waste of resources, always and everywhere, is that it teaches economic interests to look to the government for cheap answers to their problems—cheap for them anyway. Not good training for anyone.
   
2. Hard money. Yep. We got away that important conservative principle, and it’s hurt us. We got off it in the middle 1980s with the Plaza Accord and it ended in the ten year recession in Japan. Now we are battling through a similar meltdown in the global economy because Alan Greenspan got off the hard-money standard in the early 2000s.
   
3. Energy production. The Democrats are wrong on their policy to make energy more expensive to rush conversion to a post-carbon energy economy. Republicans want cheap energy, but as clean as sensible. This is a can’t lose position for Republicans.
   
4. Cheaper health care. John McCain is trying to help us move from the administrative first-dollar approach to health care. The new model is the Wal-Mart plan. Inexpensive clinics in Wal-Mart stores and you pay with your own money.
   
5. An end to ethanol subsidies. Why hasn’t Congress passed this yesterday? Everyone now understands that ethanol subsidies add up to a cruel trick on the poor. See item #1 above.
   
6. Encourage growth. That means cutting marginal tax rates, not handing out money in complicated rebates like Obama.
   
7. Free trade. People should be allowed to buy in the cheapest market. Period. Anything else is economic imperialism.
   
8. Middle-class tax relief. Same as growth, above. Simplify the tax system and keep marginal rates low for everyone.
   

Come on chaps. This isn’t rocket science.