The House voted against the bailout package. Brad DeLong says:
Bring Congress Back into Session After the Election...: ...and go for the Swedish plan: nationalize the insolvent large financial institutions: dare Bush to veto that after the election.
Democrats: 141 Yea, 94 Nay
Republican: 66 Yea, 132 Nay.
This Republican Party needs to be burned, razed to the ground, and the furrows sown with salt...
Swamped today - quickly - and holding back the shrill reaction, this is irresponsible and needlessly puts our economy at risk. I'll update with more reactions as I find them.
Update: Initial market reaction:
The Dow Jones Industrial Average, which had posted a loss of less than 300 points heading into the House vote, posted a decline of nearly 700 points as the "nay" votes reached a majority.
The market has recovered slightly. We'll see how it goes. They can revote, so there's still hope, but don't know if that is planned, or if that would do any good. But it's not the stock market I care about, it's employment and growth. Even if this is not a catastrophe, you don't take this kind of risk with the economy. Even without a major crash, it's likely a lot of people just lost their jobs, though they don't know it yet. If the problems aren't addressed, it is likely to constrain credit, that in turn causes firms to cut back on new investment projects, and as they do, employment and growth taper off. You don't see the effects as a big drop off in employment all at once since investment projects can take years to complete and momentum from the past keeps the ball rolling. But as those projects end, if they are not replaced with new ones, employment and growth will suffer. And it's not just investment, people who sell cars, refrigerators, tractors, TVs, stereos, and so on, rely upon credit markets. If the credit isn't there, they aren't needed.
I'm worried, maybe for nothing, but why take this kind of a chance with people's lives?
I didn't think it was possible to be more disgusted with politicians than I usually am, but I find it impossible to express the seething contempt that I feel at this kind of opportunism. I don't mind when they screw with the normal operation of the economy for venal personal gain. But risking a recession in order to get a cut in the capital gains tax? Letting it tank because you can always blame it on the Republicans? ...
The public doesn't quite grasp what's at stake, and there's no reason they should. But the representatives do. ... But anyone who tanks a bank bailout they think might be needed, in order to get a cut in the capital gains tax, deserves to be tried for treason.
OK, we are a banana republic: House votes no. Rex Nutting has the best line: House to Wall Street: Drop Dead. He also correctly places the blame and/or credit with House Republicans. For reasons I've already explained, I don't think the Dem leadership was in a position to craft a bill that would have achieved overwhelming Democratic support, so make or break was whether enough GOPers would sign on. They didn't.
I assume Pelosi calls a new vote; but if it fails, then what? I guess write a bill that is actually, you know, a good plan, and try to pass it — though politically it might not make sense to try until after the election.
For now, I'm just going to quote myself:
So what we now have is non-functional government in the face of a major crisis, because Congress includes a quorum of crazies and nobody trusts the White House an inch. As a friend said last night, we've become a banana republic with nukes.
Rep. Boehner and others say Pelosi's partisan floor speech is to blame for the financial rescue bill's defeat.
Barney Frank wonders why a speech would cause them to change their votes:
"Because somebody hurt their feelings they decided to punish the country."
Steve Benen adds:
But more important that than is the truly ridiculous frame Republicans are establishing for themselves by using Pelosi's speech as an excuse for their own failure. The House GOP, for reasons that defy comprehension, has decided to characterize itself as a caucus of cry babies. Worse, they're irresponsible cry babies who, according to their own argument, are more concerned with their precious hurt feelings than the nation's economic stability.
What is likely to happen next? With a bit of luck, the House will be frightened by its own audacity and will reverse itself. If a substantively similar bill (or a better bill that addresses not just the problem of valuing toxic assets and getting them off the banks' books, but also the problem of recapitalising the US banking sector) is passed in the next day or so, the damage can remain limited. If the markets fear that the nays have thrown their toys out of the pram for the long term, the following scenario is quite likely:
- The US stock market tanks. Bank shares collapse, as do the valuations of all highly leveraged financial institutions. Weaker versions of this occur in Europe, in Japan and in the emerging markets.
- CDS spreads for banks explode, as will those of all highly leveraged financial institutions. Credits spreads generally take on loan-shark proportions, even for reputable borrowers. Again the rest of the world will experience a slightly milder version of this.
- No US bank will lend to any other US bank or any other highly leveraged institution. The same will happen elsewhere. Remaining sources of external finance for banks, other than the facilities created by the central banks and the Treasuries, will dry up.
- Banks and other highly leveraged institutions will try to unload assets at fire-sale prices in illiquid markets. Even assets not viewed as toxic before will become unsaleable at any price.
- The interaction of a growing lack of funding liquidity and increasing market illiquidity will destroy the banks' business models.
- Banks will stop providing credit to households and to non-financial enterprises.
- Banks will collapse, both through balance sheet insolvency and through liquidity insolvency. No bank will be safe, not even the household names for whom the crisis has thus far brought more opportunities than disasters.
- Other highly leveraged financial institutions collapse on a large scale.
- Households and non-financial businesses revert to financial autarky, among wide-spread defaults and insolvencies.
- Consumer demand and investment demand collapse. Unemployment shoots up.
- The government suspends all trading in financial stocks until further notice.
- The government nationalises all US banks and other highly leveraged financial institutions. The shareholders get nothing up front and have to wait for an eventual re-privatisation or liquididation to find out whether they are left with anything at all. Holders of bank debt get a sizeable haircut 'up front' on the face value of the debt and have part of the remainder converted into equity that shares the fate of the old equity.
- We have the Great Depression of the 2010s.
None of this is unavoidable, provided the US Congress grows up and adopts forthwith something close to the Emergency Economic Stabilization Act as a first, modest but necessary step towards re-establishing functioning securitisation markets and restoring financial health to the banking sector. Cutting off your nose to spite your face is not a sensible alternative.
PS My remaining financial wealth is now kept in a (small) old sock in an undisclosed location.
PPS The conduct of both US Presidential candidates in this matter makes them unfit for purpose.
"I do believe that we could have gotten there today, had it not been for the partisan speech that the Speaker gave on the floor of the House," Boehner said. "We put everything we had into getting the vote to get there today." ...
Minority Whip Roy Blunt (R., Mo.) said he had 12 Republicans who would have voted for the bill but changed their minds, while Rep. Eric Cantor (R., Va.) holding up a copy of what he said was Pelosi's floor remarks - said the speaker "frankly struck the tone of partisanship." A senior aide to Pelosi rejected the Republican claims against the speaker, saying the suggestion that her speech motivated House Republicans to vote against the bailout plan was "absurd."
"You don't vote on the speech, you vote on the bill," said the aide.
Frank, speaking at a press conference, mocked the suggestion. "Give me those twelve people's names and I will talk uncharacteristically nicely to them," Frank said.
The Revised Troubled Asset Relief Plan Deserved to Pass: When the Treasury came out with its $750 bailout plan on September 22, I thought it lacked so many necessary ingredients that it deserved a thumbs down. ...
But in the negotiations between the Treasury and Congressional leaders over the course of last week, the missing ingredients were inserted. Starting with the additions that were most necessary on the merits, and moving toward the ones where the necessity was more political, they were...
The plan (TARP for Troubled Asset Recovery Program) would still be unprecedented in magnitude and in the discretion it gives the Treasury Secretary. Even if the congress had passed it today, it would not have guaranteed an end to the financial crisis, let alone averting the recession that is probably already inevitable at this point. Furthermore it does little to begin with the reforms in regulation that our financial system now clearly needs.
Nevertheless, as distasteful as it is to be "bailing out" Wall Street, or even bailing out those homeowners who took out loans that they shouldn't have, or bailing out policymakers who were asleep at the switch, my view is that the program is necessary. It is better than the alternatives:
- better than the Treasury proposal of 9/22,
- much better than the proposal we would have gotten from a pre-Paulson Bush Administration,
- better than the alternative that the House Republicans were offering, and
- (most important of all) better than the alternative of doing nothing, which would (will?) quite likely mean a severe recession.
I suppose it is not surprising that Congressmen facing elections in 5 weeks don't want to go on record supporting something so unpopular. What will happen now that the House rejected the deal in its vote today?
Most likely the stock market and real economy will plummet, until the pain gets so bad that a bailout package like this one accumulates more support.
Are people expecting soup lines?:
The S&P 500 retreated 106.59 points to 1,106.42, as only one company gained, Campbell Soup Co.
Which of the two candidates should we trust with the economy?:
The 3 A.M. Call, by Paul Krugman, Commentary, NY Times: It's 3 a.m., a few months into 2009, and the phone in the White House rings. Several big hedge funds are about to fail, says the voice on the line, and there's likely to be chaos when the market opens. Whom do you trust to take that call?
I'm not being melodramatic. The bailout plan released yesterday is ... better than the proposal Henry Paulson first put out — sufficiently so to be worth passing. But ... it won't end the crisis. The odds are that the next president will have to deal with some major financial emergencies.
So what do we know about the readiness of the two men most likely to end up taking that call? Well, Barack Obama seems well informed and sensible... Mr. Obama and the Congressional Democrats are surrounded by very knowledgeable, clear-headed advisers, with experienced crisis managers like Paul Volcker and Robert Rubin always close at hand.
Then there's the frightening Mr. McCain... We've known for a long time ... that Mr. McCain doesn't know much about economics... That wouldn't matter too much if he had good taste in advisers — but he doesn't.
Remember, his chief mentor on economics is Phil Gramm, the arch-deregulator, who took special care in his Senate days to prevent oversight of financial derivatives — the very instruments that sank Lehman and A.I.G., and brought the credit markets to the edge of collapse. Mr. Gramm hasn't had an official role in the McCain campaign since he pronounced America a "nation of whiners," but he's still considered a likely choice as Treasury secretary.
And last year, when the McCain campaign announced ... "an impressive collection of economists..." to advise him..., who was prominently featured? Kevin Hassett, the co-author of "Dow 36,000." Enough said.
Now,... the poor quality of Mr. McCain's advisers reflects the tattered intellectual state of his party. Has there ever been a more pathetic economic proposal than the suggestion of House Republicans that we ... solve the financial crisis by eliminating capital gains taxes? (Troubled financial institutions, by definition, don't have capital gains to tax.)...
The real revelation of the last few weeks ... has been just how erratic Mr. McCain's views on economics are... Thus on Sept. 15 he declared — for at least the 18th time this year — that "the fundamentals of our economy are strong." This was the day after Lehman failed and Merrill Lynch was taken over, and the financial crisis entered a new, even more dangerous stage.
But three days later he declared that America's financial markets have become a "casino," and said that he'd fire the head of the Securities and Exchange Commission — which, by the way, isn't in the president's power.
And then he found a new set of villains — Fannie Mae and Freddie Mac... (...Fannie and Freddie ... played little role in causing the crisis...) And he moralistically accused other politicians, including Mr. Obama, of being under Fannie's and Freddie's financial influence; it turns out that a firm owned by his own campaign manager was being paid by Freddie until just last month.
Then Mr. Paulson released his plan, and Mr. McCain weighed vehemently into the debate. But he admitted, several days after the Paulson plan was released, that he hadn't actually read the plan, which was only three pages long.
O.K., I think you get the picture.
The modern economy, it turns out, is a dangerous place — and it's not the kind of danger you can deal with by talking tough and denouncing evildoers. Does Mr. McCain have the judgment and temperament to deal with that part of the job he seeks?
Robert Shiller says the crisis presents an opportunity to build a better system:
Everybody Calm Down. A Government Hand In the Economy Is as Old as the Republic, by Robert J. Shiller, Commentary, Washington Post: It has become fashionable to fret that the current crisis on Wall Street marks the end of American capitalism as we know it. "This massive bailout is not the solution," Sen. Jim Bunning (R-Ky.) warned.... "It is financial socialism, and it is un-American." It is neither. The ... bailout would represent a thoroughly American next step for our economic system -- and one that will probably lead to better times. ...
Whenever the public endures a crisis, ordinary citizens start to wonder how -- and whether -- our institutions really work. We no longer take things for granted. It is only then that real change becomes possible. ...
The current crisis offers us a singular opportunity to reevaluate fundamentally the safety and permanence of the master financial institutions that we have come to take for granted...
So we ... should be open to thinking about a new set of financial arrangements... Here are some key features:
1. Handle moral hazard better. The term "moral hazard" refers to the pernicious tendency some people have of failing deliberately if they think it's advantageous to do so. Moral hazard is used to justify teaching people a lesson for their failures... the meaning of a contract.
By rescuing Wall Street tycoons who succumbed to the lure of an irrationally exuberant housing bubble, the bailouts today do pose something of a moral-hazard problem. But we can more than repair it by defining a new generation of financial contracts ... reflecting greater enlightenment, greater understanding of human psychology and the means to deal with financial failure. ...
2. To limit risks to the system, build better derivatives. Some of today's derivatives ... turned out to be "financial weapons of mass destruction,"... The problem isn't derivatives per se but a certain kind... Some kinds of derivatives, such as those maintained by futures exchanges using procedures that effectively eliminate the risk that the other party in the agreement will default, are more useful -- and far safer -- than others. It is high time to redesign derivatives...
3. Trust markets, not Wall Street titans. If institutions can be said to have charisma, such giants as Lehman Brothers and Merrill Lynch certainly had it in spades. But these firms proved not to be the sole source of financial intelligence. They were merely meeting places for smart, financially savvy people -- and for some reckless folks besides. We need to learn to trust people and markets rather than institutions...
4. Ideas matter. Maybe next time, we will listen more closely to financial theorists who think in abstract, general terms. Consider the Long-Term Capital Management debacle in 1998... Lots of people hold that the moral of the LCTM story was the failed thinking of two of the firm's founders, Robert Merton and Myron Scholes, both of whom were Nobel Prize-winning financial theorists. In fact, the collapse of LTCM was largely due to the overconfidence of bond trader John Meriwether and some of his other LTCM colleagues, who were gambling in the markets. The disgraced Merton has been working for the last decade trying to build better risk-management systems, mostly to little avail. Maybe he will be heard now. People still seem to want to trust businessmen who have made bundles and have a huge investment bank behind them, rather than listen to experts who are thinking about the fundamentals of risk management. We would have been better off this month if we'd been ignoring the former and listening to the latter. ...
If we move smartly, Americans can have a better, more robust financial democracy.... The current crisis does not mean the end of American capitalism. But if we are lucky, it will mean an important step in its evolution.
- The Shifting Tax Implications of McCain's Health Plan - Washington Wire
- McCain Admits Health Plan Would Increase Taxes - Wonk Room
- Securitization, an Ironic Solution - Real Time Economics
- Could Palin Buy Health Insurance Under McCain's Plan? - Economists for Obama
- A Weary Titan? - Economic Principals
- Bank governance and regulation interact: One size won't fit all - Vox EU
- The End of Reserve Requirements? - Zubin Jelveh
- Ben Stein Watch: September 28, 2008 - Felix Salmon
- Gross domestic income and recessions - Econbrowser
- Bloomberg Thumbs its Nose at FDIC - Felix Salmon
- Tthe risks of attracting large inflows of foreign money - The Economist
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