bailout

On virtually everything economic, the Bush Administration and much of Congress have become the gang that can't shoot straight -- and their stray bullets could take down a good piece of the nation's economic prospects. They have directed hundreds of billions of taxpayer dollars to financial institutions (and soon, auto companies), and they're getting ready to direct several hundred billion more at the overall economy. In all of these instances, a political drive to display the will and capacity for large actions has overwhelmed deliberate thinking about the specific consequences of those actions. The Obama presidency and the country may pay a big price for this scattershot approach.

The latest example of this dangerous development is the ever-expanding size of the long-awaited next stimulus. We're in a deep and serious recession and a major stimulus was certainly needed -- mainly six months ago, when the Bush Administration and Congress provided tax rebates which were largely saved and had little stimulative effect. Now we know how bad the downturn is turning out to be, and Congress and the Administration-in-waiting is preparing another stimulus of a size commensurate with what's already unfolding, once again, as if this were six or eight months ago. A stimulus providing another $200 billion to $300 billion in new federal spending makes sense, mainly as insurance for another shock to the economy. But a $500 billion to $750 billion package like the one now under discussion will miss its target by many months and mainly indicates that the new rule is that anything goes when you win and damn the consequences.

Congress seems intent on responding to this recession as if everything known about how the business cycle works can be ignored, and the consequences could be serious. The Obama team is focused on long-term investments in 21^st century energy and transportation infrastructure, modernizing health care records, expanding training and education, and extending broadband and IT access for poor children. That's all good news for the long-term health of the economy and for the incomes of many households.  The catch is, long-term investments entail not a one-time boost in spending, but continued funding. So when we raise the ante on those investments from $100 billion or so to $300 billion, $400 billion or $500 billion, we're implicitly choosing either to foreswear any other commitments, such as health care, or to embrace another round of dangerously large, structural deficits.

Since the new politics seems to involve never saying no, the likely result of the current course, on top of the extraordinary infusions of credit by the Federal Reserve, is serious inflation once the downturn begins to resolve itself. This pattern is disturbingly similar to the short-sighted and cavalier approach to long-term risks that got the nation into this mess. And it continues to develop alongside the Treasury and Congress' continuing inability to address the rising foreclosures still driving the financial crisis and the credit freeze accelerating the downturn. Yet real responses are within reach: place a moratorium on foreclosures while Fannie Mae and Freddie Mac renegotiate the terms of millions of troubled mortgages and link financial bailout funds to a commitment to use them to extend credit to businesses. If we do that, the economy won't need so much fiscal or monetary stimulus. 

The current approach presents other serious risks. This pattern of fast-rising spending, on top of the bailouts already done and those to come, as well as more tax cuts, could push the U.S. deficit to levels that even the United States will have trouble financing. The Asian and Middle Eastern governments that provide much of our public financing could stop -- either because they'll see inflation coming, too, or because the global downturn and falling oil prices sharply reduce their savings and thus, their ability to lend them to us. The U.S. Treasury will always find the funds it needs, but it may have to pay a lot more to borrow them, which means higher interest rates. So the current approach risks an interest rate spike on top of everything else, which at best would lead to a substandard recovery. With all of its talent and broad public support, the Obama presidency should be able to do a lot better than that.

The financial crisis and the profound economic reversals reverberating around the globe caught up last week with Citigroup, the world's largest financial institution. Citigroup is still solvent, but it holds several hundred billion dollars of heavily-leveraged, troubled assets – and once the market began to focus on the potential losses, as it did last week, the bailout became a foregone conclusion. But the terms of that bailout -- on top of the deals for AIG, taxpayer infusions for solvent institutions such as Wells Fargo and State Street, and new Federal Reserve loans for any financial firm holding a wide range of assets -- are beginning to look like an American version of crony capitalism. The critical distinction lost or forgotten in much of Treasury and Fed’s dealings is that the government’s proper role in rescuing or bolstering private companies during a crisis is to help them only under specific terms that directly benefit the taxpayers footing the bill.

Crony capitalism is usually associated with the way many governments in Africa, Asia and Latin America conduct public business, where government contracts, budgets and other public activities are routinely channeled to the families, friends and associates of political elites, rather than being allocated through some open bidding or other democratic processes. Variants of crony capitalism occur in the United States, too. In one infamous example, Halliburton “won” billions of dollars in no-bid contracts for Iraq while its former CEO was Vice President; and crony capitalism lurks behind billions in pork barrel appropriations passed every year by Congress. But when it begins to infect huge government operations taken to deal with an emergency, it has more serious and insidious effects. Japan famously practiced crony capitalism in its multi-trillion-yen “rescue” operations for its failing banking system in the 1990s, and bought itself a decade of stagnation and at least another decade as the worst-performing advanced economy in the world.

The terms of the Citigroup deal raise the specter of crony capitalism. The taxpayers will invest $20 billion in the company, receiving preferred stock that will pay 8 percent dividends, and Citigroup will bear the first $29 billion in losses from its current portfolio of $306 billion in troubled loans and assets. After that, the taxpayers absorb 90 percent of any additional losses in exchange for another $7 billion in preferred stock. The likelihood that Citigroup’s losses will far exceed the first $29 billion is disturbingly high. The financial crisis almost certainly will deliver additional shocks, because the current policies have done little to address the forces driving the crisis. The housing market continues to unravel; and with business investment, consumption and jobs all contracting rapidly, foreclosures continue to rise. As they do, more mortgage-backed securities and the derivatives based on them will go bad, and the consequent losses could claim much of the capital infusions that taxpayers have already provided. As the IMF and others have warned, large additional losses also could come from other sources. Most notably, the spreading global recession, on top of national banking crises in other countries, are producing enormous pressures on government financing operations in a number of nations, including some in the Eurozone, which in turn may produce sovereign debt defaults. And most of the sovereign debt that could well default in coming months is held today by financial institutions, especially ours.

While the administration’s program barely acknowledges the implications of these dangerous dynamics in its bailout policies, President-elect Obama has at least pledged to address the underlying foreclosure problem and provide very large stimulus that could begin to ease the U.S. downturn and, with it, the global recession. The larger question is whether the new administration will also reject creeping crony capitalism by requiring that the bailouts almost certain to come next year oblige the financial institutions claiming all that cash to conduct themselves in ways that directly benefit the taxpayers picking up their bills.

Remarkably, the current administration has imposed no such requirements while doling out hundreds of billions of dollars to insulate our large financial firms from the worst consequences of their own decisions. In fact, even last week, as the Treasury was bailing out Citigroup, the Federal Reserve announced another $200 billion program for financial companies holding securities backed by consumer debt, now threatened by the recession triggered by the financial meltdown. Here’s a notion for the next administration: Since the essential reason to bail out all of these various institutions is to unfreeze the routine lending that keeps the U.S. economy going, tie future bailouts to specific commitments to reboot lending American businesses and households. This is precisely what Sweden did in the early 1990s when its financial sector melted down, and the strategy of tying capital assistance to renewed lending helped produce a genuine recovery.

Crony capitalization may be the signature moral hazard of an administration which continues to believe that, even when taxpayers provide hundreds of billions of dollars to bail out powerful institutions, the government should have as little say as possible in the way they conduct themselves. It shouldn’t be good enough for an Obama presidency. When the next shocks hit our financial system and those institutions come back for more, the new administration should opt for democratic capitalism over crony capitalism, and apply lending requirements to actively open up the nation’s credit markets.

Courtesy of Politico's Ben Smith, we learn that on a conference call about ACORN earlier today, McCain campaign topper Rick Davis gave McCain credit (blame?) for blowing up the first bailout vote in the House.

Davis expressed outrage that, "in the middle of the greatest disaster in our financial system that we’d had in our lifetime, that the Democrats in the United States Senate would actually link payments to ACORN in the bailout package that they promoted -- prior to Sen. McCain coming to town and actually blowing that package up. So we can actually say that in addition to saving taxpayers millions of dollars, and we’re very happy that no more taxpayer dollars were added to the pile of money going to ACORN."

As Smith goes on to point out, it was the McCain campaign that first blamed Obama for the failure of that first vote in the House - despite the fact that McCain suspended his campaign and threatened not to debate if the bailout package wasn't passed with all haste.

So why is Rick Davis trying to reinvent the past? 

As was discussed on MSNBC's Morning Joe today, the only way McCain could have used the financial crisis to his political benefit was to oppose the bailout. McCain's camp has no doubt realized that and probably wants a re-do. (During which they would have likely ditched that gimmicky "suspension.") In the coming days, watch for Davis and Co try to recreate McCain's actions on the bailout in a manner that is more to their liking. If they don't, well...

With news coming that the Senate has loaded up the bailout bill with a number of tax provisions, including an AMT patch and crucial tax credits for renewable energy, the House vote on the proposal, should it pass the Senate, looks to be a defining moment for pay-go.

Pay-go has been the largest stumbling block in extending renewable energy tax credits – a package so popular that it recently passed the Senate with a vote of 93 to 2. Now, a bipartisan agreement by Leaders Reid and McConnell to include these provisions in the bailout bill, which is predicted to pass the Senate tonight, will only be derailed if some in the House continue to insist on pay-go.

NDN has long argued that pay-go creates far too much arbitrary, artificial rigidity in the legislative and governing processes, and this bailout serves as a perfect example. Should a bipartisan bill designed to rescue the economy on the order of $700 billion fail due to a pay-go fight over far less costly tax provisions that are partially offset, the legacy of pay-go, a provision that doubtless has limited life to it anyway, will go from murky to downright laughable.

As the economy slides into recession, one can only hope that the popularity and job creation benefits of the tax credits, especially those for renewable energy, will garner enough votes to more than offset the votes lost from pay-go proponents.