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Notes from the Midwest This Week

September 30th, 2008 . by economistmom

I am on the road this week, doing a big “Midwest sweep.”  Today I gave a speech on the outlook for the economy and the candidates’ economic proposals in Chicago for the U. of Illinois’ Institute of Government and Public Affairs.  Tomorrow morning, I’ll give the same speech here in Urbana.  Later this week I’ll meet up with the Fiscal Wake-Up Tour in Cleveland, after passing through Detroit to visit old friends.  So this week’s posts might seem a bit of a “potpourri.”

It’s kind of fun being back in the Midwest where I talk like everyone else.  (I was born in the Chicago area and moved to the Detroit area when I was 7, where I stayed until I went off to grad school.)  I made it to Chicago just fine on a nonstop flight from DC, but it turns out my suitcase decided to go onto San Francisco without me.  (I’m not going to San Francisco at all this week.)  Now I will be waiting up for it all night after it makes the flight back to O’Hare and the drive down to Urbana (2.5 hours away).  (UPDATE:  nope, never made it down to me…our reunion awaits this afternoon back in Chicago.)  That’s a lot of travel my suitcase got for that $15 checked bag fee.  (Gee, guess it wasn’t worth checking the small-enough-to-carry-on bag just to bring along my nail polish remover…)

Guess I didn’t miss much in DC today.  Everyone’s hoping a couple days off for the members of the House will bring them some much-needed maturity when they get back.  I think Barney Frank explained what happened on Monday best.

And here’s a nice Time magazine article explaining why the credit crunch is not just a Wall Street phenomenon, and why we should maybe stop calling it a “Wall Street bailout” and start thinking of it as a “rescue” of the entire U.S. economy.

Bitter Medicine, But With A Silver Lining?

September 29th, 2008 . by economistmom

It’s mixing metaphors, but the $700 billion financial rescue plan has fiscal hawks both horrified and hopeful at the same time, leading to this Congressional Quarterly (CQ Weekly) cover story by Clea Benson, labeled Time for Bitter Medicine on the cover, but speaking of a “silver lining” of a Reckoning After the Rescue in the title of the article.  As Clea explains in the opening paragraphs:

Deficit hawks aren’t generally an optimistic bunch, and they have had little to be positive about in the past several years, with an administration and Congress in war mode and intent on fighting terrorism by doing “whatever it takes” — which has generally meant spending whatever it takes. Economic stimulus measures such as tax cuts have only added to their grief.

So last week, as Treasury Secretary Henry M. Paulson Jr. asked Congress to raise the debt ceiling — the limit on the amount of money the government can borrow — budget watchdogs had further cause for concern. To deal with the Great Financial Crisis of 2008, the government says it will need to spend $700 billion more in borrowed money. The result, if Paulson gets his way, is that the total federal debt would grow as much in the next year as it has in the past three years combined, and will be double what it was when Bush took office.

Yet the reaction from these advocates of fiscal restraint included — along with predictable dismay — an unexpected note of hope.

“Bad news is sometimes good news,” said Maya MacGuineas, president of the nonprofit Committee for a Responsible Federal Budget. “You’re always looking for a silver lining, and it does feel like a wake-up call that’s going to be very difficult for politicians to ignore. . . . You’re going to be very hard-pressed to have a politician come out and say, ‘What we need to do is spend more money and cut more taxes.’ ”

MacGuineas and others see a changed landscape with new light shining on the culture of borrowing at the federal, corporate and individual levels. The legacy of the proposed $700 billion bailout, plus the other expenses of the past six months of financial failures, may be that the rising budget deficit and the accumulated federal debt will transform every major policy discussion on government programs and force tough choices at every level for years to come.

My boss, Bob Bixby, and I are a couple of those “others” who are trying to be hopeful about what the bailout will mean for the federal budget–and indeed, for the U.S. economy as a whole:

The first evidence of a new fiscal era began to appear last week on the presidential campaign trail, when Democratic nominee Barack Obama suggested that he might not be able to implement his entire agenda at once, if he’s elected. But experts say the impact may be felt beyond the next few budget cycles and even beyond the next administration.

Robert L. Bixby, executive director of the Concord Coalition, a nonpartisan group that lobbies for government fiscal responsibility, sees a parallel between the practices that led to the meltdown on Wall Street and the federal government’s own spending and borrowing habits.

“Wall Street got in trouble by being overleveraged and having books that weren’t very transparent,” he said. “And we’ve been worried the federal government is overleveraged and making huge future promises. In effect, it’s assumed huge amounts of deficit financing these programs, and just as it became impossible for Wall Street to go on perpetually propped up by debt, so it will for the federal government, as well.”

The new reality won’t just be one in which the government tightens its belt. The financial crisis and ensuing bailouts also might curb the seemingly insatiable American appetite for consumption fueled by borrowing, which drove so many households into mortgages they could not afford and pushed the national savings rate down basically to zero.

“American voters have been very nearsighted themselves, in that it’s been very hard for many to realize they are overextended, so how can they hold their policy makers accountable?” said Diane Lim Rogers, chief economist at the Concord Coalition. “It’s very scary, but at the same time, I think this current crisis is going to help people get a grip and say, ‘OK, I guess I’m going to start to save more. I’m not going to run up my credit card debt so much.’ This crisis is going to put the brakes on a lot of borrowing over the whole economy, I hope.”

…it will become more expensive for the government to borrow in the future. Foreign governments and other investors have been lending willingly to the Treasury, but they may begin to demand bigger returns as the nation’s debt level rises.

“We are pushing the limits on how much capital we can suck in from abroad,” Rogers said. “I don’t think anyone expects interest rates to do anything but come up from this point forward. The costs of borrowing are going to get much more expensive.”…

Budget experts predict this will lead to a period of severe austerity…

Bixby described the new level of indebtedness as “having the Sword of Damocles hanging over the budget,” and he suggested that it could overshadow debates on everything from Social Security and Medicare to defense, education and taxes…

The end of lax oversight of lending may lie ahead, coupled with a new focus on regulating the kinds of financial instruments that pushed so much capital into the home mortgage market in the first place. Standards for government programs that help families buy homes, such as the Federal Housing Administration’s mortgage insurance, are already being tightened.

Rogers, for one, says the public now may have an appetite for more stringent standards and more government involvement.

“It will encourage a tolerance for a bigger government role,” she said. “These symptoms we’re seeing right now are showing us the downside of letting the private market go completely unchecked, because that’s what profit-seeking is all about. Sometimes profit-seeking leads to developments in the economy that aren’t good for the public as a whole.”

Yeah, that Bob–he’s very smart.  I had no idea what his “sword of Damocles” reference was until I googled/wikipediaed it… That’s why Bob’s the boss, and I’m just his VP–uh, I mean economist.

And here’s an excellent interview Bob did with NPR’s All Things Considered over the weekend, speaking about this bitter medicine/silver lining combo.

Be hopeful.  Things can only get better, right?  (We’re going to get out from under before that sword drops on us.)

**UPDATE, 3:30 pm:   Uh… maybe not…   Tomorrow’s post will likely be something about the children in Congress… **

SNL Recaps of the Palin-Couric Interview and the First Presidential Debate

September 28th, 2008 . by economistmom

Some of the best editorials on recent events come from Saturday Night Live.  From last night, Tina Fey and Amy Poehler as Sarah Palin being interviewed by Katie Couric:  here’s the video from NBC’s website; and Fred Armisen and Darrell Hammond as Obama and McCain in the first presidential debate:  video here. 

On the Palin-Couric skit, the Huffington Post has a nice side-by-side comparison with the real thing, to show you that often truth is stranger (and more entertaining) than fiction.

The Economist Magazine Says Taxpayers Should Show Paulson the Money

September 28th, 2008 . by economistmom

“I Want Your Money” is the cover story in this week’s Economist magazine.  The Economist’s position is that yes, $700 billion is an awful lot of money to spend on this financial bailout/rescue, and that taxpayers (and the parents of future taxpayers) have a right to question who is being “saved” here, but that it has to be done:

SAVING the world is a thankless task. The only thing beyond dispute in the $700 billion plan of Hank Paulson, the treasury secretary, and Ben Bernanke, chairman of the Federal Reserve, to stem the financial crisis is that everyone can find something in it to dislike. The left accuses it of ripping off taxpayers to save Wall Street, the right damns it as socialism; economists disparage its technicalities, political scientists its sweeping powers. The administration gave ground to Congress, George Bush delivered a televised appeal and Barack Obama and John McCain suspended the presidential campaign. Even so, as The Economist went to press, the differences remained. There was a chance that Congress would say no.

Spending a sum of money that could buy you a war in Iraq should not come easily; and the notion of any bail-out is deeply troubling to any self-respecting capitalist. Against that stand two overriding arguments. First this is a plan that could work (see article). And, second, the potential costs of producing nothing, or too little too slowly, include a financial collapse and a deep recession spilling across the world: those far outweigh any plausible estimate of the bail-out’s cost.

If the economics of Mr Paulson’s plan are broadly correct, the politics are fiendish. You are lavishing money on the people who got you into this mess. Sensible intervention cannot even buy long-term relief: the plan cannot stop house prices falling and the bloated financial sector shrinking. Although the economic risk is that the plan fails, the political risk is that the plan succeeds. Voters will scarcely notice a depression that never happened. But even as they lose their houses and their jobs, they will see Wall Street once again making millions.

And the Economist goes on to warn that we don’t get carried away with policies that would outlast the temporary justification for them:

In retrospect, Mr Paulson made his job harder by misreading the politics. His original plan contained no help for homeowners. And he assumed sweeping powers to spend the cash quickly. He was right to want flexibility to buy a range of assets. But flexibility does not exclude accountability. As complaints mounted, Mr Paulson and Mr Bernanke buckled—agreeing, for instance, to more oversight. Now that Messrs McCain and Obama have returned to Congress to forge a deal, more buckling may be necessary. Ideally, concessions should not outlast the crisis: temporary help for people able to stay in their houses, a brief ban on dividends in financial firms, even another fiscal package. They should not be permanent or so onerous that the programme fails for want of participants—which is why proposed limits on pay are a mistake (see article).

That “concessions should not outlast the crisis” especially applies to the cost of all the policies we may be spurred into adopting as “part of” (however tangentially) the rescue plan.  The financial crisis is just one part of the broader problem the American economy suffers from–the “living beyond our means” one.  I worry that in frantically bailing out the troubled water from the Wall Street boat, all of us may end up falling overboard.

On Last Night’s Debate and the Candidates’ Economic “Strategy” vs. “Tactics”

September 27th, 2008 . by economistmom

When they got around to talking about the war in last night’s debate (transcript here courtesy of CNN), Senator McCain accused Senator Obama of not understanding “the difference between a tactic and a strategy.”  It struck me that that’s a distinction voters should make when they listen to Senators McCain and Obama talking about economic policy.  Both candidates often speak of their economic plans in a way that reflects campaign “tactics.”  But what we really should be listening for are the candidates’ underlying economic philosophies–and notice how what they (tactically) say (during tactical moments like a debate) actually reveals a lot about the stark differences between their fundamental “economic strategies.”

First, I stand by my comments from a couple days ago about the McCain campaign needing an “extension” on their economics assignment, and how Sarah Palin’s interview with Katie Couric was just more proof that they are really struggling with the economic issues.  (If my highlighting the interview was a “cheap shot,” then it was so cheap and easy that even conservative columnist Kathleen Parker couldn’t help taking it–and seeing the significance of it–as well, in the National Review, no less.)  The “suspension” of the campaign and the call to delay the debate seemed a clear stalling tactic.  It wasn’t just that we knew the debate would have to focus at least a little on the economic crisis at hand, it was that the economic crisis was a minute-to-minute reminder to the public that the “Bush economy” has not worked out so well for most of us–and that there’s really not much in the McCain campaign’s economic plans that sounds any different from Bush economic policy.  Senator McCain didn’t have a good, substantive response to this reality, so his campaign needed to call a “time out.”

Senator McCain’s tactical response to the economic questions last night was to:  (i) emphasize his low-tax, low-spending fiscal philosophy, going so far as to call for a “spending freeze” but not giving an inch on his tax cuts for the rich; and (ii) repeatedly point to his record as the non-“Miss Congeniality” and a “maverick” against wasteful spending, even reminding the public that he considers his VP pick to be a “maverick” as well, but (unfortunately for him) also reminding the public who he picked as his VP:

MCCAIN: It’s well-known that I have not been elected Miss Congeniality in the United States Senate nor with the administration. I have opposed the president on spending…I have a long record and the American people know me very well and that is independent and a maverick of the Senate and I’m happy to say that I’ve got a partner that’s a good maverick along with me now.

Here’s where Senator McCain explains how he’d modify his economic platform to adjust to the new demands of the financial rescue plan (emphasis added):

LEHRER: Are you — what priorities would you adjust, as president, Senator McCain, because of the — because of the financial bailout cost?

MCCAIN: Look, we, no matter what, we’ve got to cut spending. We have — as I said, we’ve let government get completely out of control.

Senator Obama has the most liberal voting record in the United States Senate. It’s hard to reach across the aisle from that far to the left.

The point — the point is — the point is, we need to examine every agency of government…

[went on about cutting wasteful spending in the defense budget...]

LEHRER: What I’m trying to get at this is this. Excuse me if I may, senator. Trying to get at that you all — one of you is going to be the president of the United States come January. At the — in the middle of a huge financial crisis that is yet to be resolved. And what I’m trying to get at is how this is going to affect you not in very specific — small ways but in major ways and the approach to take as to the presidency.

MCCAIN: How about a spending freeze on everything but defense, veteran affairs and entitlement programs.

LEHRER: Spending freeze?

MCCAIN: I think we ought to seriously consider with the exceptions the caring of veterans national defense and several other vital issues.

LEHRER: Would you go for that?

OBAMA: The problem with a spending freeze is you’re using a hatchet where you need a scalpel…

The other problem with that is that it sounds like McCain is exempting most of federal spending from that “freeze,” which would mean that he’d really have to cut, not just freeze, the spending he’s not exempting, just to pay for a mere fraction of the tax cuts for the rich that he’s not willing to admit could be considered lower-priority “spending” as well.  And that spending that McCain would have to cut is exactly the type of spending that Senator Obama mentioned as critical last night, which was Obama’s “tactical” response to the questions about how the bailout would affect his new administration’s budget:

OBAMA: Well, there are a range of things that are probably going to have to be delayed. We don’t yet know what our tax revenues are going to be. The economy is slowing down, so it’s hard to anticipate right now what the budget is going to look like next year.

But there’s no doubt that we’re not going to be able to do everything that I think needs to be done. There are some things that I think have to be done.

We have to have energy independence, so I’ve put forward a plan to make sure that, in 10 years’ time, we have freed ourselves from dependence on Middle Eastern oil by increasing production at home, but most importantly by starting to invest in alternative energy, solar, wind, biodiesel, making sure that we’re developing the fuel-efficient cars of the future right here in the United States, in Ohio and Michigan, instead of Japan and South Korea.

We have to fix our health care system, which is putting an enormous burden on families. Just — a report just came out that the average deductible went up 30 percent on American families.

They are getting crushed, and many of them are going bankrupt as a consequence of health care. I’m meeting folks all over the country. We have to do that now, because it will actually make our businesses and our families better off.

The third thing we have to do is we’ve got to make sure that we’re competing in education. We’ve got to invest in science and technology. China had a space launch and a space walk. We’ve got to make sure that our children are keeping pace in math and in science.

And one of the things I think we have to do is make sure that college is affordable for every young person in America.

And I also think that we’re going to have to rebuild our infrastructure, which is falling behind, our roads, our bridges, but also broadband lines that reach into rural communities.

Also, making sure that we have a new electricity grid to get the alternative energy to population centers that are using them.

So there are some — some things that we’ve got to do structurally to make sure that we can compete in this global economy. We can’t shortchange those things. We’ve got to eliminate programs that don’t work, and we’ve got to make sure that the programs that we do have are more efficient and cost less.

Despite this being an (effective) Obama “tactic” to avoid talking about the pain of specific spending or tax cuts he’d have to give up upon confronting a tighter budget, I thought the Obama campaign’s underlying economic strategy was also clarified.  While Senator McCain repeated his opinion that “the worst thing we could possibly do is to raise taxes on anybody”, Obama explained that there are ways to raise revenue that don’t involve raising tax rates:

OBAMA: …John mentioned the fact that business taxes on paper are high in this country, and he’s absolutely right. Here’s the problem: There are so many loopholes that have been written into the tax code, oftentimes with support of Senator McCain, that we actually see our businesses pay effectively one of the lowest tax rates in the world.

And what that means, then, is that there are people out there who are working every day, who are not getting a tax cut, and you want to give [the rich people who are getting the Bush tax cuts] more.

It’s not like you want to close the loopholes. You just want to add an additional tax cut over the loopholes. And that’s a problem…

Obama’s economic strategy clearly leans towards raising taxes on the rich over cutting spending, and last night he emphasized that his administration would undo a lot of the Bush Administration’s economic policies, which he feels reflects the Bush Administration’s misguided priorities:

OBAMA: There’s no doubt it will affect our budgets. There is no doubt about it. Not only — Even if we get all $700 billion back, let’s assume the markets recover, we’re holding assets long enough that eventually taxpayers get it back and that happened during the Great Depression when Roosevelt purchased a whole bunch of homes, over time, home values went back up and in fact government made a profit. If we’re lucky and do it right, that could potentially happen but in the short term there’s an outlay and we may not see that money for a while.

And because of the economy’s slowing down, I think we can also expect less tax revenue so there’s no doubt that as president I’m go doing have to make some tough decision.

The only point I want to make is this, that in order to make the tough decisions we have to know what our values are and who we’re fighting for and our priorities and if we are spending $300 billion on tax cuts for people who don’t need them and weren’t even asking for them, and we are leaving out health care which is crushing on people all across the country, then I think we have made a bad decision and I want to make sure we’re not shortchanging our long term priorities…

I just want to make this point, Jim. John, it’s been your president who you said you agreed with 90 percent of the time who presided over this increase in spending. This orgy of spending and enormous deficits you voted for almost all of his budgets. So to stand here and after eight years and say that you’re going to lead on controlling spending and, you know, balancing our tax cuts so that they help middle class families when over the last eight years that hasn’t happened I think just is, you know, kind of hard to swallow.

Because after all, McCain’s economic strategy–no matter how he may tactically put it–is overwhelmingly Bush economic policy extended. 

In fact, with this week’s attempted “time out,” or swooping into the “rescue” of the financial rescue plan, the McCain campaign has only underscored their alliance to Bush Administration economic policy.  McCain seemed sympathetic to the House Republican (Republican Study Committee) revolt against the negotiations that seemed close to coming together between the Administration and Congress.  The House Republicans have been calling for a decrease in government involvement in the bailout, which they’re labeling as a concern for American taxpayers.  What the House Republicans are really asking for is less, not more, government involvement and regulation, and more deficit-financed tax cuts for the rich–to help the private sector come up with the money to do more of the “bailout” itself (not that anyone thinks that they can even with more tax cuts).  The Washington Post’s Steven Pearlstein sees right through this, of course, in his “Johnny One Note” column in today’s paper.  “Johnny” refers to John Boehner, the House minority leader.  But it could just as well be referring to John McCain’s current alliance to the same economic philosophy/strategy (emphasis added):

Minority Leader John Boehner and his crew have never met a problem they think couldn’t be solved by attracting private capital, and never met a dollar of private capital that couldn’t be lured with a tax cut. So it should have been no surprise that they would try to use the same approach to plug the trillion dollar hole that’s been blown in the American financial system.

That’s right, my fellow Americans, we can lick this financial crisis just by offering an additional capital gains tax break to any investor or hedge fund that agrees to invest in a bank or Wall Street investment house. It seems the prospect of forfeiting a mere 15 percent on their investment profits to the government is what’s discouraging investment in financial institutions, and not that mountain of bad loans and toxic securities that are weighing down their balance sheets. What exactly the optimal capital gains tax rate would be, Republicans aren’t saying. But my suspicion is that, if they could have their way, they’d bring it down to zero.

What we witnessed this week was the last death rattle of the Republican old guard in Congress, whose zealotry for tax cutting and deregulation, and whose hostility toward any government involvement in the economy, has now brought the global financial system to the brink of a meltdown. The ideas that brought them to power in 1994, while useful at the time, have since become so corrupt that they now are bankrupt — intellectually, politically and morally. And though they may have succeeded in delaying passage for a day of a badly needed rescue for the financial system, they failed miserably in their ultimate goal of making themselves relevant again.

Let’s remember that McCain’s economic advisor, Doug Holtz-Eakin, warned us this summer that McCain’s economic philosophy of (extremely) small government would ultimately prevail–that the folks who might be “horrified” by the drastic cuts in spending implied by a balanced budget goal coupled with trillions of dollars of tax cuts for the rich “better get ready.”  This is the McCain economic strategy that went largely undisguised by the tactical remarks he made at last night’s debate.

Concord’s Take on the $700 Billion Financial Bailout

September 26th, 2008 . by economistmom

The Concord Coalition’s official “position” on the financial rescue package was released today.  Here is a cut and paste of it:

WASHINGTON — As Congress and the Bush Administration negotiate a $700 billion plan to shore up credit markets by purchasing “troubled assets,” The Concord Coalition urged them to heed the lesson of Wall Street’s failure: corrective actions are more effective and much less costly if taken in advance of a crisis rather than in the face of one.

Concord said that in dealing with the immediate crisis, policymakers should limit taxpayer exposure, maximize transparency of any new obligations and develop a debt repayment plan to ensure that the short-term emergency measures do not result in further deterioration of the long-term budget outlook. More fundamentally, however, policymakers must acknowledge and begin to address the fact that the federal budget is itself suffering from the same over-reliance on debt and lack of transparency that doomed the institutions they are now rushing to rescue. If they fail to do so, the eventual and inevitable consequences for the economy are no less stark.

“It’s fine to hope for the best, but we should budget for the worst. While the intent of this plan is to recoup much, if not all, of the initial cost to taxpayers there are no guarantees. The value of the assets to be purchased is highly uncertain. What we know for certain is that the government will incur a huge upfront cost, immediately adding to the debt and immediately incurring compounding interest payments. All of this will be layered on top of a deficit expected to exceed $500 billion next year, and an overall fiscal policy that is unsustainable. Meanwhile, we are borrowing increasing amounts from abroad to make up for our inability to make crucial budgetary decisions. The answer to every problem in Washington seems to be more debt. That simply cannot go on. Given the uncertainty of the return on this $700 billion of new borrowing, and the daunting challenges already confronting the fiscal outlook, Congress should adjust budget policy either though phased-in spending cuts or tax increases to ensure against any permanent fiscal deterioration,” said Concord Coalition executive director Robert L. Bixby.

The Concord Coalition further stressed that once the immediate threat has passed, and the new administration and Congress start their work next year, their agenda must confront the nation’s long-term fiscal challenges. 

“Washington can normally act in the face of a crisis.  We don’t need to relearn that lesson.  A more fundamental issue is whether we can learn from the current crisis and finally break the pattern of routinely ignoring long festering problems. It is no secret that our nation is entering an unprecedented and permanent demographic transformation to an older society and that we are doing so with steadily rising health care costs and steadily falling national savings. This is a dangerous combination for the future health of the economy. And yet, nothing in the budget process requires Congress to review the current-law outlook beyond the next five years, much less take corrective action.  If we learn from Wall Street’s mistakes, we can act more effectively, with less pain, and more time to prepare the public for difficult but necessary choices. If we don’t change course, the federal government itself will be in need of a bailout,” Bixby said.

I would add two of my own personal complaints about the $700 billion bailout proposal, in the context of fiscal discipline.  I have heard the price tag referred to in two ways:  (i) $700 billion is a small amount to add to the federal debt relative to the $53 trillion in unfunded liabilities (”fiscal exposures”) that Dave Walker talks about in I.O.U.S.A.; and (ii) that other deficit-financed spending that Congress is working on passing is small relative to that $700 billion.  Both such comparisons undermine Concord’s message.  The $700 billion would be an immediate increase in the debt and would begin to rack up associated debt service costs (i.e., compounding interest) immediately.  And using the $700 billion increase in debt as an excuse for waiving pay-go on other spending or tax cuts that amount to “just” tens of billions of dollars is just shameful.

What’s likely a “silver lining” in this bailout proposal is the negative reaction of Americans who understand this represents a huge burden that would be shifted to American taxpayers.  (It really represents a potentially many-fold burden on future taxpayers, but it’s the fact that current taxpayers are scared about their own financial security that is getting everyone to finally pay attention.)  This may be exactly the kind of “wake-up call” our country has needed.

In case you hadn’t heard, no deal on the bailout has yet been worked out.  Policymakers will continue to work on it over the weekend.  Meanwhile, tonight’s debate will go on.

CBO Explains Why It’s Hard to Know How Much Taxpayers Will Pay

September 25th, 2008 . by economistmom

Yesterday the Congressional Budget Office’s (CBO) director, Peter Orszag, testified before the House Budget Committee on the “Federal Responses to Market Turmoil,” focusing on the Treasury proposal for a $700 billion rescue plan.  Peter’s blog post on it is here.  Here are some key passages of the testimony that explain why it’s so difficult to quantify the ultimate cost to the taxpayer–and will remain so even after more details of the plan get worked out by policymakers.  (Emphasis added.)

The legislation would appropriate such sums as are necessary, for as many years as necessary, to enable the Secretary to purchase up to $700 billion of troubled assets at any point during the two-year window of opportunity (though cumulative gross purchases may exceed $700 billion as previously purchased assets are sold) and to cover all administrative expenses of purchasing, holding, and selling those assets. The federal debt limit would be increased by $700 billion.

At this time, given the lack of specificity regarding how the program would be implemented and even what asset classes would be purchased, CBO cannot provide a meaningful estimate of the ultimate net cost of the Administration’s proposal. The Secretary would have the authority to purchase virtually any asset, at any price, and sell it at any future date; the lack of specificity regarding how that authority would be implemented makes it impossible at this point to provide a quantitative analysis of the net cost to the federal government.

CBO expects that the Treasury would probably fully use its $700 billion authority in fiscal year 2009 to purchase various troubled assets. To finance those purchases, the Treasury would have to sell debt to the public. Federal debt held by the public would therefore initially rise by about $700 billion. Nevertheless, CBO expects that, over time, the net cash disbursements under the program would be substantially less than $700 billion, because, ultimately, the government would sell the acquired assets and thus generate income that would offset at least much of the initial cost.

Whether those transactions ultimately resulted in a gain or loss to the government would depend on the types of assets purchased, how they were acquired and managed, and when and under what terms they were sold…

Concerns about the government’s overpaying are particularly salient when sellers offer assets with varying underlying characteristics that are complicated to evaluate… [but on the other hand,] [i]t is…at least possible that the prices of some assets are below their fundamental value; in that case, to the extent that the government bought now and held such assets until their market prices recovered to reflect that underlying value, net gains would be possible.

In addition to any net gain or loss on the purchase of $700 billion or more in assets, the government would also incur significant administrative costs for the proposed program.

[T]he federal government could purchase too many risky or impaired assets without enjoying sufficient price discounts…[D]etermining fair market prices using an auction is difficult for assets that are not clearly the same or very similar in quality—that is, when the seller has more information about the quality of the asset than the buyer does. In such cases, each auction participant will offer up assets with unique attributes known only to the seller, thus increasing the likelihood that the government will pay too much. That type of problem is likely to be particularly severe for assets like individual home mortgages or esoteric derivative products entirely owned by specific financial institutions.  Substantial purchases of such assets would make it unlikely that the Treasury could operate the proposed new program at little or no net cost. 

In other words, the more that the Treasury program concentrates on assets that are difficult for a buyer to value, the more likely that the government will overpay. The more that occurs, the more the program moves beyond simply reestablishing trading in illiquid financial markets and instead subsidizes the particular financial institutions selling assets to the government, at a cost to taxpayers…

So how to build in more “protection” for the American taxpayer?  Try to build in more of an equity stake (rather than just a debt stake) in these financial companies that are being rescued.  (I like how Paul Krugman yesterday explained on his blog how buying “bad paper” is not how the government normally rescues financial institutions.)  CBO explains there are alternative strategies that would try to give the government (and taxpayers) more claim to such equity:

Under some alternative proposals, the government would receive shares in an institution if it ultimately lost money on the sale of assets purchased from the institution…

[Or a]n alternative approach that is more directly aimed at addressing insolvency concerns is for the government to invest directly in financial institutions to strengthen their capital positions, without directly purchasing troubled assets…along the lines of the Reconstruction Finance Corporation, a Depression-era institution.

The testimony goes on to explain that these alternative approaches have their advantages and disadvantages, an illustration of the broader challenge of this federal bailout/rescue of the financial sector:  the “inherent tension between minimizing the costs to taxpayers and pursuing other policy goals.”

So it’s very difficult to guess how much this will ultimately cost taxpayers, or probably more likely, future taxpayers.   I don’t pretend to know, but I worry we shouldn’t necessarily take $700 billion as an upper bound, even with all the talk of the potential to get some money back to the Treasury over time.  There’s just too much uncertainty to (prudently) count on the eventual cost being much less than that.

Why McCain Needed an Extension on His Economics Assignment

September 25th, 2008 . by economistmom

To pick up where I left off last night, if you’re wondering why Senator McCain decided to take a “time out” from the campaign, or as I prefer to think of it, ask for an extension on the due date of his “economics assignment,” fortunately his VP, Sarah Palin, clarified it for us in her interview with Katie Couric yesterday (here is the video)… No emphasis needed:

Next, Couric asked about the $700 billion government bailout of bad debt - and whether she supports it.

Palin: I’m all about the position that America is in and that we have to look at a $700 billion bailout. And as Sen. McCain has said unless this nearly trillion dollar bailout is what it may end up to be, unless there are amendments in Paulson’s proposal, really I don’t believe that Americans are going to support this and we will not support this. The interesting thing in the last couple of days that I have seen is that Americans are waiting to see what John McCain will do on this proposal. They’re not waiting to see what Barack Obama is going to do. Is he going to do this and see what way the political wind’s blowing? They’re waiting to see if John McCain will be able to see these amendments implemented in Paulson’s proposal.

Couric: Why do you say that? Why are they waiting for John McCain and not Barack Obama?

Palin: He’s got the track record of the leadership qualities and the pragmatism that’s needed at a crisis time like this.

Couric: But polls have shown that Sen. Obama has actually gotten a boost as a result of this latest crisis, with more people feeling that he can handle the situation better than John McCain.

Palin: I’m not looking at poll numbers. What I think Americans at the end of the day are going to be able to go back and look at track records and see who’s more apt to be talking about solutions and wishing for and hoping for solutions for some opportunity to change, and who’s actually done it?

Couric: If this doesn’t pass, do you think there’s a risk of another Great Depression?

Palin: Unfortunately, that is the road that America may find itself on. Not necessarily this, as it’s been proposed, has to pass or we’re going to find ourselves in another Great Depression. But, there has got to be action - bipartisan effort - Congress not pointing fingers at one another but finding the solution to this, taking action, and being serious about the reforms on Wall Street that are needed.

Couric: Would you support a moratorium on foreclosures to help average Americans keep their homes?

Palin: That’s something that John McCain and I have both been discussing - whether that … is part of the solution or not. You know, it’s going to be a multi-faceted solution that has to be found here.

Couric: So you haven’t decided whether you’ll support it or not?

Palin: I have not.

Couric: What are the pros and cons of it do you think?

Palin: Oh, well, some decisions that have been made poorly should not be rewarded, of course.

Couric: By consumers, you’re saying?

Palin: Consumers - and those who were predator lenders also. That’s, you know, that has to be considered also. But again, it’s got to be a comprehensive, long-term solution found … for this problem that America is facing today. As I say, we are getting into crisis mode here.

Couric: You’ve said, quote, “John McCain will reform the way Wall Street does business.” Other than supporting stricter regulations of Fannie Mae and Freddie Mac two years ago, can you give us any more example of his leading the charge for more oversight?

Palin: I think that the example that you just cited, with his warnings two years ago about Fannie and Freddie - that, that’s paramount. That’s more than a heck of a lot of other senators and representatives did for us.

Couric: But he’s been in Congress for 26 years. He’s been chairman of the powerful Commerce Committee. And he has almost always sided with less regulation, not more.

Palin: He’s also known as the maverick though, taking shots from his own party, and certainly taking shots from the other party. Trying to get people to understand what he’s been talking about - the need to reform government.

Couric: But can you give me any other concrete examples? Because I know you’ve said Barack Obama is a lot of talk and no action. Can you give me any other examples in his 26 years of John McCain truly taking a stand on this?

Palin: I can give you examples of things that John McCain has done, that has shown his foresight, his pragmatism, and his leadership abilities. And that is what America needs today.

Couric: I’m just going to ask you one more time - not to belabor the point. Specific examples in his 26 years of pushing for more regulation.

Palin: I’ll try to find you some and I’ll bring them to you.

Sarah Who?…Phew!

September 24th, 2008 . by economistmom

Perhaps the silver lining in this thick, dark cloud:  we are getting back to focusing on the issues that really matter in this campaign.  No more lipstick…

Phew!

UPDATE (3:30 pm):  What the …?!!!  McCain is suspending the campaign and calling for a delay in the debate?!!…   I guess when the momentum of issue #1 is turning against you, you’re not ready to give a real response, and you’ve already unveiled Sarah-who?, the only thing left to do is call for a desperate ”time out” and hope that enough Americans will mistake it as a sign of leadership.  But the passage or not of the Treasury proposal certainly does not depend on McCain (or Obama) suspending the presidential campaign.  I think what McCain is really doing is asking for an extension on his assignment, because he hasn’t yet got it figured out (not that anyone really has), and thinks he’d get a bad grade if he turned it in on Friday (debate day).  If he turns the assignment in late though, I think the American public ought to mark him down a grade or two anyway.

UPDATE #2 (9:30 pm):  Senator McCain didn’t just call for a suspension of the campaign and a delay of the debate today; he canceled his scheduled appearance on the Late Show with David Letterman.  Big mistake, because Dave went on without him, with last-minute substitute Keith Olbermann (that’s how big a mistake you know it was for McCain)… Here’s how it went (video highlights of the taping, posted on YouTube).  If you’re reading this before the show airs at 11:30 pm, this is a sneak preview for you.

Dare We Bring Up Fiscal Sustainability This Week?

September 24th, 2008 . by economistmom

 

Here’s this morning’s Tom Toles cartoon from the Washington Post.  Kind of says it all…  One might imagine the tune of “Ring Around the Rosie” in the background…

I happen to have organized a special one-day conference of the National Tax Association on “Attaining Fiscal Sustainability: State & Local Perspectives and the Federal Outlook,” this Friday, Sept. 26, here in DC (at the Urban Institute).  The program and registration form is available on the NTA website; advance registration by tomorrow (Thursday) is required.  You will see we have a lot of prominent policy experts from within and outside the Beltway, a Member of Congress (if he’s not too busy on Friday…), and a special appearance of the Fiscal Wake-Up Tour of IOUSA movie fame (Dave Walker, Bob Bixby, Belle Sawhill, and Alison Fraser) to kick it all off.  Gene Steuerle, the Peter G. Peterson Foundation’s new VP, is the luncheon speaker.  (The fee is only $20 which includes continental breakfast and lunch, and the room only holds 125 people, so fax your registration form into the NTA as soon as you can–and by no later than Thursday.)

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