The Failed Bailout: A Drop in the Bucket and Abusive to Renters

The last week has witnessed phenomenal political & economic events. Observers, including every pundit under the sun and businesses around the planet, have stood transfixed by a dramatic series of negotiations over a plan that would transform America's economy.

Henry Paulson, the Treasury Secretary and former Wall Street banker, initially proposed squandering even more than $700 billion of taxpayer money -- enough money to fund the Department of Education for the next 115 years -- to buy bad loans from failing banks.

The audacious proposal has inspired rampant criticism from all sides: ideological free market conservatives argue it represents socialism; progressives rail against its offensive distributive implications and its proponents' hypocrisy; the financial sector has argued it places too much power in the hands of the Treasury Secretary; and economists say it won't work. Each of these criticisms is fully justified.

Only one argument meaningfully favors the plan: its reported necessity. But in fact, the scheme can't possibly work without abusing taxpayers. At best, it could help ease the nation's eventual recovery from an increasingly inevitable depression - quite likely, one the likes of which few people alive can remember. But it won't keep our economic chickens from coming home to roost.

And while the bill's many economic injustices have faced criticism, one in particular has largely escaped notice: its complete disregard for, and financial abuse of, 100 million Americans who rent their homes.

Making it Up as They Go Along

In addition to writing his column for The New York Times, Paul Krugman is also a world-renowned economist who has taught at Yale, Stanford, MIT and Princeton, where he specializes in studying financial and currency crises. He noted when Paulson first introduced his plan that, "after having spent a year and a half telling everyone that things were under control, the Bush administration says that the sky is falling, and that to save the world we have to do exactly what it says now," without delay. Dean Baker of the Center for Economic and Policy Research agrees that "Henry Paulson...totally missed [precursors to the current crisis], and has been wrong about almost everything."

Yet, roughly two weeks ago, "the realization...that American capitalism was going through something historic -- and not in a good way," prompted a plan that "may redefine Washington's role in the marketplace for years."

Paulson's initial proposal would have granted him unprecedented authority over a $700 billion revolving pool with which to purchase bad loans from failing banks -- at full price and without any equity for taxpayers.

According to Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, Paulson would have gained the authority to "make any loan he wants under any terms to any entity or individual in America that he thinks is economically justified." Because the plan shielded Paulson's decisions from review by any court or administrative agency, Krugman interpreted it as a "sheer demand for authority: give us total discretion and a blank check....There was no explanation of...why we should believe the proposed intervention would work."

After the original plan was ultimately amended to accommodate various concerns raised by Democrats, a "revolt" by House Republicans on Thursday derailed the compromise between the White House and congressional leaders. In its place, House Minority Leader John A. Boehner (R-OH) proposed an alternative plan based on government insurance for failing mortgage-backed securities, rather than outright state ownership. On Friday, Rep. Eric Cantor (R-VA), the lead author of Boehner's plan, admitted that it was unworkable.

After lawmakers and the President got "back on track," marathon negotiations over the weekend culminated in a consensus that would reportedly find bipartisan support. But it was rejected on Monday by Republicans in the House of Representatives, inspiring a massive stock market crash in which over a trillion dollars evaporated and which continues to "ripple[] across the globe."

While markets around the world reeled from news of the House's vote, the unfortunate reality is that no economic stimulus plan can shelter the U.S. economy from failure.

A Discredited Administration's Latest Ruse

The $700 billion requested by the Administration for Paulson's bailout plan dwarfs even the cost of the Iraq War, which offers a host of eerie parallels. Back in 2002, the Administration fired Chief Economist Lawrence Lindsey for forecasting that the Iraq conflict would cost as much as $200 billion, instead promising that it would cost only $50 billion. The White House's error attained an order of magnitude, as the war has cost nearly $600 billion so far, not to mention over 4,000 American lives, those of nearly a million Iraqis, and an untold number of physical & psychological wounds suffered by survivors in both the U.S. and Iraq, as well as their families.

Paulson's equally half-baked bailout plan deserves the skepticism it has received.

Like those offered before the invasion of Iraq, the Administration's official cost estimates are unreliable. Some observers, like Daniel Alpert of Westwood Capital, argue that "when you add up all the problems in the residential housing market still to come -- further erosion of housing prices, mortgage foreclosures and so on -- we are going to need another $1 trillion of write-downs."

Uncertainty is even greater on Wall Street today than in Iraq five years ago. Questioning "What's All This Stuff Worth?", The New York Times explained that the bailout involves "troubled investments that even Wall Street is struggling to put a price on." Debt portfolio manager Andrew Feltus suggests the price taxpayers pay "might be 20 cents on the dollar or 60 cents on the dollar, but we won't know for years."

Under these conditions, absurd notions that taxpayers might conceivably profit from the bailout are naive.

Beyond its uncertainty, the Administration also appears as disingenuous as it did on Iraq. Five years ago, officials cried wolf about weapons of mass destruction that were never found. Over the last week, many of the same people raised alarms about an all-too-real financial crisis, but then proposed a plan that would have lined Wall Street pockets, advancing the crony capitalism favored by the Administration elsewhere.

Its very willingness to even recognize the crisis underscores the Administration's lack of credibility: "Compare their dire proclamations with their outright refusal to even entertain the notion of a recession as little as seven months ago." At least one economist has confessed a "sneaking suspicion...that they started [the current crisis] with a determination to throw money at the financial industry, and everything else is just an excuse." Economists concur even across the political spectrum: Allan Meltzer, a monetary policy expert at Carnegie Mellon and former economic adviser to President Reagan, characterized the Administration's rhetoric as "scare tactics to try to do something that's in the private but not the public interest. It's terrible."

Finally, there is the audacious hypocrisy of "people who have spent their careers arguing that government is in the way of progress -- that its role must be pared to allow market forces to flourish -- [now] calling for the biggest government bailout in American history." The "revolt" within the GOP House caucus that blocked the bailout on Monday was prompted by outrage over precisely this double standard. Rep. Ron Paul (R-TX) confessed, "I don't know who the conservatives are and who the liberals are."

Like the occupation of Iraq, the bailout plan forces the American people to pay for the Administration's errors, in order to place a band-aid on a doomed financial system whose failure is now inevitable.

A Drop in a Bucket...

Our nation has already fallen off a financial cliff. According to Roger Kubarych, former chief economist at the New York Stock Exchange, "Historic events over the past two months have fundamentally changed the US financial landscape, and additional shocks to the system are likely....[B]old action didn't calm financial markets, far from it." In fact, "[t]he bailout discussions came on a day when the Federal Reserve poured almost $300 billion into global credit markets and barely put a dent in the level of alarm."

Krugman (the scholar of economic crises) predicts that the Paulson plan would fail to achieve even its core aims, even setting aside the various economic problems that lie well beyond its scope. "[I]t might -- might -- break the vicious circle of deleveraging....[but e]ven that isn't clear: the prices of many assets, not just those the Treasury proposes to buy, are under pressure."

Moreover, the plan addresses only one of several structural problems pervading the financial system. "Even if it works, the system will remain badly undercapitalized. ....[T]here will be $800 billion or more of real...losses on home mortgages. Only around $480 billion have been acknowledged by financial institutions so far. So even if the fire-sale discount is removed, we'll still have a crippled system. And Paulson is offering nothing to fix that...."

Finally, Paulson's earlier efforts to limit the crisis may have made it even worse. Describing it as a "Hail Mary pass," business journalist Joe Nocera observes that "[t]he rescue of A.I.G. further undermined confidence because....[it] suggested the Treasury Department was as confused about what to do as the rest of us. So rather than help solve the crisis, the Treasury Department has actually contributed to the biggest problem...an utter lack of confidence." The AIG bailout also reflected conflicts of interest that further undermine Paulson's credibility.

...With a Hole at the Bottom

Recall that the "bad loans" from which Paulson proposed to rescue banks are mortgages on which homeowners will likely default. The bailout plan does nothing to address the underlying reasons why people are having trouble paying their mortgages. It also does nothing to stop banks from pursuing the same -- often predatory -- practices that got the economy into this mess in the first place.

The crisis prompting the bailout remains the tip of an iceberg, as faults pervading the economy stretch well beyond the financial system. Put simply, "[t]he U.S. consumer is under stress. The unemployment rate has climbed above 6% and anxiety about job stability is high....Wage gains are barely keeping up with inflation. Housing prices are still falling...." Even without the current crisis in the credit sector, consumer spending -- the "main engine" for economic growth -- would continue to weaken. At bottom, several fundamental weaknesses threaten the U.S. economy.

Fist, and most important, unemployment is "soaring" across the nation, even in geographic areas and industrial sectors that were recently robust, like Silicon Valley and the tech industry. Moreover, joblessness is even more troubling than it might seem, since official statistics systematically understate the extent of real unemployment by excluding three large groups of workers: part-time workers seeking full-time work; workers employed in jobs that fail to leverage or reward their training; and discouraged applicants who have stopped seeking work.

Household debt has also reached unsustainable levels. The household savings rate dropped from over 10% of disposable income, in the 1980s, to a record low of 1% earlier this decade. At the same time, household debt has risen, from "roughly 65% of disposable income in the early 1980s, to 80% in the early 1990s, to 95% in 2000...." Earlier this year, BusinessWeek exclaimed that household debt has gone "through the roof," amounting to "almost $14 trillion, nearly equal to the annual output of the U.S. economy." The combined debt of households and the federal government now amounts to over $23 trillion, or 168% of GDP, "far higher even than in the brief spike during World War II."

Working families suffer declining purchasing power for other reasons, too. The credit crunch emerging in the wake of the crisis is "further crimping budgets and family spending" by restricting access to capital. Despite various "indirect subsidies," over 40 million Americans lack health insurance, which not only adds further uncertainty and depresses spending, but also the foremost catalyst of bankruptcy. The healthcare and credit crises find further fuel in the rising costs of higher education, as well as worker-management pay differentials that have grown a hundred-fold over the last generation. Put simply, Americans make less money than we used to, yet we (sometimes by necessity, but more often by choice) spend more.

Ultimately, "even if by some miracle the financial meltdown could be resolved tomorrow...powerful forces already at work...will suppress business activity. The failure of several more financial institutions would make things somewhat worse; but saving them would not make economic prospects much better."

Berkeley economist Barry Eichengreen forecasts unavoidable budget deficits, higher taxes to service that debt, higher interest rates and more strictly regulated banks that will lend cautiously. "We've had a decade of relatively successful economic growth and have been living beyond our means," Eichengreen said. "Now we'll have a decade of the opposite. It's payback time."

Protecting the Little Guy?

Democrats called last week for attention to the needs of homeowners, arguing that an effort to save banks should not ignore "the little guy." Speaker of the House Nancy Pelosi was blunt: "We will not simply hand over a $700 billion blank check to Wall Street."

The compromise that eventually emerged from the White House bore few mechanisms to concretely help homeowners facing foreclosure. For instance, a proposed provision to allow bankruptcy judges to alter the terms of troubled loans was rejected. Instead, the bill merely invites banks to consider relaxing loan terms and provides some tax breaks for homeowners facing foreclosure. (At the same time, incidentally, the GOP's latest assault on voting rights has taken the form of seeking to disqualify voters who suffer foreclosure).

Solutions that actually help borrowers secure more favorable terms from their banks would be innocuous. In sharp contrast, the Administration planned to buy loans en masse from the banks themselves, in exchange for equity warrants that could theoretically be exchanged for stock if the banks recover in the future.

However, more robust protections for homeowners can hold troubling implications. On the one hand, individuals & families deserve government support more than banks. But distributive concerns raised by most observers overlook the one-third of Americans who rent our homes.

Renters Take it on the Chin: Moral Hazard & Distributive Injustice

Renters - roughly 100 million of us - pay taxes just like homeowners. In fact, we pay more taxes, since homeowners receive massive government subsidies through tax deductions for mortgage interest. Yet, while proposals for mortgage relief (such as the rejected measure that would relax bankruptcy rules) would help homeowners whose assets are threatened by the downturn, the most renters have been offered is the right to remain in our homes should our landlords suffer foreclosure.

Why should renters bear a disproportionate burden of insulating banks from accountability for making bad investment decisions -- or homeowners, for their's?

According to market principles, banks should bear the responsibility of their poor risk management. Rewarding failure ("moral hazard" in the language of economists) is untenable in a market economy. Outrage at the idea of the government paying banks for failing was one issue prompting the revolt by House Republicans that sank the bailout.

Peter Goodman explains that "[t]he financial system got to its dangerous perch by betting extravagantly on real estate. When housing prices began plummeting and borrowers stopped making payments, financial institutions found themselves with huge inventories of bad loans....These were the investments that Wall Street bought, sold and borrowed against in cooking up the money it poured into housing." Beyond being greedy, banks may stand at even greater fault: the "possibility of fraud" has prompted investigations by the FBI of several firms that have sought government assistance, and federal housing and Treasury authorities have criticized predatory lending techniques such as "deception or fraud, manipulating the borrower through aggressive sales tactics, or taking unfair advantage of a borrower's lack of understanding about loan terms."

Like banks, homeowners accepted "risk, an essential part of capitalism," when choosing to buy their homes. Conventional wisdom may posit that real estate prices never go down, but no rationale suggests government price supports. Like the banks that extended them loans beyond their means, borrowers made decisions about how to allocate their capital that proved to be catastrophically bad.

In contrast, we renters look pretty smart these days. Or at least we did, until the bailout proposed to punish us for correctly opting not to invest in an unsustainably inflated market and foregoing the capital appreciation enjoyed by those who profited (often immensely) from the speculative bubble. Driven by recognition that the "bailout requires responsible Americans to pay for the acts of greedy bankers, mortgage brokers, flippers, and over-extended home-borrowers," some 60,000 have signed the petition at www.angryrenter.com, which decries "whining from reckless home borrowers and their banks."

On the one hand, the blatant unfairness in rescuing corporations that pay lavish salaries to rich executives, while letting working families suffer, has raised predictable outrage. "How is it that the administration and Congress, which have not tried to find huge amounts of money to, say, improve the nation's health insurance system or repair bridges and tunnels, can now be ready to come up with $700 billion to rescue the financial system?"

On the other hand, banks are so deeply embdedded in the economy that their failure will hurt everyone. "[I]naction...could imperil the retirement savings and other investments of Americans who are anything but rich."

That's true. That is also precisely the point that fiscal liberals have been making for years: we live in an interdependent world in which one's collapse inevitably threatens others.

But then why bail out banks -- or for that matter, even homeowners -- to the exclusion of renters also impacted by the economy's collapse? Many kinds of assets are deflating in the current environment, not just home prices. Homeowners may find themselves holding less and less equity in their homes as housing markets erode, but renters also bear costs. We endure losses in our retirement savings and other non-housing investments; compete for housing in an increasingly tight rental market "tough for those looking for housing...[but] great for landlords"; and as the credit crisis deepens, face dim prospects of getting mortgages to purchase homes in the future.

Like some homeowners who suffer foreclosure, renters impacted by the country's economic crisis will face a litany of their own. Some will lose their jobs, others will confront catastrophic medical bills, and some will end up on the streets, where they will face disproportionate risks of mental illness, addiction, crime and sickness - each of which entail economic externalities that affect all of us. For instance, emergency room visits stretch hospital budgets, and crowded jails & prisons force states to pump taxpayer dollars into corrections.

The Economic Emperor Has No Clothes

As American's banking system has visibly crumbled, so has the conservative ideological establishment. First went its principles, as the attachment to free markets was jettisoned by proponents of the Paulson plan. Then went its credibility, as the deregulation long championed by conservative ideologues emerged as a principal cause of the crisis. Then went its political power, as House Republicans who remained ideologically consistent obstructed a consensus (on however ineffective and unfair a solution) between a President of their own party and the bipartisan congressional leadership.

Laissez faire capitalism now appears as bankrupt as Lehman Brothers.

While a lot of Americans hammered by the meltdown will likely join them, the proposed bailout is no solution. It can't stop the crisis, and won't help homeowners. And even if it did, it would still throw 100 million Americans who rent their homes to the economic wolves.

Comments

[SamirSF]

part deux

I also disagree with doom and gloom scenario. This crisis is the S&L crisis 20 years later (granted, with a much more globalization and a few magnitudes higher). People like us who rent will get more screwed as you argue, but their is global economic livelihood at stake. All the people who work so hard to pay the US government bills are not going to stop working. Thus, budget surplus governments will loan to the US and trickle down economics will work. I'm confident that the economy will get its credit fix.

What's uncertain is whether or not the necessary steps will be taken to avoid this type of crisis. I liked what Obama said last week, but we do need radical change that believes in 20 year plans that address how this mess came to be and how to avoid it and other crises in the future.

An example of the opposite of radical change is the negotiations around the bailout plan. It would seem that congress would fight for more valuable concessions than the meager ones that I've heard about.

[Shahid Buttar - Huffpost Blogger]

Just to reply to both your posts at once:

-- It sounds like we're generally on the same page.

-- I totally agree that laissez faire capitalism is not what's actually practiced in the U.S. In fact, I write in a range of contexts about implicit economic subsidies for rich people (e.g., inheritance rights) that blatantly violate free market principles. My argument here is that many proponents of free trade have abandoned their supposed principles in seeking a bailout by the government for their faulty decisions.

-- On the economy, it's less about the credit fix than the job crisis, which is just beginning in earnest. I didn't mention this in the article, but the 188-year-old law firm where I cut my teeth after graduating from law school, which employs 650 lawyers around the country as well as thousands of support staff, dissolved last Friday: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/10/01/ED5R139QPO.DTL. It's illustrative of the trend across the country. Heller Ehrman and Lehman Brothers will have lots of company, regardless of whether or not some version of the bailout is ultimately approved.

-- We're on the same page about the need for fundamental, radical change. Fundamentally, we need to reign in corporations in a range of contexts, not just in the financial services industry.

[SamirSF]

I agree with most of what this article outlines. Government officials are hypocritical and too often than not liars. Corporate officials will use their capital power to maintain their business. Both these groups (and especially in conjunction) are not positioned at this time to help all individuals efficiently or effectively.

I disagree though that what we've witnessed so far has been laissez faire capitalism. Like the Iraq war, there were calculated risks that were taken to try and achieve certain goals (flow of oil, increased military spending, pax americana). In this financial crisis, there was a battle over many years between regulation and deregulation. Many states actually went to the federal government asking for the lax regulations to be reigned in years ago. Many predicted the housing bubble (heck, it happens every business cycle). There were choices made about the regulations. State intervention took place. Notions such as the free market, the invisible hand and laissez faire are problematic because they mask what's really going on, which is that individuals and groups are making decisions, placing bets and doing whatever it takes not to lose. I'm not saying that these ideas are not helpful, but rather that let's take them for what they are "ideas," not necessarily a practiced reality.

[bkindie]

insightful...thanks

[PenFighter]

"How is it that the administration and Congress, which have not tried to find huge amounts of money to, say, improve the nation's health insurance system or repair bridges and tunnels, can now be ready to come up with $700 billion to rescue the financial system?"

Well done, Shahid. You wrapped up so many elements in this, including renters. As another who didn't jump on the "housing is a high-return investment" bandwagon, It's hard to put into words how infuriating it is looking at being dinged for any of this bailout.

Oh, and there's another group the employment stats leave out: the self-employed, especially in services which depend upon "discretionary spending"; when the economy craters us out of our incomes, we don't get unemployment or the dubious pleasure of showing up in the unemployment stats.

[Shahid Buttar - Huffpost Blogger]

That's a great point. The self-employed are indeed excluded from unemployment statistics, which is especially interesting when you consider the rhetorical reliance of free market conservatives on entrepreneurs. It's as if Republicans say those whose businesses prove successful are the American dream, while those who do less well need to stop whining. They're persona non grata.

[JLibertelli]

The standard crisis solution offered by the political and economic "elite" unsurprisingly seems to be corporate socialism - let's give a huge "cut" of taxpayer dollars to their pals in the private sector, be they the Haliburtons in Iraq or the health insurance companies in the US.

In the case of this financial crisis, it would be better and cheaper for the government to become an equity partner with homeowners who can't afford re-structured mortgages, per A Trickle Up Bailout from today's Washington Post at

http://www.washingtonpost.com/wp-dyn/content/opinions/?nid%3Dtop_opinions&sub=AR.

[Shahid Buttar - Huffpost Blogger]

The "trickle-up bailout" proposal is indeed a far better alternative than the proposal currently under consideration by Congress. Here's the permalink, BTW:

http://www.washingtonpost.com/wp-dyn/content/article/2008/09/30/AR2008093002316.html

Having said that, I will note that even the trickle-up alternative (a) won't stop the impending economic depression, and (b) will still exclude renters from its protection -- even though it would remedy many of the objectionable distributive impacts of the original Paulson proposal and its successors.

[JordanKokich]

McCain and Establishment Republicans

I heard McCain's economic advisor Martin Feldstein last night on Charlie Rose propose an asset swap measure that would essentially allow the government to assume creditor authorities over these overvalued mortgages. The Treasury Department would buy up every bad mortgage from these Wall Street banks without any market-to-market measures to bring these assets back to reality, ergo the banks would have no problem charging the government up the "fanny" (no pun intended) for this essentially worthless paper. This coupled with continued market instability assuming the Wall Street giveaway doesn't trickle down, could usher in the largest transfer of private property to the government in American history. Most off this would target the country's most vulnerable citizens as they were the chief victims of the predatory lending practices of the past two years and account for the majority of the toxic assets in the marketplace. Clearly McCain's economic people have a different concept of who the victims are in this crisis. Not to mention the prospect of this asset swap has the Libertarians pulling their hair out.

The only commonality between all parties involved at this point seems to be in bolstering FDIC coverage to $250K per account. This is seen as a purely psychological measure aimed at calming the markets.

So please, Progressives stand up, call your Representitive and lets stop this Wall Street giveaway tomorrow!

[JordanKokich]

Obama and Establishment Democrats

The problem with Obama's and the Congressional Democratic establishment's tacit support of the Paulson-Plus Plan is it is inherently a top-down approach which ever way you slice it. The Democrats can attempt to place measures capping CEO pay, attempt to demand taxpayers see an equity stake in future gains, and establish oversight committees to see this through, however the dirty little secret is that most of these measures are fraught with legal ambiguity and would be nearly impossible to enforce provided the government does buy these Banks' toxic paper. Perhaps more disconcerting is the fact that no one really knows for sure what this paper is worth anymore due to the complete halt in trading of mortgage-backed securities, thus the government is almost sure get overcharged. What the Democratic establishment is not telling us is that everything they have proposed amounts to little more than lip service. Even worse, in an attempt to pander to House Republicans, the Paulson-Plus Plan now has the capital gains tax suspension. This certainly won't help our deficit and is sure to undermine future Progressive programs.

[Shahid Buttar - Huffpost Blogger]

The point about the capital gains tax suspension is especially crucial -- I would have included it in this piece had the news emerged before I submitted it. It's a huge concession to conservative interests and basically represents an alternative way to subsidize Wall Street in the wake of executive pay being limited. Investors of all kinds will appear to benefit, but the real beneficiary will be Wall Street, which will once again get rewarded for failure.

[fisharefreinds]

Oh God, what do we do. They are lieing and they are going to keep pulling puches with credit and markets if this doesn't go through. There has to be a day of reckoning and the people of this country have to stand up and revolt against both parties.

[JordanKokich]

http://www.youtube.com/watch?v=mbD62gNi9WE&feature=related Rep. Marcy Kaptur- "Mama" speech

http://www.youtube.com/watch?v=S27yitK32ds Rep. Marcy Kaptur- "Let's Play Wall Street Bailout" speech

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20080930/REG/809309958 "No Bailout Act" the DeFazio-Kaptur plan

It is my view that this would be the most principled Progressive undertaking, a true bottom-up approach, one that gets at the heart of what is causing the credit crunch, that being the imminent threat of rolling home foreclosures due to these overvalued mortgages. Also, this is the only plan offered thus far that would not add trillions more to the skyrocketing deficit.

[Poboy]

We have just witnessed the complete failure of government at the federal level, where the executive, legislative and judical branches all have failed the American people.

[KillTheMessenger]

Actually, all we have witnessed is the failure of the neocon ideology. Government will work just fine, again, once these people are removed from it.

:-)