This is Too Much to Ask?

Brad DeLong provides his summary of how the Geithner plan would work. It still sounds like a phenomenal deal for the private investors who get to go along for the ride - we put up $97 to their $3, then split any profits 5:1 (fortunately in our favor), and almost nothing to lose if they walk away. But despite some melodrama, DeLong offers by far the clearest explanation and most compelling argument in favor of the plan that I've heard to date.

If Geithner (or Summers) were to offer an understandable synopsis, like this, or even just confirm, "Yeah, that's what I'm talking about," we could have a much better conversation about the bailout. Is that really too much to ask?

(I still await an answer to Krugman's concern - what if this isn't just about the banks' balance sheets? Or the question raised by others (possibly inlcuding Krugman), what if the prices offered at auction are below the banks' "book values" for the assets and are rejected? It occurs to me also - will this be like an auction of repossessed autos, you can look at the surface but no test driving permitted, or will investors be allowed to fully scrutinize the securities in advance of the auction?)

Democracy is... Flat?

Tom Friedman shares his insights....

If you want to guarantee that America becomes a mediocre nation, then just keep vilifying every public figure struggling to find a way out of this crisis who stumbles once - like Treasury Secretary Timothy Geithner or A.I.G.’s $1-a-year fill-in C.E.O., Ed Liddy - and you’ll ensure that no capable person enlists in government.

We could call this "meta-condescension". If I don't excuse Liddy for being condescending to me about contract rights and the importance of overcompensating people in the financial industry, I get a condescending lecture from Friedman about how unfair I was to react to the condescension.

Sure, I've had my moments of conscience about talking about the mistakes of both of these men, whose biggest sins appear to be that they are extraordinarily conventional thinkers for their respective industries, further hampered by tin ears. But that doesn't mean I'm not going to respond to a patronizing commentary about the "sanctity of contracts" from the former CEO of Allstate, or dismiss his notion that the people at AIG are doing taxpayers a great favor by unwinding contracts that should have landed the company in bankruptcy court, not made it the beneficiary of the largest taxpayer bailout in history. You know what? If the choice is between sitting silently while Liddy earns his $1, or being able to fully and fairly criticize the decisions of the CEO of AIG, I say pay him a market wage.

Geithner's department is far from fully staffed, and he's taken on a tough job - in normal times, probably only 1% of Americans even know who the Treasury Secretary is, and probably not many more than that know that we have one. As I said yesterday,

I'm still willing to assume that Geithner is a dedicated, hard-working public servant who means well, and who believes in this approach to the problem. But if he can't or won't explain himself, he deserves no deference.

We also shouldn't overlook the fact that public servants, first and foremost, are supposed to serve the public, and the public has the right to question them when their priorities appear to be the advancement of private commercial interests. Frank Rich captures the apparent attitude of the officials who are supposed to be addressing our concerns:

Bob Schieffer of CBS asked [Larry] Summers the simple question that has haunted the American public since the bailouts began last fall: “Do you know, Dr. Summers, what the banks have done with all of this money that has been funneled to them through these bailouts?” What followed was a monologue of evasion that, translated into English, amounted to: Not really, but you little folk needn’t worry about it.

Contrary to Friedman, I'm not content to be treated like a toddler just because Geithner is paid about $200K/year. I want to know what's in the bitter pill I'm being asked to swallow, and why other remedies aren't better.

You will ensure that every bank that has taken public money will try to get rid of it as fast it can, so as not to come under scrutiny, even though that would weaken their balance sheets and make them less able to lend money.

Oh no.... You mean, private banks that don't need government money wouldn't take it, and market forces would dictate their ultimate success or failure? What a horrible possibility! And again, you say, the solution is for us to "shut up and take it"? That seems like the least we can do....

And you will ensure that we’ll never get out of this banking crisis, because the solution depends on getting private money funds to team up with the government to buy up toxic assets - and fund managers are growing terrified of any collaboration with government.

Arguably the solution involves nationalizing the troubled banks, including those of the "big four" that can't make it on their own, cleaning up their balance sheets, and restoring them as quickly as possible to public ownership with new shareholders and new management.

Friedman has apparently embraced Geithner's solution - the government provides the money for private companies to buy up toxic debt, providing enough of a subsidy that they're willing to pay the valuation given to them by the banks that hold them, while "sharing" profit and protecting the private buyers from taking losses. It assumes that the assets at issue aren't grossly overvalued by the banks, or that the real estate bubble will quickly reinflate, or... well, we can't really be sure, because Tim Geithner won't tell us his assumptions. And Friedman implies, "We have no business asking; shut up and take it."

What's funny is, Friedman can't even follow his own advice:

Right now we have an absence of inspirational leadership. From business we hear about institutions too big to fail - no matter how reckless. From bankers we hear about contracts too sacred to break - no matter how inappropriate. And from our immature elected officials we hear about how it was all “the other guy’s fault.” I’ve never talked to more people in one week who told me, “You know, I listen to the news, and I get really depressed.”

The first words, put into the mouths of "business", could as easily be assigned to Geithner (or Ben Bernanke), who plainly believes that certain banks and financial institutions are "too big to fail". The "banker" could easily be AIG CEO Liddy, whose deference to compensation contracts goes way beyond what I can recall ever hearing from an employer, let alone from an insurance executive. And to attack public officials as immature and self-serving? As someone, oh yes, Thomas Friedman put it, "If you want to guarantee that America becomes a mediocre nation, then just keep vilifying every public figure struggling to find a way out of this crisis who stumbles once".

Yesterday, addressing bankers, Ben Bernanke commented,

Many of you likely are frustrated, and rightfully so, by the impact that the financial crisis and economic downturn has had on your banks, as well as on the reputation of bankers more generally. You may well have built your reputations and institutions through responsible lending and community-focused operations, but nonetheless, you now find yourselves facing higher deposit insurance assessments and increasing public skepticism about the behavior of bankers - outcomes that you perceive were largely caused by the actions of larger financial institutions. Many of you managed your businesses prudently and shunned more exotic instruments and activities. And many of your customers--households and businesses - avoided excesses and are able to meet their financial commitments on a timely basis.

No doubt this frustration has been heightened by the problems caused by financial firms that are too big or too interconnected to fail. Indeed, the too-big-to-fail issue has emerged as an enormous problem, both for policymakers and for financial institutions generally. Creditors of a firm perceived as too big to fail have less incentive to monitor and restrict the firm's risk-taking through adjustments to the price at which they lend money to the firm. If left unaddressed, this weakening of market discipline creates an unlevel playing field for smaller institutions, which may not be able to raise funds as cheaply, even if their individual risk profiles are better, or at least no worse, than those of their larger competitors. The erosion in market discipline distorts market behavior and can give firms an incentive to grow - either internally or through acquisitions - in order to be perceived as too big to fail.

Government rescues to prevent the failure of major financial institutions also have required large amounts of public resources. These actions have involved extremely unpleasant and difficult choices, but given the interconnected nature of our financial system and the potentially devastating effects on confidence, financial markets, and the broader economy that would likely arise from the disorderly failure of a major financial firm in the current environment, I do not think we have had a realistic alternative to preventing such failures.

Yet where Geithner and Bernanke appear content to (possibly) create a solution for these institutions to apply "next time", I think "There's no time like the present". I would be creating a Chapter 10 bankruptcy for companies like Chrysler and GM that are "too big to fail", and putting the weakest of those companies through it as a "test case". I would do the same thing with the "too big to fail" financial institutions. Why not? As Bernanke says,

Finally, an important element of addressing the too-big-to-fail problem is the development of an improved resolution regime in the United States that permits the orderly resolution of a systemically important nonbank financial firm. We have such a regime for insured depository institutions, but it is clear we need something similar for systemically important nonbank financial entities. Improved resolution procedures for these firms would help reduce the too-big-to-fail problem by giving the government the option of safely winding down a systemically important firm rather than keeping it operating.

There's no time like the present.

Avoiding Consequences

You would think, from the way the latest bailed out company bonus scandal hit the press, that nobody could have seen this coming. Wrong. Quite obviously, AIG CEO Edward Liddy saw it coming. For that matter, everybody within AIG who was "entitled" to a bonus saw this coming. To the extent that Geithner and Summers didn't see this coming, it was because they were deliberately kept in the dark - and perhaps also that they chose not to ask.

Here's an interesting theory (albeit most likely incorrect) on how Liddy may have tried to scare Geithner out of any meaningful confrontation over the bonuses.

I take this to mean that if a bunch of AIGFP managers quit because they didn't receive bonuses promised in their contracts, then France could, if it wanted, to appoint its own designee. And if that happened, then it would equate to a default and those contracts would kick in, at a cost to AIG the US government of at least tens of billions.

I doubt that such an outcome was likely and, if it were, my preference would have been to talk to France about the many reasons they weren't going to do any such thing.

But really, I think the legalistic rationalizations are just meant to give Liddy cover - he wanted to pay the bonuses, and the best way to do what he wanted to do was to keep quiet about them until the secret could no longer be kept, thereby avoiding the chance that Congress will revise the strings it has imposed on bailout money, then dump a convoluted legal rationale on the credulous and compliant Timothy Geithner in order to avoid any serious action before the bonuses can be distributed. [Addendum: Certain key people, probably including Geither and Summers, knew about these bonuses for a considerable time before the news was made public; so part of this assumption was unfair to Liddy.]

Larry Summers is worried about having policy created out of anger? This is increasingly looking like the straw - a word that strangely enough fits, because in the larger scheme of things these bonuses are a tiny part of the bailout - that broke the camel's back.

Larry Summers: Liar?

Larry Summers dissembles as follows:

"If we simply throw up our hands, refuse to deal with any of this, we'll have the kind of financial catastrophe that we saw after what happened at Lehman Brothers," Summers said. "[Treasury] Secretary Geithner has negotiated very forcefully with AIG. He has done everything that is legally permissible for the government to do to limit the payment of bonuses. But where there are contracts, binding contracts that were entered into long before the government put any money in to AIG - we're not a country where contracts just get abrogated willy-nilly."

The government can do a lot of things - put AIG in receivership, sell off its profitable pieces, and liquidate the rest. They could avoid fear-mongering about what happens if it fails, and either create a "Chapter 10" bankruptcy for companies that are "too big to fail" or simply say, "If you don't renegotiate those bonuses, bankruptcy court awaits."

Again, quite obviously, the "sanctity of contracts" isn't an issue in relation to the auto industry bailout. Abrogation and renegotiation of contracts has been made a condition of any bailout. This is different only because Summers and Geithner are continuing the Bush Administration's incompetent, poorly conceived bail-out that somehow deems it wrong for the people who ran our economy into the ground to suffer a financial consequence. Not when they can be fully paid, courtesy of the taxpayer.

Flashback to November:

Someone in the Obama administration, with both business savvy and a suitably tough-minded approach, could bring together the parties, including the dealers, the union and the company. He (or she) could force the union and the company to renegotiate their contracts. With his input, Congress could perhaps pass a law that dealt with the state laws governing dealerships. (Or the government could pay off the dealers itself, instead of having G.M. do it.) He could sign off on plant closings. He could force the companies to come up with real plans that would return them to profitability. And in return, the government would make federal loans that would give them the breathing room they need.

Come to think of it, this would be a perfect first job for Lawrence Summers, who is expected to become an economic adviser to the president-elect. If he can’t knock these heads together, nobody can.

When did I miss the retort from Larry Summers that we don't renegotiate contracts in this country, no matter how unprofitable a business, and no matter how much taxpayer money is on the line? It would be a nice thing to clear up, now that he's actually been given that job.

When he makes the same type of "A contract is a contract", "the government cannot just abrogate contracts" statement about the auto industry, we'll know he's not a liar. Otherwise....

Note to Obama: I know these guys haven't been on the job very long, and neither have you, but this combination of spinelessness and rudderlessnes on the financial crisis has to stop. If you believe that this type of continuous bailout of AIG, despite its complete lack of willingness to take responsibility for its past actions or financial condition, or additional TARP-type bailouts of banks are necessary, you had best be thinking of alternatives - this may have just destroyed the chances that you'll get the funding.

Update: Josh Marshall's observation,

I don't believe the bonuses themselves are the heart of the matter, nor the fact that they're going to the very executives who caused AIG's implosion or even the galling reality that, since all money is fungible, they're being paid with taxpayer dollars. What's really driving this forward - and what makes it such a dangerous moment for the White House - is the jarring image of the administration's impotence....

Few exchanges have so captured the disconnect that makes this situation so politically explosive. We're collectively taking our country's future in our hands, spending vast sums of money to keep these companies from suffering the consequences of their own folly and (in many cases) criminality. And in return we're receiving cavalier dictates about pay-outs and bonuses from executives who by any reasonable measure work for us - dictates we promptly accede to. There's a beggars can't be choosers problem there. And the disconnect is so mighty that it fuels the impression that the whole enterprise is not what it seems, not what we've been told, that in addition to picking up the tab we're being played for fools.

Update 2: Glenn Greenwald addresses Summers on the "sanctity" of contracts:

Legal strategies aside, just as a business matter, one of the first things which every compnay in severe distress does is go to its creditors, explain that it cannot make the required payments, and force re-negotiations of the terms. That’s as basic as it gets. To see how that works, just look at what GM and other automakers did with their union contracts – what they were forced by the Government to do as a condition for their bailout....

There may be other reasons why the Treasury Department decided it wanted AIG to pay these bonuses (Marcy Wheeler considers some of those reasons here), but this claim from Larry Summers that the sanctity of contracts precludes any alternatives is not just false, but insultingly so.

Update 3: Summers suggests that withholding the bonuses could have caused AIG to fail.

"Secretary Geithner has used all the legal authorities that are open to him to contain and limit the payment of bonuses," said Summers, chairman of the National Economic Council. "What he did not do, and what would have been irresponsible to do, as outrageous as these payments are, would have been to put at risk the stability of the financial system.

"To have courted the kind of disaster that followed the decision to let Lehman Brothers simply collapse might have felt good briefly, but it would have touched the lives of a huge number of Americans who would have unnecessarily become unemployed or seen destruction of their lifetime savings."

Are we really supposed to believe that? Other than the AIG lawyers who were paid to tell Liddy exactly what he wanted to hear, who actually believes that a refusal to pay the bonuses could constitute a default and cause AIG to fail?

Justifications

With all of the reasons tossed out for why a stimulus bill needs to be conservative, at least in comparison to the amounts many said would be necessary for an effective stimulus, what's the future of the bank bailout? I may not be thrilled about taking a huge money gamble to fix an economic mess largely created by the idiots who run our nation's banks, but I'm even less thrilled by spending hundreds of billions more to help save their jobs and prop up their bankrupt companies.

And in terms of that bailout....

Summers suggested the bank rescue plan may offer incentives for private investors to buy mortgage-related assets that have lost value because of the collapsed U.S. housing market.

"It can't all be private capital," Summers said on "Fox News Sunday."

It only takes enough private capital for securities not already guaranteed by the government to establish their market price; then the government can buy the rest at market value? Yeah, right.

"But with the right kinds of government guarantees, with the right kinds of financing ... with the right strategic approaches, Secretary Geithner believes that we can bring in substantial private capital," Summers said.

Why do I suspect that with Summers' version of "the right kinds of government guarantees", whether it's public money or private that "buys" the security, the taxpayer bears all the risk.