Financial Crisis and Political Opportunity

Long post. Go get yourself a drink and settle in.

The market turmoil of the last few days has led to some extreme reactions among both left and right commenters. The meme I keep seeing in various forms is that the financial system has been "nationalized", with much wringing of hands and gnashing of teeth. Oh, corruption of the pure markets! Oh, run away, run away from the power grab of the state! Oh, look at the completion of the whatever conspiracy it is to make the evil gummint in charge of all our moneys! It's particularly thick on the ground with the people who have been screaming for a few months that poor people don't deserve loans and should go back to the ghetto/barrio/Mexico/trailer park/[insert favorite cultural/ethnic slur here] where the losers belong. I'm always amused at the posts of one guy who I personally know who rails at the financial irresponsibility of others while failing to subscribe to any of those standards to himself. My point here is that paranoia and schadenfreude are not a very helpful combination for assessing the mess. More important, they do not lend themselves to seizing a moment of political opportunity.

Now, I've got some deep suspicion of anything a Republican administration does with regards to markets, finances and, well, uh, anything, because they will do their damnedest to siphon up the wealth and screw everybody else. However, it strikes me that what we're seeing falls far short of nationalization, and that the actions by the various government players are rational and necessary for the long term health of the economy. They cannot be dismissed as simply protecting the wealthy, not letting market players be "punished" for bad risks, or trying to seize monopolistic powers through capturing the financial sector, even if some would like to do these things. The real problem here is that the power of the state was not brought to bear soon enough. What we are seeing is what Bill Clinton described so well in his convention speech, the logical outcome of Republican policies being enacted exactly as they wanted them done. Financial meltdown is the end point of their policies.

Repeat after me - Republican policies, when allowed to go to their logical conclusion, end in the devastation of whatever the policy addresses. It goes beyond their towering greed. What they do is deconstruct the boundaries and barriers that give protective shape to the large scale and impersonal transactions of a modern society. And I unequivocally like modern society. I like contraceptives and clean water and electricty and public transportation. I like medicine that allowed my friends to have an oversized breech baby delivered safely and not risk the lives of mother or child. I like a wage economy where I can earn my own living and not be dependent on my male kin to decide whether I get to eat that day. And so forth. These take institutions. The people united make a bigger target. The people wrapped up inside laws, regulations and practices have some leverage. Collective action, to be effective, must persist over time, and that is the purpose of insitutions. That's why the rich and powerful want their own and want to dismantle yours.

Which gets us to Paul Krugman, Calculated Risk and Hillary Clinton. Krugman's column, Crisis Endgame, is a short, sharp, frightening look at why the financial market actors are behaving the way they are:

The story so far: the real shock after the feds failed to bail out Lehman Brothers wasn’t the plunge in the Dow, it was the reaction of the credit markets. Basically, lenders went on strike: U.S. government debt, which is still perceived as the safest of all investments — if the government goes bust, what is anything else worth? — was snapped up even though it paid essentially nothing, while would-be private borrowers were frozen out. ...

This flight to safety has cut off credit to many businesses, including major players in the financial industry — and that, in turn, is setting us up for more big failures and further panic. It’s also depressing business spending, a bad thing as signs gather that the economic slump is deepening.

And the Federal Reserve, which normally takes the lead in fighting recessions, can’t do much this time because the standard tools of monetary policy have lost their grip. Usually the Fed responds to economic weakness by buying up Treasury bills, in order to drive interest rates down. But the interest rate on Treasuries is already zero, for all practical purposes; what more can the Fed do?

The market went to the government for safety, exacerbating the crisis. When the only player in a reasonably stable and liquid condition is the government, then it is the entity that needs to act. You don't have to posit some Big Brother creeping authoritarianism to see that the government has an obligation to act in the best interests of the population, even if the current administration has no particular interest in doing so.

While CR has been tied up just in reporting the news as it happens the last few days, he did take the time to write up one solid analysis post, Comment on Crisis: Necessary Steps. Here are key points, but I urge you to read the entire post. My emphasis throughout:

This crisis might have first become visible to Wall Street and the Federal Government in August 2007, but this crisis has been unavoidable for several years. If action had been taken in 2004 or 2005 to curtail the loose lending practices, the problem wouldn’t be so severe, but the crisis would have still occurred. The damage had already been done. Unfortunately the U.S. failed to prevent this crisis, and now we have no choice but to pay the price for the cleanup. The good news is the U.S. is finally taking the necessary steps towards eventually resolving the crisis.

First, whether you agree or disagree with the FHFA and Treasury Secretary Paulson placing Fannie and Freddie in conservatorship, it has been obvious for some time that the U.S. Government had to explicitly guarantee the debt of Fannie and Freddie, or face a complete shutdown of the housing and mortgage markets. At least this guarantee was accomplished with the shareholders (both common and preferred) taking losses before the U.S. taxpayers. Since I have viewed a guarantee as inevitable, I consider this a necessary step toward the eventual resolution of the credit crisis. ...

Second, Secretary Paulson's no bailout approach to Lehman removes some moral hazard from the process. Although the fallout from Lehman's bankruptcy has just begun, this liquidation is probably a positive for the market. It appears this approach has already reaped some benefits with John Thain of Merrill Lynch calling Ken Lewis of BofA on Saturday morning to propose a buyout. Clearly Thain could read the writing on the NY Fed's wall.

It's true that the rescue tonight of A.I.G. suggests there are still moral hazard issues, but an A.I.G. collapse posed significant risks to the system, and the Fed was stuck with a dilemma and no good alternatives. I believe a collapse of A.I.G. would probably have been worse than the rescue. ...

Third, one of the reasons the credit crisis has lingered (in addition to house prices still being too high) is that a number of financial institutions have been unwilling to adequately mark down their assets. The reason for this reluctance is obvious as Lehman just discovered; too many write downs can lead to bankruptcy. ...

There will be more grim news, perhaps for another year or more. And there is definitely some possibility of a systemic financial collapse (see Professor Roubini’s excellent discussion of the downside risks). But unlike observers that believe this only marks the end of the beginning, I believe there is a chance that these events mark the beginning of the end of the crisis.

The points CR makes focus on the structural inevitability of the crisis underway. Moralistic railing and/or conspiracy spinning is pretty much irrelevant at this point, though it may make individuals feel better. What matters now is how the government will intevene, what it will require of the crooks and cons who set up this situation, how it will fulfill its obligations to the nation while werstling the intrinsically selfish interests of the financial market (an industry the government players are all too sympathetic towards, unfortunately), and what will the next administration and Congress do to bring the financial industry back under regulation. The key here, is what Krugman notes (my emphasis):

There’s only one bright spot in the picture: interest rates on mortgages have come down sharply since the federal government took over Fannie Mae and Freddie Mac, and guaranteed their debt. And there’s a lesson there for those ready to hear it: government takeovers may be the only way to get the financial system working again.

Some people have been making that argument for some time. Most recently, Paul Volcker, the former Fed chairman, and two other veterans of past financial crises published an op-ed in The Wall Street Journal declaring that the only way to avoid “the mother of all credit contractions” is to create a new government agency to “buy up the troubled paper” — that is, to have taxpayers take over the bad assets created by the bursting of the housing and credit bubbles. Coming from Mr. Volcker, that proposal has serious credibility.

Influential members of Congress, including Hillary Clinton and Barney Frank, the chairman of the House Financial Services Committee, have been making similar arguments. And on Thursday, Charles Schumer, the chairman of the Senate Finance Committee (and an advocate of creating a new agency to resolve the financial crisis) told reporters that “the Federal Reserve and the Treasury are realizing that we need a more comprehensive solution.” There was no official confirmation from those agencies — but it’s pretty clear that the big buyout is on its way. ...

But it’s no use whining (sorry, Senator Gramm) about the prospect of a financial rescue plan. Today’s U.S. political system isn’t going to follow Andrew Mellon’s infamous advice to Herbert Hoover: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” The big buyout is coming; the only question is whether it will be done right.

Having the government clean up the mess in a public way that imposes conditions, constraints and accountability is something the Republicans do not want to see happen. They do not want the state to look more competant than the market. They want the state to shovel the cash out and let the market decide how it will make use of it. They want the money to remain handled at the very highest level, in difficult to follow transactions with plenty of opportunity for skimming and pocketing of the dough. The emphasis should be on returning the institutions to independence ASAP, after they've cannabalized each other at fire-sale prices.

This is where political philosophies matter. If you are committed to the idea that government is the problem, or that use of government power to structure outcomes and compel compliance is always suspect, you will not be able to move decisively to take advantage of this political opportunity. Yes, it's trite, but a crisis is danger and opportunity. Things uprooted can be replanted in better locations, or replaced by smoething else entirely. You have to know what you want at several levels, and be able to explain it in a way that the ordinary person can grasp and agree to. Kind of like this. First, put the blame where it belongs, on the heads of the people in charge:

Now, we know that many CEO's are paying lower tax rates than their receptionists. We know that President Bush and those who carry his mantle seek to lower those taxes even further. Middle class families have seen their wages decline even as the cost of living has skyrocketed. This administration has the worst job creation record in 70 years. Millions of families were locked into ballooning and unaffordable adjustable-rate loans as this administration stood by denying there was a crisis. Regulators and regulations designed to keep pace with the markets have been steadily chipped away by Washington Republicans even as companies experimented to the tune of hundreds of billions of dollars in ever more complex and risky financial instruments.

Now, we were reassured that the risk was too diversified and investments too sophisticated to put our economy in jeopardy. Meanwhile, behind closed doors, the cracks were showing as the value of mortgage-based securities slipped day by day by day. And the President and his supporters in Congress repeatedly chanted – and still chant the mantra today – that the fundamentals of our economy are strong. The administration waxed philosophical when middle class families started facing foreclosures at record levels.

The administration and their allies derided my proposals over the last two years to offer assistance to troubled homeowners seeking refinancing as a bailout. They dismissed my concerns and the concerns of millions of Americans even as the storm clouds gathered. They said they didn't believe the government should intervene and provide borrowers an affordable opportunity to avoid foreclosure. Even when I and others warned the Bush Administration repeatedly from the start of this crisis that decisive action was demanded immediately to help families stay in their homes, that that was the best way to stave off a deepening economic crisis, their only responses were predictions for a soft landing and that the crisis could be contained.

Make the opposition own this shitpile, and make it clear who is really paying the price for the pile. Then point out what a really bad response looks like:

But their response was half-hearted, without adequate resources or a commitment to enforcement. And so the home mortgage crisis slowly but surely eroded the value of risky debt instruments upon which Wall Street firms were depending. The house of houses of cards began to fall. My proposals, as well as those of others, were greeted as too much, too soon. Now we are forced to reckon with too little, too late.

When giant Wall Street firms revealed their dire straits and turned to this administration for the exact same help as we had sought for middle-class families -- discounted loans, loan modifications and government-backed lending to weather the storm, Adam Smith was nowhere in sight.

Taxpayers have loaned these banks upwards of half a trillion dollars. And after years of laissez-faire policies for the middle class, the Bush Administration has acted on behalf of Wall Street with the largest and most significant federal interventions in the history of our modern financial system. The largest banks in the world can have closed-door meetings with the White House and the Federal Reserve and the Treasury Department to discuss their bailout options, but millions of homeowners with mortgages worth more than their homes, or who are facing default and foreclosure, don't have the same opportunity.

And this administration seems to be once again paralyzed.

Too little, too late. Remind people that the Bush administration's actions when caught by crisis - 9/11, Katrina, this meltdown - is to freeze, like a deer in the headlights, unable to make any decisive action at the appropriate time. Then talk about what is at stake if we stay on that course:

But we must cast aside the haphazard, half-hearted approach of this administration and bring every stakeholder to the table to seek out and implement the right solutions. We must be as vigilant on behalf of homeowners and middle class families as we are on behalf of Wall Street firms. We must chart a new course based on the facts at hand, not the ideology at work for eight long years. We've tried being reactive. It's time now to be decisive.

No options should be off the table, certainly not because they don't fit into a narrow ideological prism that this administration abandoned -- for some -- at the first signs of trouble. Ideologues in Washington or in the market who thought that the only danger to the marketplace was the Federal Government are now going hat in hand to that same government seeking help to stay afloat.

So to those who suggest that the steps taken thus far are enough, let me be clear: we may need to take even more significant steps to avoid a self-sustaining cycle of depressed home prices and foreclosures with the consequent effects on the entire marketplace.

We've already pumped hundreds of billions of dollars of liquidity into the markets but we still cannot see the end of this crisis. The biggest problem now is that our entire financial market is anchored down by the mortgage securities that are untouchable. We've seen the banks and the financial institutions that had the largest exposures to these instruments among the first to fail. But now we've begun to see some of the mightiest institutions, even those making a profit, fall by the wayside, the market thrown into upheaval, and others the target of predatory short sellers.

The Federal Reserve has used virtually every arrow in its quiver, from rate cuts, opening its lending windows and in desperation has even created some new arrows through its new lending facilities. By some estimates, the Fed has put out more than a half a trillion dollars through discounted loans, bailouts and takeovers to stabilize the market and the economy. While necessary to prevent even deeper disaster, we've seen that the benefits of these actions have had limited effects. ...

The real problem has always been the way our home mortgage system got totally out of whack with new kinds of instruments that were sold many times over with very little regard to the realities of life, human nature, and the inevitable ups and downs in the economy, with the results that until we reach in and fix the home mortgage crisis, we can bail out everybody from here till kingdom come, we will not get a handle on this economic crisis.

I'll leave you to read the rest of Hillary's speech for her very concrete recommendations. She combines an analysis of high and low, financial services and individual finances, government policy and daily life, complex financial deals and the ordinary life decisions. The point here isn't that only Hillary has a good idea of what to do or even that hers is the best. It's that she has presented them in a way that is both political and practical, earning support by attending to real needs and interests. That is what a Democratic answer has to be. It may be fun to snark and speculate, but political opportunities this big do not come along very often.

This crisis is a political opportunity to do what is right and to secure political capital. The current Democratic leadership does not appear able to take it to the bank.

Anglachel