Not Dead Yet

The auto bailout failed cloture in the Senate last night, 52-35. The Dems needed four votes to pass this thing.

The tally is here. They got 10 Republicans, which should put them at 61. Three Dems (Baucus, Lincoln, Tester) voted no. They lost a vote when the junior Senator from Illinois resigned in anticipation of his next office. (Wasn't that a little earlier than strictly necessary? Are we sure that gentleman a far-sighted genius strategist, as widely advertised and agreed?) Kennedy might be too sick to vote, but the Senate has all sorts of collegial gimmicks (vote pairing, etc) for such things (and that's not a bad thing).

I'm surprised the Republicans had the nerve to stop this, and the skill to make UAW intransigence the morning headline. Well played, Senator Corker, Senator McConnell, Senator Shelby.

Plan B is an Administration drawdown on the TARP.

Plan C? The Dems claim there is none, outside bankruptcy. But I think the next Congress is seated on 4 January, before the Inauguration. (It was in 2005.) That Congress will seat 7 additional Senators, and would be able to pass this same legislation that very day. Are we to understand that GM can't get its suppliers and creditors to stretch them three weeks? I'm sure the Congressional Democrats don't want to start the next Congress by bailing a core constituency, but I don't see why the President should concern himself with that.

Congratulations

I stopped posting because there just wasn't much left to say leading up to the election. Toward the end I saw a glimmer of hope for McCain's campaign, but didn't imagine it more than putting the best face on things. Those hopes proved illusory.

Congratulations to the Obama supporters, who certainly worked hard for this. The election of a black man to the American presidency is a great human moment, an enormous testament to the power of free people to correct the errors of their history.

I hope that all my concerns about an Obama presidency prove false. God bless Barack Obama, President-elect of the United States of America.

The Grade on JFK's Testing

"It will not be six months before the world tests Barack Obama like they did John Kennedy. The world is looking. We're about to elect a brilliant 47-year-old senator president of the United States of America. Remember I said it standing here if you don't remember anything else I said. Watch, we're gonna have an international crisis, a generated crisis, to test the mettle of this guy."

-- Joe Biden in Seattle, Washington, on Sunday 10/19/2008

The Bay of Pigs crisis was not "generated" by some outside actor. It was an American initiative, an "invasion" of Cuba by Cuban partisans recruited, trained and funded by the CIA. The project was doomed in concept, poorly planned and executed, and belatedly undercut by JFK's cancellation of the American air support promised in the original plan.

The effort was launched under Kennedy's go-ahead. He lacked the experience to properly review the plan, and the confidence to overrule the career national security experts who recommended it.

JFK did better as he went on. His Berlin speech is famous, and the Cuban Missile Crisis is regarded as a triumph. But careful analysis of the missile crisis suggests that the rewards weren't worth the risks, and that our success was due in part to luck and Russian prudence. In Viet Nam his policy was a muddle of contradictory goals and beliefs that the stage for a disaster.

This mixed record came at a moment of national consensus on the strategy and tactics of containing Soviet Russia. Kennedy was largely an implementer of a Cold War architecture established by a bipartisan collection of "wise men" led by Truman and Eisenhower. We don't currently have such a consensus response to Islamist terror, and the development of that consensus is among our chief foreign policy problems.

Biden invokes Kennedy to suggest that Obama's brilliance will provide foreign policy successes similar to Kennedy's. We ought to consider whether it will provide similar risks, and ask how lucky we're feeling.

No Galt

Dr. Helen wonders if we should go Galt. I left the following monster comment, because I'm a hack without manners or style:

The coming government will be more "progressive" than its citizens.
-- The left-liberals took over the Democratic party.
-- The Democrats are winning because the Republicans were unprincipled spenders who ignored their duties.
-- Even the good ones hardly understand their principles -- if McCain will pay off overextended borrowers, well, the improvement over Obama is marginal at best.
-- The press don't understand either, and look for conventional wisdom that can be safely repeated.

And still McCain was winning on character before the bailout demonstrated executive and legislative incompetence. We might know the Democrats can be worse, but the less alert probably find it hard to imagine.

A Galt Strike attacks a _society_ that insists on taking. Ours is a free working society inherited from immigrants, whose government is momentarily seized by political entrepreneurs. The solution is to take back those institutions, starting with a Republican party. The electorate will choose self-reliance and freedom, but it has to be offered truly and fairly.

And a Galt Strike imagines that a reasonable government emerges naturally, as people learn their lesson. It won't. Abuse of power is the most natural human instinct. _Every_ democracy is vulnerable to politicians adapting moral arguments to justify expansion of their powers. The true principles of the civil rights movement are as subject to political misappropriation as the medieval Church.

A free society requires constant resistance against status accumulation by political entrepreneurs, and vigilance against their innovations. And yet government must still adapt to real changes in technology, demographics and trade, and society must still reject any real errors conserved in its institutions. Government isn't easy, and while its principles maybe "natural", their actual enactment isn't.

It's not enough for the Galts to produce economically. They have to produce politically, too.

Ayers, The Issue

Candidate McCain's focus on Candidate Obama and Professor Ayers is an odd thing.

It seems unlikely to affect the election, which nows seems entirely determined by reactions to the markets. McCain's understanding of the situation is better only in that he assigns important responsibility to the GSEs, worse in that he has been kind of flailing around and that his latest mortgage proposal is a flat-out bailout of reckless behavior. Neither candidate understands the banking markets, or the measures required to minimize the damage to them, or the limitations on the help such stabilization provides the larger economy. Before this, McCain could argue that Obama isn't ready for the Presidency. Now it seems that neither of them are ready to handle our financial problems -- so Obama's relative callowness is remarkably diminished. It's obvious that a Republican Administration has fumbled the past month badly, and that they are clearly associated with many of the regulatory problems leading up to this. The Democrats bear important responsibility too, but that is far less clear. So the crisis has minimized Obama's relative weaknesses, and reminded voters of Republican incompetence. They are going to their initial instinct to vote against the Republican.

So raising the Ayers relationship and the background questions is unlikely to matter much, and it is likely to agitate the political debate. On the other hand, they are legitimate questions that the press should have addressed a year ago. It hardly seems irresponsible to notice the absence of scrutiny before we elect the guy. Then again, if McCain was going to raise those issues, shouldn't have done so when there was time to discuss them? But it looked like he wouldn't need to, so why get everybody all worked up?

The background questions capsulize the larger situation: our elites have departed so far from factual, reasoned discussion, and neglected the fundamental issues so completely, that we now find ourselves without any good choices. No choice leads toward any solution. We're just wandering around here.

Meltdown

"The government would buy the existing troubled loans at face value -- absorbing the haircut itself -- and the Federal Housing Administration would issue a new, federally guaranteed 30-year fixed-rate loan, based on the property's present value, at a "manageable" interest rate, the McCain camp said."

WSJ, 10/9/2007

The idea is based on Martin Feldstein's proposal, which would lend homeowners with negative equity 20% of their principal at government rates on their personal credit. This would give them an incentive to keep the house, and reduce their interest payments, without reducing their total debt. I'm not sure it's a great idea, and I wonder how aggressively politicians would enforce those personal notes, but it doesn't give the homeowners a pass on overextending themselves.

McCain would. Homeowners here get government funded forgiveness of excess debt. I haven't seen any suggestion that the government would get a position in any capital appreciation of the house. This might reduce foreclosures and thus downward pressure on housing prices. But that pressure is only temporary anyway -- the long term value of mortgages is driven by the long-term value of the house, and that is driven by real estate economics which are temporarily distorted by the foreclosures. We don't know the "right" level for housing prices, and probably won't for a while -- if they go lower still, are we going fund a second round of principal reductions?

I can't support this. It's a huge incentive to irresponsible financial behavior, added to existing government incentives in health care and disaster relief, and sets an ominous precedent for handling coming problems with retirement savings. Even if it did help with the current situation, we still might well be better off suffering a recession than telling people the government will bail out their stupid decisions. And I certainly don't want to do this without a lot more thought McCain has given this, and a lot less suspicion of political motivation.

McCain is really reaching here. Some of this is panic, some pandering. I don't think he understands economics sufficiently to understand the moral hazard problems of this, or how they differ from those in the proposals of Feldstein and others. But whether its errors come from ignorance or ambition, I can't agree to something this bad.

Too Busy, Too Foolish

"But health insurance is complicated and scary; most people don't have the time or expertise necessary to make wise choices. They rely on their employers to make sure they're getting a good deal — and to fight for them if the insurance companies try to cheat them. And with many employers slouching away from that responsibility, the public seems ready to turn to the government for protection. "

-- Joe Klein, Time 10/9/2008

I can't imagine a better description of the welfare state's infantilization of the public. If people won't take responsibility for their own health, just exactly are they responsible for? A person who won't take care of themselves has no one to blame but themself when they are told what to do and what to think.

And I'd add that health care's unavoidable complications are compounded by regulatory requirements like the Mental Health Parity Act that Congress just added, in an afterthought, to the bailout bill.

And just what exactly is someone to do if the government doesn't make wise choices for them, or refuses to fight for them? What alternatives will they have, what resources can they bring to bear?

A healthy society raises people who take the time to take of themselves, and can develop the expertise they need to do so. We should help those few that could never manage for themselves (though it's necessary to add that our moral responsibility doesn't imply their political right). That's what conservatism ought to be about. It's failing because our "conservative" politicians are too interested in incumbency to take on a tough case.

And I'm afraid that McCain, with his proposal to write down overextended borrowers on the federal dime, is hardly more principled.

Umm, How's That Again?

"Getting it right is as important as getting it done quickly"

- Hank Paulson, October 8 2008

Debate

Not a good night for McCain. Why exactly is it a good idea for me and my fellow taxpayers to help our overextending neighbors pay for houses that were always beyond their means? Yes, he wants to put a floor under housing prices -- but price setting is what a government does worst.

It's a shame that McCain didn't realize years ago that political power is about economics, and gone to school on the subject. He's so good, but he lacks any central and convincing message on the economy, or explanation of how Washington's narcissism threatens it.

Obama -- he's like R.E.M. The first five minutes sound great, but the more you listen, the more every answer sounds the same, and then you wonder why that is, and then you start to realize the whole thing is just one set of talking points after another. I don't hear any serious effort to engage any subject, and he treats every topic as an opportunity to sound prepared and thoughtful rather than communicate his own philosophy. I find this kind of thing maddening, because there is absolutely no chance of convincing a guy like this of anything, and very little hope of learning anything from him.

I'm worried the next four years are going to be pretty bad.

Ayers

For all the left-wing blather about "fascism", this country is fundamentally safe from political violence precisely because of its disgust at people like Bill Ayers. No serious person would ever join up with a craven coward like that precisely because they understand that good arguments are enough in this country, and because no one wants to live in a country where politics are settled by guns. Most serious people would be embarrassed to even be associated with him.

Barack Obama doesn't seem to share that revulsion. That's a problem.

Shell Game

Chairman Frank is happily reassuring his colleagues that the bill gives Treasury the power to buy mortgages and reset their principal and interest rates, and that the Secretary has been told that the bill is passed with the understanding he will do so.

It would be hardly surprising if any gains the fund makes on some investments were diverted to marking down the principal on other mortgage investments. If there are losses, those go to the taxpayer. If there are gains, they will go to Democratic constituencies.

It's a remarkably bad bill, and Chairman Frank is promising he'll be back to work on regulation next year. Certainly the Democrats don't sound unhappy that this is passing. It's depressing to see so little understanding of our financial system, and so little resistance by confused members against the social pressure for this.

It's a landmark event, the beginning of a new era of Democratic leadership and progressive policies.

Second Verse, Same As The First

Everyone is agreed that the House will pass the next bill. They have to do something, right? They're hearing from their districts, and the new bill has some tax reductions and the FDIC deposit insurance increase, and they'll do the right thing.

Except, I didn't hear from any House Republicans until this evening, and Roy Blount wasn't so convincing. The only yes vote they could get to discuss it on McNeil was Ray LaHood, who is retiring. The Blue Dogs won't like the tax increases without offsets, and the growing lists of special items is making it harder to regard the matter as truly that serious.

I've noticed that CNBC et al have got the memo that this is a "rescue" rather than a "bailout". Dissenting opinions have vanished from the airwaves, and the Great and the Wise are out in force insisting this is the only way. But no one can explain how this works. Buffet was on Rose tonight saying that bought at market, the government will make money here -- but Bernanke and Paulson have said they will buy above market.

Painting the opposition as uninformed and ideological won't necessarily help. Members of the House minority don't get a lot of respect in the first place -- why are House Republicans going to care about the opinions of people who won't talk to them in any case? They may even welcome the opportunity to show their independence from the Establishment. I'm by no means convinced that this bill passes the House.

Keystone Kops

"Republicans -- from McCain's top economic aide to the House GOP leadership -- initially blamed Pelosi, saying her floor speech . . . poisoned the atmosphere and invited partisan retribution.

"In truth, few Republicans were on the floor to hear that speech, and those who were there showed no signs of discomfort, as they often do. Republican leaders backed away within hours, conceding they never had the votes they had promised."

Washington Post, 9/30/2008

I'd like something a little more definitive, but the Post is by and large pretty trustworthy. The GOP leadership is just weak. Both Pelosi's speech and the blame assigned were stupid. I'm reading different things about the count Boehner promised the Democrats -- one account says he promised 70 and thought 10 more might follow a surge on the floor, but it seems odd that the Democrats would call the vote without knowing they had enough Democrats. Then again, it's the majority's job to pass bills, and while that's easier with a reliable minority count, it's still the majority's responsibility.

All in all, further confirmation that our politicians are mostly just incompetent.

Use Your Own $1.2 Trillion

Commentators are noticing that the markets lost $1.2 trillion after the House voted down the $700bn bailout.

So what? If the folks in the market want to band together and fund a bailout to protect their own interests, that's great. But why should we take money from taxpayers, many of whom don't own stocks or own different stocks than those that fell, to bail out stockholders? Wall Street and its sympathizers have convinced themselves that their interests are the country's. It simply isn't so. So long as they think this, they'll be convinced that Congress must do something, and befuddled when it doesn't.

No Deal

Bailout fails. House GOP says they lost about a dozen votes because of Speaker Pelosi's partisan closing remarks. Me, I think with these guys it's just business, nothing personal. You don't spend fifteen years building a political career to make your biggest vote on one speech. If the congressmen thought they had a deal to keep this issue out of the November election, maybe then
the Speaker disabused them of an already silly illusion.

What's next? They need about twenty votes. They could try to get them with amendments, but it seems the problems are first fundamental and then political. If folks don't think this enormous project will work, what can you offer on the margin to bring them on board? The Dems could probably pass it on their own if they added in the bankruptcy stuff or the housing slush fund, but they can't go too far or they lose the 60 votes they need in the Senate.

The twenty votes might emerge if the markets blow up entirely, or if members here from their business constituents that they have to do something. Absent that they may need a new idea, or a new Treasury Secretary.

But it's been ten days since Secretary Paulson said we must have this. If the world keeps turning as we go through these gyrations, that assertion might begin to accumulate a discount.

ADDED: A lot will also depend on feedback from the districts. A lot could depend on the constituency condemnation / congratulation of the "no" votes, and what heat the "yes" votes take. The next few days could show some political price discovery.

Things That Make You Go Hmm

The bill has a provision directing the Secretary provide "financial assistance" to banks taking losses from positions the preferred of the GSEs (FNM and FRE). Interestingly, banks from Massachusetts -- Chairman Frank's state -- are disproportionately represented among such banks.

Coincidence?

The bill's position on the preferred:
"Section 103
In exercising the authorities granted in this Act, the Secretary shall take into consideration—. . .

(6) providing financial assistance to financial institutions, including those serving low- and moderate-income populations and other underserved communities, and that have assets less than $1,000,000,000, that were well or adequately capitalized as of June 30, 2008, and that as a result of the devaluation of the preferred government-sponsored enterprises stock will drop one or more capital levels, in a manner sufficient to restore the financial institutions to at least an adequately capitalized level;"

The position of Massachusetts banks in the preferred:
"About a quarter of the nation's banks lost a combined $10 billion to $15 billion in the wake of the federal government's takeover of mortgage giants Fannie Mae and Freddie Mac, a new industry survey found. In the survey, the American Bankers Association reported that 27% of the nation's 8500 banks held preferred shares in Fannie and Freddie in their investment portfolios. The shares are expected to be worthless. The survey found that 85% of the affected institutions were community banks -- those with less than $1 billion in assets. Many were located in Massachusetts, followed by Illinois, Connecticut, South Carolina and Virginia.

". . . The banks are asking for the government to consider paying "a reasonable level" of dividends on Fannie and Freddie preferred stock to preserve some of the shares' value.

". . . It's not clear why so many banks that held the preferred stock were in Massachusetts. Daniel Forte, president of the Massachusetts Bankers Association, noted that the state has more than 200 banks, an unusually high number compared with most other places that have seen more consolidation."

WSJ, 9/23/2008

Lehman Was A Surprise

From this morning's WSJ:

"...[The Bear Stearns bailout] created a false imporession among investors that the government woudl step into rescue bondholders when the next bank ran into trouble. By letting Lehman fail, the government had suddenly disabused the market of that notion."

The government isn't under some general obligation to bail about investment banks. It does have a responsibility to set clear and predictable rules by which it will act. When it doesn't, there will be considerable confusion, and players will lose confidence in the overall system.

We know there is a lot of bad paper out there and that it's straining the system. It isn't clear to me, though, whether the most recent crisis reflects concern about those assets, or uncertainty about what Treasury will do in the next emergency. Nor do we know whether the markets could have sustained the Lehman fail if it had better understood Treasury's intentions and had more time to prepare.

These are important questions. The bailout bill places enormous confidence in Treasury's management of its large powers.

Will It Pass?

It isn't clear to me that this thing will pass. Congressman Van Hollen (D-MD) was just on CNBC, saying that as of 10:30 last night as many as 120 Democrats were voting against the bill. That would be a majority of the Democratic caucus (there are 235, plus Sanders), and (if the Dems get Sanders) would require 102 Republicans (out of 199). Congressman Van Hollen wouldn't say that Democratic challengers would refrain from criticizing GOP members voting "yes". John Harwood reported that Speaker Pelosi had set a goal of 100 Republicans, and that they might not get there.

This is already a bad bill. There is a lot more for Democrats to like here than Republicans, what with the various provisos singling out various of their constituencies for special consideration, and the project's overall ratification of interventionist government. House Republicans have been complaining about the bill all along, and it doesn't reflect much important movement toward them (the insurance provision isn't much, and Secretary Paulson is signalling that he'll ignore it).

So if a majority of Democrats can't vote for this thing, how can a majority of Republicans? I've read that the whip effort is focused on the votes of retiring members -- not a good signal. The President's support doesn't mean much, as he can't help with this election or any future. Candidate McCain's support is tepid. And very much doubt that House Republicans will trust the Democratic leadership to avoid exploiting their vote.

Nor do we see major leadership figures saying the bill would pass. With market confidence struggling, I might expect them to do so -- unless they fear a reversal similar to last Thursday's.

The only positive signal is the vote's schedule for noon. They won't vote if the bill will fail, but postponement would signal trouble, and might begin to unravel the deal. Perhaps a later vote might have given opposition time to organize, so this scheduling suggests that this is the likeliest time for success. If they can't get this done, the whole thing could come apart. I don't know what happens at that point.

Depressing

Congressional Democrats are apparently singing Hank Paulson's praises. And why not? He's negotiating one of the largest expansions of federal power in decades. The bill is nearly silent on the prices of assets purchased and has minimal provisions for loss recovery. What recovery provisions it has are ridiculously weak (don't have shares authorized to give us warrants, and doubt your shareholders will approve them? Okay, we'll take a note.) But it has dozens of detailed requirements for looking after myriad interests: homeowners, local communities, state and local governments, banks that held GSE preferred, etc.

In the best case, a Democratic Administration will wield these powers. Worst case, Congress can influence Treasury's deployment of them. And Congress gets a historic argument against free markets, and an unbelievable opportunity to hide the excesses of its affordable housing policies.

Hank Paulson got taken. He wasn't intellectually ready for a crisis of this magnitude, and he didn't understand the long-term political motivations of the people across the table from him. He put himself in a position where he had to have the Congressional Democrats, and they've made full use of the opportunity. And there wasn't enough firepower in the Senate or House minorities to stand up and stop this.

House GOP Alternative

Here is the first detail on the House Republicans' proposal.

Here is how they would fund coverage of the mortgage assets:

"...any rescue package should adopt a plan to insure mortgage backed securities (MBS) through payment of insurance premiums....However, rather than taxpayers funding the insurance, the holders of these assets should pay for it. The working group’s proposal would direct the Treasury Department to design a system to charge premiums to the holders of MBS to fully finance this insurance."

I don't see how this works on a post facto basis. Insurance spreads risk across a group. Included at the start, cash flows include a cushion for insurance premiums which makes an excess available for shortfalls. After the fact, the whole problem is that cash flow falls short of expectations. Paying insurance on Security A requires taking cash from Security B, which reduces the value of Security B. And there can't be any more insurance than there are payments, so nothing can actually pay out at par. This spreads out the risk and diversifies particular securities, but that actually punishes anyone who was careful about their purchases in the first place.

What if the insurance just provides a floor and insures just (say) 50% of cash flow? That might be doable, as there should be cash in some securities in excess of the floor. But it is still just spreading the pain, and punishing the careful still more as a portion of their securities' cash flows to those below the floor.

And how would this handle complicated instruments like IO strips and Z tranches? These are priced in part on the risk of default (which pays out principal but stops interest payment) and on assumption of first loss risk. Would these be insured? Why should they be?

I don't see how this can solve the problem.

The proposal does suggest recapitalizing the system with tax breaks and dividend freezes. This isn't a bad idea, but there isn't any reason that the government should get these taxes foregone back, with interest, before the banks resume dividends.

I think this process needs more ideas.

Who Shot John?

Did McCain blow up the deal? Are the Candidates helpful? Did the House Republicans pull a fast one? Are the Adminstration and Congressional Democrats trying to steamroll this thing?

It doesn't matter. It isn't answerable. We don't have enough inside information to tell, what information we do have is offered by folks with a stake in the argument, and any analysis will be skewed to the prejudices of the analyst.

What matters is the quality of the deal that emerges. The politics will shake out after that, when people start to pay attention again. Could a player influence that assessment with clever positioning and arguments? Maybe, but they'd have to read some mighty tricky currents to find themselves in the right place. It's just an incredibly volatile situation. Attention to positioning could reap huge returns, but it could fail because of events beyond anyone's control or forecast. And in any case it loses everything if it's read as positioning. I know politicians are incredibly good at this stuff, but I would think the best bet would be to just forget all that and sort things out on the other side.

Memories

The stubbornness of the House Republicans reminds me of the Gingrich revolt against the Bush/Darman tax increases of 1991. It set the stage for the Contract With America and winning the House in 1994.

If the Democrats take responsibility for a risky and wildly unpopular Wall Street bailout, they open up a lot of scenarios for losing Congress in the cycle after this one. Never mind Paulson and Bush, they're gone in three months, and getting away from Bush on domestic policy is hardly a political loser anyway.

Without the House GOP, the political risks to the Democrats are huge, and politicians hate risk. I don't think there's a deal without the House minority.

Missed Opportunity

It does look like the core idea of the Paulson Plan will be enacted and the Treasury empowered to buy impaired paper in large quantity. It has been clarified that this will be bought at some discount, and probably priced in some reverse auction. Candidate McCain's "campaign suspension" will force the Congressional Republicans to agree to something, and the Democrats will be only too glad to enact the basis of a regulatory expansion while complaining it was the Administration's idea.

Chairman Bernanke's stated motivation is price discovery. I think he believes that if the government can set market prices for the paper, banks will be able to value holdings and understand their counterparties' solvency, and will be able to lend with greater confidence. He has argued against "punitive" steps like warrants and compensation limits because they will constrict the pool of sellers and reduce the value of the price discovery from the reverse auctions. (He further argues that there is no policy basis for punishing someone for selling something at a market price, as there would be if they were bailed out.)

But I'm skeptical of the government's ability to discover market prices, even in an auction. These are complicated instruments, with exposures to interest rates, housing prices, and consumer credit. Their value will vary among buyers according to each buyer's risk appetite, outlook, investment horizon and capital cost.

Up until recently, they have bought by hold-to-maturity investors like pension funds and insurance companies, and by hedge funds as speculators and funding arbitrage players. I suppose the borrow short, lend long buyers (the funding "arbitrageurs") have driven prices to date, but these are the players driven from the market by the liquidity squeeze. It's the long-term holders that will set the ultimate bid. They may be reluctant to bid because they are uncertain of the securities' performance, or concerned what borrower relief would look like, or simply lacking the institutional capacity to evaluate this stuff. Or they may be afraid of touching anything with such a bad reputation,
or unsure what assumptions would be viewed as "reasonable". Or, they may be fully invested and lack liquidity. In any case, we won't know their pricing expectations until they actually do step forward to buy this stuff. So how can the government now set a proper price?

A reverse auction risks underpricing assets (if driven by the most desperate sellers) or overpricing (if driven by collusion). I fear that Treasury is likely to set a minimum price at the point where most institutions can sell without becoming insolvent. Otherwise, the auctions could fail, or institutions pushed under when marking to the prices set. Treasury has already had several failed "solutions", and would be deeply embarrassed by another, so they have every incentive to set rules that "work" regardless of their soundness.

So I'm afraid that we're headed into a very flawed approach, that will be staunchly defended by a variety of political and financial players with stakes in its success. Those defenses are going to badly muddle the principles we ought to apply to economic policy, because they won't make much sense. It will be very hard to argue against progressive interventions that don't make sense when many expert voices are arguing for this intervention that doesn't make sense. Both types will have reasons to avoid closely inspecting arguments and facts in a fashion that would actually illuminate events.

What we're seeing here isn't a complete failure of market principles. The crisis is founded in part in political pressure to extend credit to low income homeowners through the banks and GSEs. (Among other causes, among them a degree of overoptimism about the judgments of market players.) And the proposed resolution doesn't strike me as a particularly intelligent application of those principles. But many will read it that way, and will notice that a lot of Establishment players were willing to abandon those principles to serve their particular interests. We're seeing a major step away from a more intelligent political and economic structure, and it's founded in part by the prior departures from principle by the Congressional Republicans and the lapses of judgment by the Administration.

I suspect the current situation could be managed without financial collapse through a collateral lending approach. I imagine other, less drastic solutions are possible. I agree that if something isn't done we will have a serious financial crisis that will lead to years of recession. And I agree that the manner of any rescue has implications for the pace and extent of any credit unwind. (For example, a collateral approach might halt credit growth if institutions built reserves against losses in their collateral and to get out from the equity payment constraints.) I wonder if these differences would be so great in the long run, as we're looking at a credit contraction in any case.

But I think slower growth, and even the risk of financial crisis, might be better than the damage we're doing to the principles applied to these problems. The bailout as proposed further ratifies the notion that the government should be the ultimate absorber of all risk. That assumption has already driven bad policy on health insurance, storm damage, trade policy and a host of other areas. It won't help as we confront problems of retiree income and health care, and further adjustments to international trade patterns and health policy. We might manage through this crisis, but our politics are taking a real turn for the worse.

McCain Suspends Campaign

No one would pay any attention to a foreign policy debate anyway, so that's sound. This is very important and urgent (though bad) legislation, and it's arguably more important than more politics.

But I'm not sure how McCain helps the bill. This isn't a case of an obvious solution gummed up by partisanship. The proposal has real problems, and I haven't yet heard the framework of anything better. Knocking heads together won't help, and McCain isn't the guy to invent something in this area over the weekend. McCain probably can help round up enough Republicans to deliver this thing, but then he attaches himself to something that really doesn't make much sense.

On the other hand, Obama could come off looking inflexible, too focused on politics, and unwilling to engage hard choices.

Paulson/Bernanke Testimony

I heard the first half of Paulson and Bernanke's Senate testimony.

1. Bernanke clearly sees this as a price setting exercise. I suppose he thinks that a real market price would allow institutions to properly account for their holdings and thus establish mutual confidence.

But we don't have market largely because there is no liquidity for any buyer, and/or sales at available prices would force recognition of losses that put the holders into insolvency. If the only bidder is Treasury, that isn't a market. Perhaps they think using a reverse auction allows price setting? But aren't the marginal sellers going to be that set of institutions best balancing a need for capital with an expectation of prices at which they can mark the rest of their portfolio? Isn't there a grave danger of collusion among sellers here? And given the diversity of these securities' features, what does the price of one really tell you about the price of another?

And I'm not sure transparency helps. A lot of players would appear short-term insolvent, how is that going to help them borrow?

2. Bernanke and Paulson view equity stakes and comp limits as "punitive". They want players to participate, I guess so they can get their accuracy in pricing and get this stuff out of the system. I see the point that you shouldn't punish someone for selling if they sell at the "right" price, but that depends on getting the right price in the first place.

3. Paulson says this is a plan, but I think Shelby is right when he says that Paulson basically wants latitude to continue reacting to circumstances as he sees fit. He would direct this at a large class of assets, but his approach to that class would continue to vary as he works through this. Flexibility is a fine thing but I don't see a persuasive diagnosis of the root problems supporting a pathway out of this.

4. It is very, very clear that Lockhart views his job as gettting the GSEs back to business as usual. He clearly views their problems as products of past management and bad practices, and not fundamental to their nature. No one in the Congress or the Administration seems to disagree.

5. A better than usual performance by the Senators, with less parochialism and preening than I'm accustomed to. [...snip...] In general, maybe a third of the committee seems competent to meet their responsibilities.

Not a confidence inspiring session, though I do think they'll muddle through without blowing up the markets. But this thing is going to have a lot problems, and while it might forestall a meltdown, I'm not sure this thing will get the financial system functioning properly, absent a complete bailout of the institutions.

Questions

Of Treasury's proposal:

At what price will the government rescue purchase distressed assets -- par, "market", something else?

What provisions will be in place to hold the current owners of those assets liable for any future losses on them?

Why aren't these answers available, three days after this proposal was first broached?

Of the press:
Why hasn't the absence of these answers been mentioned by the Times, Journal or Post? Or anyone else, for that matter?

My Bailout Plan

Government intervention should provide liquidity, not coverage of losses. Institutions ought to remain liable for their own poor decisions, while receiving stretching out the time available to absorb those losses.

So why buy these things at any price? Accept them as collateral for loans, with maturities equaling that of the collateral. The loan notes should carry covenants forbidding any payouts to equity (dividend or repurchase, common or preferred). Cash compensation to management should also be capped. Large asset purchases for cash should also be forbidden. I'd like the government's position to be senior to all other obligations, but perhaps this is legally difficult, and might forestall further financing. But the idea is that no cash leaves the borrower to its equity or management until the government has been made whole.

I don't know how to price the collateral. "Market" levels don't really exist, and would force the banks to take the losses that cause the problem to begin with. Par levels would expose the government to borrower counterparty risk. I think you go with the latter, as the point is to create space to work out the losses while restoring liquidity.

Won't this constrain credit expansion as equity is dedicated to working out from under the government note? Yes. But credit ought to contract anyway. As credit rates rise, institutions will see advantage in building up loan portfolios rather than repaying the government. And they'll have the liquidity they need to operate and lend. At the same time, they'll have incentive to repay the notes.

Paulson & Bush: First Impressions

Where was the Congressional leadership? The Administration proposes enactment over the weekend of interventions undreamt of in seventy years without any demonstration of partisan or executive-legislative cooperation. I don't think the Democrats are easy -- Schumer was campaigning against McCain yesterday afternoon even while setting off a rally with the news that Democrats agreed in principle with McCain's MFI idea -- but why make any announcement before you've got a deal? And since you are, what's the point of warning against "controversial proposals" in the deal? The Democrats have already stated mortgage relief as their price, and now you're committed to delivering something. If you want a package fast, you might as well agree to that upfront and get this done, rather than pretend you might avoid it.

Why are we doing this now? What has changed since summer, spring, last fall? The new fact this week is the collapse of the money funds, but that is a Treasury initiated event. Clearly, the Sunday decision to let Lehman fail was a mistake, as it cratered the second most conservative asset class in the market. The optimistic, calming rhetoric since the Bear deal seems like a mistake, as it convinced the markets the government would bail out anything of similar size. And if that rhetoric was truly necessary, then Treasury had to perform the Lehman-scale bailouts it implied.

Paulson said the "bazooka" of funding authority requested to support the GSEs would never be needed because of its size, but its poor structure foreclosed private sector solutions. He's had six months, at least, to seek more effective and larger tools for market intervention. Instead he's headed into the biggest poker game since Yalta waving a pair of aces around. He's claiming to be "bipartisan" while seeking enormous new authorities for the benefit of Republican constituents without even a nod to those of the Democrats. Barney Frank gives me a stroke but even I have to agree that's completely unreasonable.

McCain's Green Bay statement this morning points to the GSEs as the crisis epicenter, calls for the RTC like entity (which would "keep people in their homes") and emphasizes the importance of economic growth. Never mind Chris Cox, he ought to call for Paulson's resignation. Maybe that's too scary for the markets, but if so he ought to hint at it.

It's hard to assess the management of economic officials, who have much better and more current information than most observers. But at this point, it really seems to me that Paulson has done a pretty poor job. I'm shocked at the mismanagement, and disgusted at the compromises of principle required to clean up the mess.

McCain Throws Cox Under A Bus

"The chairman of the SEC serves at the appointment of the president and, in my view, has betrayed the public's trust," McCain told a rally in this battleground state. "If I were president today, I would fire him."

Geez. The SEC doesn't set capital standards, doesn't oversee investments and doesn't supervise consumer lending. But it has allowed short sales, enabling those greedy speculators to make money just betting on stock prices! John McCain doesn't see how that can help the economy of people who actually make stuff, so it must be wrong. Then again, Candidate McCain has admitted that economics isn't his strong suit, so maybe he isn't the best reference on the morality of trading.

The trouble is, Candidate McCain is fundamentally a moralist. He traces most problems to failures of integrity, and his ethics are country-club conventional rather than a product of his own contemplation. The country-club folks have a lot of common sense and their ethics aren't so bad, but they're founded on what worked last time. Not so helpful when we're dealing with something new. Candidate McCain can't ignore a historic financial seizure, so he has to say something, and he's gone after the regulator who can most plausibly said to have countenanced greed.

Meanwhile, Candidate Obama is signaling approval of Senator Schumer's and Representative Frank's proposal to legalize the default of subprime borrowers. Candidate Obama's economic policy was already the explicit reallocation of wealth through tax credits and the expansion of progressive taxation to fund retirement payments.

I don't hear any political force talking about improving productivity, or reforming market institutions to give participants incentives for behavior conducive to systemic stability. I don't see any awareness of the distortions created by government risk underwriting through mechanisms like the GSEs. I love John McCain's integrity and outrage, but it does little good when detached from a sound understanding of our system.

Lehman And The Money Funds

Secretary Paulson's decision to let Lehman fail made sense to me. If Treasury and the Fed bail out creditors to every institution of any prominence, it becomes impossible to credibly suggest that they won't do so again in the future. Lenders would be free support any amount of leverage provided the borrower is large enough, and the government would be writing deposit insurance for them no matter how risky the enterprise. It's a recipe for excess leverage supporting the riskiest possible assets.

But Lehman's collapse contradicted conventional wisdom. Last week I heard Bob Rubin tell Charlie Rose that if you save Bear's creditors, you would probably save Lehman's, which certainly sounded plausible. Since then Treasury's decision has been justified by the argument that the markets had time to prepare for Lehman that they didn't have for Bear. But that's belied by the losses from Lehman paper to Primary Reserve. Maybe they were the only fund with such exposure, and if so, maybe they were just stupid. But I'm also hearing that money fund exposures to AIG were part of that bailout decisions. If a money fund that big thinks the government will support Lehman, then the government's signals aren't getting through with enough clarity.

Note to self: if Treasury Secretary, adjust rhetoric to nudge money fund holdings into general correspondence with internal information on borrower soundness.

Financial crises are too fluid for simple decision rules. But the principles driving those decisions ought to be clear enough that players can make reasonable predictions. The ability of conservative players to accurately find the boundaries of safe decisions is one acid test of that clarity. Maybe the most important -- if the point of all this is to stabilize markets, then shouldn't investors be able to know what they can and can't count on? I question whether the possibility of a Lehman or AIG collapse, without government support, has been communicated by Treasury with enough clarity so that investors as conservative as the money funds would know enough to steer clear. And if Treasury and the Fed aren't communicating the rules of the road, then it is no wonder that the markets are confused, and looking first to their own safety.

Letting Lehman fail might have been a good decision. Letting the government's tolerance of that failure surprise anybody was not. Secretary Paulson has constantly been emphasizing the soundness of the system, for understandable reasons. But perhaps it would have been well to note that the bailout of Bear's creditors was motivated in part by the lack of time to prepare. That would have caused short term problems, as investors moved against the possibility of failures without government support. But it might have laid better ground for a sustainable solution to all this.

Sending these signals is a difficult blend of encouraging realism without inspiring new doubts. Setting these policies is a balance between meeting today's challenge while writing the rules for the next challenge. It isn't easy. But it seems to me that Secretary Paulson is relying chiefly on building up the market's confidence, without underwriting that confidence with a government guarantee. It might be better to do more to encourage market players to move toward positions that are secure without such support from the government.

Palin on Readiness

"I think because I am a Washington outsider that opponents are going to be looking for a whole lot of things that they can criticize and they can kind of beat the candidate here who chose me as his partner to kinda tear down the ticket," Palin responded. "But as for foreign policy you know I think I am prepared and I know that on Jan. 20 if we are so blessed as to be sworn into office as your president and vice-president, certainly we'll be ready. I'll be ready. I have that confidence. I have that readiness and if you want specifics with specific policy or countries go ahead. You can ask you can play stump the candidate if you want to. But we are ready to serve."

From Political Radar.

Questions about the readiness of a two-year Governor are prudence, not partisan tear-downs. She may think herself "prepared" for foreign policy leadership, but she doesn't offer any reason for anyone else to think so. Not only does her answer neglect to advance the debate, it begins to suggest either ignorance of the difficulties or arrogance in her assumption of readiness to handle them.

The challenge to "stump the candidate" makes matters worse. Specific questions are pointless if they'll get answers as empty as this.

The truth is, she isn't prepared. If President McCain died on the way back from his inaugural, we would have a leadership problem, and any vote for him is a bet that he won't. Many people will be comfortable with that Inauguration Day bet, especially compared with the bet offered by Senator Summit With Anybody. But the more plausible possibility is a Palin Presidency in, say, two years. I'm not sure that errors from incompetence are better than errors from flawed and politicized thinking. At least we would learn something from the latter.

The question was, "please respond to that criticism [of your perceived lack of foreign policy experience] and give us specific skills that you think you have to bring to the White House to rebut that or mitigate that concern."

I think her answer should have been, "I do lack that experience. I've been addressing myself to the duties of the Alaskan Governor to her state's people, and those involve only a peripheral attention to foreign affairs. My duties have always brought new challenges to me, and so far I've met them successfully. Those duties have involved a deep understanding of energy economics, which is one of many topics important to our national security, and my understanding of those is a start on my preparation for these challenges. I wouldn't stand for President myself, but I'm convinced that John McCain is the right man to make the next decisions on the structure of our foreign policy and to lay out the principles for how we go forward, and I'm honored he thinks I can help him attain the Presidency so he can take us forward in these difficult times. If, God forbid, I should have to serve in his place, I would strive to implement the policies and views established by his wisdom. And I would add that my preparation isn't so different from that of the top of the opposing ticket, who would pursue a very different philosophy that can only increase our troubles. So, yes, I lack experience, but I'm learning fast, and I am learning from a basis of sound principles ."

I'm no politician but that sounds more plausible and more to the heart of the matter. I want Candidate Palin to succeed, and have believed that she can, but right now she is falling short of the learning curve I expect of someone who can actually do this job.

Econ 101

I've become quite supportive of John McCain's candidacy, but I have to say his rhetoric against Wall Street bosses is disappointingly typical of a politician.

"Too many people on Wall Street have been recklessly wagering instead of making the sound investments we expected of them. And when their companies collapse, only the CEO's seem to escape the consequences. While employees, shareholders, and other victims are left with nothing but trouble and debt, the people who helped cause the collapse make off with tens of millions in severance packages. I have spoken out against the excess of corporate executives, and I can assure you that if I am president, we're not going to tolerate that anymore. In my administration, we're going to hold people on Wall Street responsible. "

It is true that the heads of Bear, Lehman, Merrill, AIG, et cetera didn't understand their investments, and/or didn't understand the funding model that provided that liquidity. It's true they were paid handsomely for little more than tracking the market. But it would be no surprise to learn they managed these companies with an eye to their personal interests. This is just human nature, which won't change, and isn't subject to regulation. The answer to the problem doesn't lie in legislated probity, but in the design of systems and institutions that either align interests or guard against them.

Neither McCain nor Obama really understand these markets. I haven't heard any Congressman that does. Our political class simply doesn't understand economics.

The Economy

Lehman gone, Merrill sold, AIG tottering . . . . Quite a weekend.

Neither candidate displays the slightest understanding of what's going on. Seriously, zero. Our financial institutions have funded themselves with short-term funds borrowed on mortgage-based collateral, in part to fund the acquisition of mortgage assets. Those loans were all made on the assumption of rising house prices, which were fueled by years of declining interest rates and the extension of mortgage credit to marginal borrowers. The former was the initial and primary driver, with the credit extension first justified by the price increases from the rate reductions. But as banks crowded into the trade the proportion of credit extension grew to be the primary driver. Relaxed lending standards based on price increases driven by further relaxation of lending standards is a tautology that even Wall Street will eventually notice.

The markets now have to reprice those assets for sustainable housing values, which we're still discovering and which depend in part on the financing available, which of course depends on those assets. The markets also have to adjust to reductions in leverage available, as mortgages are no longer good collateral. That is exaggerating financing difficulties beyond their long-term levels, and will probably depress housing prices somewhat below those long-term levels. These are interdependent variables and it will take some time for everything to shake out.

There were other excesses in lending standards as the securitization model was extended to items like credit card debt and corporate securities, all initially justified by lower interest rates. The contraction of those structures is also hurting the supply of liquidity and the demand for debt assets. The overall debt environment was also supported by the recycling of dollars by exporters (Asian manufacturers and oil producers) who were reaching for yield.

These financial events reach the real economy through consumer spending and housing construction. Less mortgage finance means reduced housing demand and reduced housing construction. Housing price increases fueled consumer demand directly through home equity loans, and indirectly through increased consumer credit as credit card debt was tacitly protected by the borrower's ability to reach that increased home equity. The wealth effects of higher housing prices made consumers willing to use that newly available credit. Lower financing costs also probably helped business investment at the margin.

The dislocations and anxiety we're feeling is the logical adjustment to all this. We should worry, because we've lost the security on which we depended for the past ten years, and the reduction in consumption is the necessary and logical consequence of those worries. That security was always financial and exaggerated. The productivity of the American economy hasn't changed, but yes, we will have to focus a little more on what we actually need. It's disturbing but not terrible.

The pain is worst for those in marginal jobs and industries, but their position was never well founded to begin with. No government action will bring it back. We were mistaken to focus on anything but the core productivity of our workers and our economy, and we would be mistaken to focus on anything else right now.

I don't hear any of that from the candidates, probably because they don't understand any of it.

Palin on Gibson: C

I only saw the bit on the evening news. She wasn't impressive. She sounded like she was repeating talking points and uncomfortable discussing principles. She didn't sound like someone who had given much serious attention to foreign policy, or had serious considered alternatives to her stated positions. Her comments on Georgia and NATO sounded glib, her insistence the invasion of Georgia was "unprovoked" seemed ignorant of nuance.

I didn't see the curiousity or humility needed to recognize and tackle the learning curve ahead of her. She seemed a little overconfident, as if doubts about her preparation are nothing but the product of a hostile media. Friend, you are _as_ qualified as a two year Senator with years service in a state legislature. Neither of you are _actually_ qualified, and I personally would appreciate a greater recognition on your part of your own failings.

I though the Bush Doctrine question fair, and that she should know it -- and in any case, prepared to discuss the fundamentals of the policy of the past seven years. (The rhetorical damage was limited by Gibson's misunderstanding of the "Bush Doctrine", though I guess there is a school that says its about preventive war rather than holding sovereigns responsible for proxies.)

She did have a great answer to the "holy war" question, and her discussion of Lincoln's theology showed real depth. She can master what she studies, but she has to show that capacity on more contemporary and practical questions.

Now, I don't think Obama's foreign policy principles are much better thought out. He is far better prepared to speak about the subject, and his confidence suggests mastery -- but that doesn't mean the actual words make any sense. Then again, while I believe an Obama presidency would generate setbacks, at least these would then discredit a stated philosophy. (Or it might work!) Setbacks from incompetence don't even advance our understanding. If Palin can't hack it then we're choosing between a gamble on McCain's health and giving a flawed opposition policy a chance to show its worth.

Palin might get by with this sort of thing, but I was disappointed. She has to get to firmer ground or she'll do poorly when called upon to lead. More performances like this could suggest she can't grow into the job -- and that would bring McCain's judgment and integrity right back to the center of the debate.

Hey, Barack! Time To Stick And Move, Buddy

The Left is too outraged to see that the Moderate Middle likes Sara Palin, and thinks the charges (to date) are petty, baseless or wildly exaggerated.

Obama's strategy was always Defeat Bush-McCain. That's shot, the Palin pick makes it crystal clear that McCain is no Bush.

Plan B would be, just keep pushing your themes and programs. But if Campaign Obama were confident in those, they'd already be pushing them. And McCain has seized control of the debate, so your stuff might not get through anyway.

Time for Plan C:

1. Welcome, Governor Palin. Sorry about the pig thing -- thoughtless at best, I'll do better.
2. Please tell me, what are your views/track record on manufacturing jobs and competitiveness, economic fairness, shipping jobs overseas, urban education?
3. We know you agree with Sen. McCain on Iraq and Afghanistan; but what are your views on the proper military structure going forward? our relations with China? Islamic countries? Africa?
4. Oh right, the _Presidential_ nominee. Senator, you're no George Bush, but what is _your_ plan for the economy, environment, education?
5. Congratulations, you've just vetoed all the pork Congress can muster. You've saved what, 5% of the federal deficit? Now what?
6. You're about change, that's great, is there an iota of evidence that there is anyone outside your party actually with you on this? In the lower 48, please.
- Outside of crazed Oklahoma doctors. The Republican hates Tom Coburn as much as the Democrats.
- We'll give you Lindsey Graham.
- Why is it that the only other ally you've got in the Senate is a _Democrat_ (btw, we're taking Joe Lieberman back, the whole Lamont thing was shameful)?
- Your election would empower the same Senators that backed Trent Lott and Bill Frist!
6. Never mind Afghanistan, everyone agrees on refocusing there. What with half the army sitting in Baghdad, what the hell are we going to do if Pakistan melts down? China goes after Taiwan?
7. You're 72? You don't look a day over 65.
8 I've got a reform agenda in my own party:
- Look at me, here in Newark condemning the party bosses slowing down Cory Booker!
- What, teachers unions in XXX are stifling reform? Not on my watch!
- I just discovered Bob Byrd was in the KKK! And he's moving the seat of government to West Virginia! We'll throw _him_ out!

Get McCain off "reform" and make _him_ state what _he_ means. Get people asking why he won't come to your turf. Accept Palin's bona fides as an at least plausible candidate, if only to get the focus off her, but press her to address issues, and in particular stuff outside her history and off the briefing books. Show some signs that you'll actually contest at least the worst excesses of your own party (frankly, it's probably too late for that to stick, but at this point it might be worth a shot anyway).

The risk of this is, 1) McCain/Palin get to answer the questions and thus continue to drive the debate; 2) their answers might be good!; 3) your answers aren't so compelling; 4) if voters think government is full of hard questions they can't answer themselves, they may look instead to the candidates' philosophy and character, and you're already nervous about that comparison. And 5), McCain may succeed at just ignoring you, though I doubt that'll work for seven weeks.

Obama and his allies have completely misread the general reaction to Palin, and so missed their best opportunities to highlight her real weaknesses. They were counting on the Bush-McCain / out-of-touch stuff, and at this point all that is shot. It isn't clear they've got anything else, and I'm not sure they've got the depth to respond. But they have to try to move the debate back to their terms and issues, and they can't do that while complaining that Palin is a moron and whining it's all so unfair. It's risky, but so was Palin, and now look where things are.

At this point, Obama looks like an inflexible strategist with only one or two arguments, and a guy who can't take a punch. They can sit around wishing it was mid-July again, or they can get off their ass and take a shot. This whole thing is in their court right now.

Overboard

Quoth Joe Biden: "[Hillary] is qualified to be president of the United States of America, she’s easily qualified to be vice president of the United States of America, and quite frankly, it might have been a better pick than me."  He was responding to a comment that she would have been a bad pick because of her history.

Snarks Campaign McCain: "Biden . . . suggests, himself, that he wasn’t the right man for the job, and that Hillary Clinton would have been a better choice."

Guys, the man was defending a friend, and in a self-deprecating manner.  This is stupid.  Grow up.

Obama's Recovery?

Never mind the headline, the Post reports nerves among the Democratic insiders. Everything's fine, reports Campaign Obama. Meanwhile the Times reports they're fundraising could be behind budget. The top of their ticket is calling the bottom of McCain's ticket a "pig", and the critique of McCain's claim to "change" has a plaintive tone. It doesn't look like Candidate Obama can take a punch.

Why not, and how well he recover?

The Palin nomination is working because it draws attention to McCain's reform agenda, and because that agenda gains credibility under scrutiny. He's done hard things, he's bucked his party and heroes, he's crossed the aisle to get things done. Dumb things, sometimes, but he's no partisan. The Palin pick shows those who know him that he's serious about this stuff. Those who don't know him are intrigued by the pick, look to see if McCain's reform agenda is for real, and find a biography and record testify to his seriousness. She doesn't validate him, or at least not beyond a certain point, but she grabs people's attention, and he can make the sale from there. She makes it obvious that he isn't Bush-Cheney III, and she makes the "out of touch" charges ridiculous. With her help, McCain is making a strong case for the Presidency.

Obama isn't. He has "programs", but they're complicated, and people are generally suspicious of government even if they're the supposed beneficiaries. His blend of change is Democratic policies rather than Republican, which is fine but doesn't address any fundamental problem with Washington. Is Harry Reid really that much better than Bill Frist? Is Nancy Pelosi truly different than whoever the GOP had as Speaker? The argument that he is actually more of the same is not implausible.

Perhaps Obama's candidacy was never that strong to begin with. He was fresh and exciting as a black politician who didn't play to a black base, and as a Democrat making a studied effort to speak to people of faith, and as someone who wasn't attached to the partisan battles of the past. Obama looked like change among traditional Democratic alternatives -- but even then, he won the nomination in part by better organization and careful optimization of return on efforts through a strategic focus on caucus voters. A win is a win, but such a win signals less popular appeal than a win based on decisive margins in large primaries. As a Generic Democrat facing a Generic Republican, he looked pretty good, especially since the electorate is rightly and deeply disgusted with Republicans these days.

But the Palin pick took the perception of McCain out of the Generic Republican box. It's less clear that Obama knows what to do against John McCain, as opposed to Generic Republican. His campaign was essentially founded on a rejection of George Bush. Now that McCain has decisively escaped that identification with Bush, Obama needs a new plan. Looking at his campaign, I don't see what that will be.

(The 9/11 appearance won't help, either. I first thought it would hurt McCain, by suggesting parity in their opposition to terrorism. But it does emphasize foreign policy, turf where McCain compares well. And it shows McCain reaching out to build consensus there, a crucial and ugly failing of the Bush Administration. His effort here will underline the differences in his approach from Bush's -- further complicating Obama's effort to collapse the two.

(McCain doesn't have a great reputation as a strategist, but he sure seems to be playing this game awfully well lately.)

Is That All You've Got?

Campaign Obama is fully focused on Candidate Palin and the "change" message. Yesterday Candidate Obama was claiming her opposition to the Bridge to Nowhere was false; over the weekend his reply to the idea of John McCain, Change Agent was "give me a break". He also backed off the tax increase portion of his program, at least while we're in recession, which probably takes any argument about fiscal responsibility off the table for the time being.

It's noticeable that Campaign Obama isn't pushing "programs" or policies, which doesn't suggest great confidence in their appeal. Campaign McCain has announced its preference for a debate on personalities and biographies, and that's what they're getting, because the other side has decided to double down on the Palin nomination.

If Obama can expose falsehood in her record, her appeal deflates -- reformers need candor. So far this effort doesn't seem promising. Her record on the Bridge to Nowhere is less straightforward than advertised, but it still seems strong. (This morning I heard an NPR anchor caveat her opposition as arriving only after the project was "untenable", but this seems more opinionated than persuasive.) On the evangelical grab-bag, her positions are not unexpected and not really an emphasis for her governance. This line of attack seems more wishful thinking than anything else. If the best Obama can do is argue the nuances of McCain's running mate's record, he's neither making his own case nor addressing McCain's.

Obama is also drawing attention to Palin and her ongoing performance. She does have to get into interviews and press conferences (though Obama doesn't do many of the latter himself). Obama is highlighting any potential stumble. But if she performs solidly and avoids obvious gaffes, people may be underwhelmed, but they aren't going to disqualify McCain. If she performs great, Obama has just made McCain's case for him.

Obama is taking the other side of the Palin gamble -- increasing his gains from her stumbles and his losses from her triumphs. It doesn't signal confidence in his own message. It also frames the issue in terms Campaign McCain can control: with preparation and thoughtful rollout, they can give her every chance to succeed. And by setting up Palin as an acid test of McCain's judgment, he has actually lowered the bar somewhat. Previously the question was, how will she do? And an underwhelming performance might have sowed doubt. Now the question is becoming, is she so bad that her nomination is an obvious and serious mistake? And if she performs with the expected norms of national politicians, the answer will be no.

Obama is also hoping that a sympathetic press will shape perceptions of her in his favor. The press is certainly trying. But each refutation of some breathless allegation reduces their credibility and casts them as players with agendas of their own. At some point they may find that even a reasonable charge is ignored because they've cried wolf so often. At some point the public may turn them off entirely, which would shut down an important communications ally for the Obama message. Or, if the attacks don't start to stick, the press may pick up a "she was underestimated" theme.

Obama's response so far doesn't reveal confidence in his own program. It doesn't suggest any essential critique of John McCain. (Where are the "out of touch" and "Bush-Cheney III" themes?) The reliance on the press risks transparent cynicism, and diminution of a key ally. The whole approach suggest any strategic judgment beyond a gamble that someone else will fail. And it raises questions about Obama's communication skills -- if he can't shape the message now, then was he shaping the message all year? or did this "change" thing just fall in his lap?

The challenge for McCain now is, don't let it be about Palin. Keep making your case, get yourself out there, draw the focus to your message and story. Keep rolling her out, but let that story sell itself. She has changed the game and confused your opponent, but don't make her the endgame. Obama is signaling your message is more appealing than his -- press that. Eventually the focus must return to the top of the ticket, and now is your opportunity to shape the terms used at that point.

Bailing Out Fannie and Freddie

Treasury has effectively written an unlimited capital put. Bondholders are reassured that the GSEs can issue any amount of equity capital required to protect their balance sheets.

Why would the GSEs ever need the actual capital? The puts ought to assure any debt rollover. So long as their operations stay cash flow positive, there isn't any reason to actually exercise the puts.

So the shareholders could easily live to fight another day -- they'll pay 10% on the first preferred tranche, but after that they keep any gains. Any losses end up at Treasury. They have to start shrinking their portfolios, but not until 2010, and until then they finance those portfolios at Treasury rates.

There is the possibility of dilution via those warrants. But that's _political_ risk, a gamble on government action. If the government won't blow up the equity now, why on earth would they ever do it?

Why is Treasury doing this? The trillions of GSE debt is held by all kinds of financial institutions, and used in all kinds of money market financing transactions. The increase in GSE spreads has marked down the value of all that paper -- slightly, but those losses are spread throughout the whole financial sector. And the instruments are much less reliable, which makes them much less useful for funding operations like repos, and less liquid stores for capital reserves. That's a real systemic threat.

Why doesn't Treasury wipe out the common shareholders? The GSEs have enough political cover from Congress to make that controversial, and enough legal cards remaining to make it uncertain. A fight over the common would only create uncertainty, which is the very thing Treasury is trying to avoid here.

The bottom line is that the GSE equity holders are getting very cheap equity, largely because they have become foundational to the capital markets and because their friends are prepared to hold those markets hostage to keep the GSEs afloat. The equity will have to be patient, and it has to bear political risk, but that's what the GSEs have always been about.

Why McCain's Speech Was Dull

So. I thought Candidate McCain's acceptance speech was inevitably dull. He doesn't have "programs" because he isn't an ideological guy. He thinks people take care of themselves pretty well, but he isn't interested in rehashing debates about government in order to roll it back. He'll live with the government we've got, but wants to address the emergent issues without building new nests for various politicized rent-seekers.

Since taking Congress in 1994, the GOP's establishment has sought rents with the best of them. Elected to reform government, they preferred to carve out niches for their friends and collect fees for redirecting its resources and navigating its regulations. Our Constitution has checked the inevitable human impulse to abuse power, but the welfare state has created opportunities to instead milk it. We've evolved a political class that understands that power exists in journalists and administrators and academics and organizers and has expanded itself to include them all. Selling office outright is dangerous because the purchaser could use the power to reappropriate the fee, so they've revised simony to instead lease out the office -- it's safer, and the income stream is just as good a lump sum payment. They share the wealth with book deals and consulting contracts and promotions and job security. Jack Abramoff was just stupid -- why expose yourself breaking the letter of the law when you make plenty of money hiding behind half-truths and plausibilities?

Candidate McCain doesn't really like his party. His favorite line was the promise to veto to pork barrel appropriations. His party doesn't really like him, he's going to reduce the size of the pie available. But this subset of the political class knows they don't get any pie at all without him -- it's the only reason they're nominating him. It's a bitter deal and he can't rail too much against them for fear they'll get so demoralized they'll just give up. And he's too intelligent to believe that Clintonesque "programs" will make a damn bit of difference, and too honest to pretend he thinks he does.

John McCain would mark the country through his action, not his program. He would demonstrate the faults of a culture and an approach. That's fuzzy stuff, but it's real, and he has the record to show just how he would act in the future. If Teddy Roosevelt was a response to the perversions of free market principles by monopolists and businessmen, John McCain is a response to the distortions of "equality" by welfare state rentiers. It makes for a dull speech, but it is a positive response to the challenges we face right now.

Whoops

Yesterday I wrote a long post on McCain' s speech, the gist of which was the message is the man and he doesn't offer any program because he's Teddy Roosevelt against the entrenched powers and doesn't have a program. It convinced me that he's actually in pretty good shape.

But, it doesn't seem to have actually posted. Hmm.

Last night Candidate Obama's riposte was, they're talking about personality but the campaign is about issues and if you elect me at least you'll know someone in the White House is thinking about you. That doesn't even make sense. If it's about issues, talk about your proposals. If this comes down to the focus of the candidate, Candidate McCain has a reform record, an honorable history and a folk-hero running mate. If Candidate Obama's "programs" are so compelling, why is he talking about his good intentions?

A Won Battle

Sarah Palin arrived from the North last night, an American Valkyrie stooping from the heavens to shatter the ranks of the Mighty and the Important, and cry defiance against any and all who harrass her children or her neighbors. She offered no complaint of her treatment, nor sought any assurance of fair play. Disdaining to ask for any quarter, she directly engaged her enemies and drove relentlessly at their soft spots. She reminded everyone of an America equal to any hardship and too strong to even want help, and called for restoration of that country's government by elevating one of its greatest living heroes. Amid a conservative retreat from years of stumbles and confusion, Sarah Palin is calling a rally that could swell to real and effective counterattack.

Is that capsule a little purple in its prose? Well, that was an amazing performance.

Last night had glimpses of substance and intelligence, but combat was the theme. That's well after a week of belittling questions and double standards contorted into a semblance of a formal fairness. But while Americans applaud the knockdown of bullies like the New York Times, they also know bullies can be also ignored. There is no ignoring the economic and international challenges before the country.

The economy grows better than you'd think, but the uncertainties are real. Houses are the chief wealth of most Americans, and the freefall in their value is scary. As is the explosion of gas prices, and the ongoing adaptation of the economy to the productivity gains of trade. The collapse of GM, Ford and Chrysler, though long-expected, still reminds everyone of the frailty of particular economic institutions. The promise of stability through Law and Management is tempting.

Campaign McCain has to explain how it will address structural problems. It has to explain how we'll secure the energy our economy requires, and work toward educational institutions that will found real productivity in real learning. It has to address financial innovation that produces new opportunities faster than institutions evolve to bend them to an average consumer's interest. It has to show how the diversion of resources from our least productive institutions will free income for the things we care about. There is a case against Campaign Obama's economics: this is no time to raise taxes or squander resources in the deadweight loss of inefficient redistributions. Abandoning the power of individual choices out of fear will only make things worse, and reminding Americans of their strength will give them heart in an uncertain moment. But Campaign McCain has to show forswearing the Nanny State doesn't mean neglecting the government's responsibility to provide the economic structure required to support those more-efficient markets.

If John McCain can show that he will look after that structure; if he shows that the programs by which the Democrats offer security are themselves thwarted by captivity to interest group rent-seekers; if he reminds people that people are strongest when allowed to provide for themselves, and Americans famous for prodigious returns on those freedoms; if he makes a positive case for his Presidency, then he will put in place the last element needed to push Campaign Obama back on its heels.

By steady application and shrewd risks John McCain now finds himself poised to wholly define this campaign. Tonight he can seize the initiative entirely, and force Campaign Obama to respond to a crisis they never should have permitted in the first place. John McCain can force Barack Obama to meet a crisis for the first time.

Sarah in Wonderland

By the way, I love the media argument that Candidate Obama is "qualified" because he's been tested by voters. Of course _Democrats_ assert he's qualified. Whether the rest of us do is the question of the whole election! It's a question-begging sophistry, transparently advanced to justify a double standard. Who needs Lewis Carroll when you've got Mark Halperin?

All Candidate Obama has proven is the ability to operate politically on a national stage. We'll soon see Candidate Palin's abilities.

Odd Couple

The convention reception of Senator Lieberman struck me as less generous than the man deserves. This is a political moderate who was once nominated by the Democrats for vice-president. If he thought first of healing his rift with his party, he himself might dream of the Presidency. Perhaps delusionally -- he's a lousy campaigner -- but politics are full of deluded people. Instead he is opposing his party and a truly historic nomination from conviction that this moment requires better leadership.

This convention is, and Denver was, full of people who are less decent and principled and wise than men like Joe Lieberman and John McCain. That's a real problem for McCain, whose candidacy would be an odd fit in any political party. He's an anti-institutional figure trying to use an institutional apparatus to take power. I'm not sure it can work.

Compare and Contrast

Over the weekend, the McCain campaign has turned the national focus to Gustav, forfeiting a big chunk of free TV time and truncating its opportunity to make its case for election.

In the meantime, the progressive fever blogs have dug through the Palin family garbage. The haul so far: outing a teenager's pregnancy, a 20 year-old spousal DUI, a flirtation with with some crackpot secessionists 15 years ago, and some "nuance" on the Governor's position on earmarks. That last bit speaks to her candor and is actually important, but it might get lost in the teen pregnancy uproar.

Candidate Obama has declared the pregnancy out of bounds, and has also been talking about Gustav -- but hasn't stopped campaigning.

Bureaucratic inertia makes common sense rare in politics, so the convention suspension demonstrates real leadership. Even if it is "calculated", the electorate can see Candidate's appreciation of national values and perceptions. The progressive trash-pick is par for the course, but still another reminder of what those folks are about. These blogs do play in message generation and distribution, but they are diminishing their own credibility and thus their influence over mainstream opinion. No matter what the Obama campaign thinks of the gossiping, the squalid display of its known allies can't reflect well.

Campaign McCain now has to present a compelling case for election and introduce Governor Palin in greater detail. She must continue to give strong performances in her speech and interviews. After a mediocre Democratic convention, the GOP has the opportunity to set the terms of the debate. This is a precious opportunity to take the initiative and force Candidate Obama to react rather than drive. Its conversion would compound Obama's strategic problems with questions about its judgment to date and its ability to react. McCain is showing that such challenges can become opportunities to show strength, and Obama could react well. But so dangerous a moment for Obama so early in the race would be unexpected, and would speak well for the skill of Campaign McCain.

But they first have to use that initiative well. And Governor Palin must perform well, and on occasion after occasion after occasion. The focus doesn't turn to Campaign Obama's reaction to pressure until Campaign McCain creates that pressure.

Obama's Acceptance Speech

I didn't think this was a strong speech. It lacked the aspirations and freshness that drove his 2004 convention address, and the charisma that animated his 2008 stump speeches. But I don't know that he could have done better.

Obama's appeal has been the offer of a new politics and approach. He certainly offers at least one important innovation: he's a black politician seeking a core white constituency. His de-emphasis of the civil rights agenda typical of black politicians is a powerful example of attending to common issues before interest groups. It's still more powerful (and really, only works) because it's tacit. And his opposition to the war is Change, as was his distance from a pre-invasion establishment consensus that seemed as much political calcuation as anything else.

Important stuff, and in a primary election these things signaled real differences. But these departures from expectation are less noticeable in a general election, and the Senator's more recent predictability has dimmed his novelty. Civil rights is never more than a part of a Democrat's Presidential campaign, so Obama's de-emphasis of the issue is less striking here than in the nomination campaign. The Democratic establishment's late repudiation of the war has made his opposition less dramatic. The Senator's reluctance to acknowledge the success of the surge is similar in kind, if not degree, to the Administration's craft of foreign policy comments for domestic political effect, tarnishing the testimony to integrity won by his early opposition to the invasion. He does offer the occasional responsibility trope, but not enough to suggest that the Democrats are attributing any real part of individual outcomes to individual choices.

And even in the primaries the Senator needed more to win the nomination. There he used his real innovations to cast himself as the most effective leader of the _existing_ Democratic coalition. His policies were similar to Clinton's, which were notably to the left of her husband's, and are quite similar to progressive Democrats going back to Mondale: redistribution, social insurance, prioritization of domestic spending over military, redress of problems by increased resources through established institutions and policies. Obama argued that his outsider status, detachment from prior bickering and opposition to the war would validate him to a worried and disappointed electorate. But he didn't propose a new coalition founded on new principles.

This becomes obvious when he offers specifics. His nomination acceptance, the first appeal to that Presidential electorate, was exactly what I would expect from any progressive Democrat. Maybe that's what the country needs, and it's certainly change from a Republican Administration, but it ain't change from the politics of the past thirty years. Progressive Democrats welcome this stuff, but swing voters won't read it as new or inspiring. And while Obama offers some real changes to our politics, his alliance of them to a powerful and established is hardly evidence of principle.

Obama was stuck as he walked to the podium. He had to offer specifics to refute the celebrity lightweight stuff. But those specifics distance him from the Change elements that made him so exciting to begin with. Rather than promising a revision of partisan alignments, Obama's acceptance speech promised good but solidly Democratic State of the Union speeches.

What This Is

From time to time I send long political opinions to various heavyweight bloggers. They ignore this stuff, which is neither well written nor clever.

But I like writing. The iterations of revision evolve my initial premises and conclusions from a reaction to an argument. It's basically a conversation with myself about what I really think, and the topic is, obviously, without general interest. But it's important to me.

This is just an experiment in publishing those exercises into obscurity.