Kevin Drum

The Rumble in the Corner

| Thu Oct. 9, 2008 2:51 AM EDT

THE RUMBLE IN THE CORNER....As regular readers know, I'm a fan of NRO's The Corner, which I think of as sort of a direct pipeline into the conservative id. Lately, as an Obama victory has become more and more likely, the Cornerites have started going completely around the bend, venting their frustration in lunatic conspiracy theories and manic love notes that are increasingly untethered from the real world. This afternoon, after reading their latest bunch of posts about Obama being a secret Maoist, I thought maybe I should finally write something about it. In the end I was too lazy to do it, but luckily Hilzoy came through with a post that hits all the high points I was going to make anyway. Go check it out to get a sense of how the impending doom of an Obama victory is sending conservatives into cloudcuckooland.

But why are they going so stone batty? My theory is that Obama is driving them crazy the same way that Ali drove Foreman crazy in the Rumble in the Jungle. You remember that fight, don't you? Foreman was the heavy favorite, a brawler who had dropped Joe Frazier in two rounds and seemed likely to beat Ali to a pulp. But Ali won by playing mind games on Foreman. He sat on the ropes, took hit after hit, and then taunted Foreman in the clinches to hit him even harder. An enraged Foreman kept swinging wildly, but nothing worked. Ali took everything he could dish out, and the furnace-like heat finally did Foreman in. In the eighth round, drained and exhausted, he was knocked cold by an Ali combination that ended the fight.

The same thing is happening to McCain and his supporters. They're throwing everything they have at Obama, and he's just taking it. Nothing seems to have an effect, so they keep swinging ever more wildly. But that isn't working either, and it's driving them crazy. Who is this guy? Why won't he go down? It's enraging. They just can't believe they're losing to this punk. And so they become ever more unhinged, making up wilder and wilder stories and becoming more and more enraged when they can't get any traction with them. At this rate, their next stop is a padded cell at Arkham.

Personally, I wish Obama were doing more than playing rope-a-dope: it's going to win him an election, but it might not win him the war. Still, it is pretty likely to win him the election, and it's driving lots of conservatives crackers at the same time. We could do worse, I guess.

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Another Finger in the Dike

| Thu Oct. 9, 2008 12:59 AM EDT

ANOTHER FINGER IN THE DIKE....A couple of days ago we learned the startling news that AIG has already blown through $61 billion of its $85 billion bailout cash. What to do? Answer: give 'em more money:

The Federal Reserve Board said Wednesday that it would provide up to $37.8 billion to the embattled insurer the American International Group to help it deal with a rapidly dwindling supply of cash.

....A.I.G. said Wednesday that it would use the $37.8 billion from the Fed to improve the liquidity of its securities lending business, which is losing cash rapidly. By stopping that flow, A.I.G. said, it would be able to preserve more of the Fed loan and use that money more effectively to wind down the affairs of A.I.G.'s troubled structured finance division, known as the financial products unit.

"Financial products unit" = credit default swaps, just in case the terminology is a little opaque here. That one unit was basically responsible for bringing down the entire company.

More Capitalization

| Wed Oct. 8, 2008 6:36 PM EDT

MORE CAPITALIZATION....Speaking of capitalization, I see that Justin Fox answers a question today that's been on my mind for a while. The bailout plan passed last week was designed to buy up troubled assets, but are the powers it gives to the Secretary of the Treasury so broad that the funds can be used to directly recapitalize banks instead? Apparently so:

Did anybody else notice that when Hank Paulson was describing in his press conference today what the Emergency Economic Stabilization Act enables Treasury to do, the first thing he listed was "to inject capital into financial institutions"?

That wasn't how Treasury initially advertised its Troubled Asset Relief Program. It was sold as a way to get the market for mortgage securities moving (or, to use the jargon, liquid). Lots of academic economists objected that liquidity wasn't the problem, it was insolvency. What Treasury needed to do was recapitalize financial institutions and take equity stakes in return.

....Yesterday Ben Bernanke hinted that a change in emphasis might be in the offing for the TARP. And today Paulson seemed to confirm it....I take it as one more sign that we're headed toward a Swedish solution of our banking crisis — recapitalization and temporary nationalization of much of the banking system. This is the right thing to do, I think. But I'm still a little bit confused as to why Paulson had to back into this instead of asking for it in the first place. Maybe because he thought President Bush would never sign a bill to nationalize the banks? Just a thought.

Very interesting.

Capitalization

| Wed Oct. 8, 2008 6:23 PM EDT

CAPITALIZATION....A couple of days ago I complained about pundits and economists who (seemingly) couldn't make up their minds about whether the real problem preventing banks from making loans in the current market was (a) fear or (b) lack of capitalization. I got a few emails asking me what I was talking about, and it occurs to me that a lot of people are just assuming that all us non-economists understand why capitalization is important. But that's certainly not the case, so here's the kindergarten version of what it means.

Suppose that Acme Bank has $2 billion in capital and is leveraged at 20:1. This means they have $40 billion in assets, primarily consisting of loans of one kind or another.

Now, suppose that due to trading losses their capital is reduced to $1 billion. Unless they want to increase their leverage even further, that means they need to reduce their loan portfolio to $20 billion.

But it's worse than that. 20:1 is an insane amount of leverage. It ought to be closer to 10:1, and lots of banks are now in the process of deleveraging to get there. But with $1 billion in capital and leverage of 10:1, Acme can only have $10 billion in outstanding loans.

In other words, over the course of a few months, they need to reduce their loan portfolio from $40 billion to $10 billion (for example, by declining to roll over commercial paper when it comes due), and until they get there they can't loan out any more money. It doesn't matter if the borrower has a AAA rating. It doesn't matter if Acme's CEO is calm or frightened. Until they get their asset base down to $10 billion, they can't make any more loans.

(The grown-up version of this is way beyond my pay grade and includes a working knowledge of things like Basel risk-weighted asset requirements and our own local version of them. Obviously you're not going to get that from me. But hopefully the kindergarten story at least provides the basic picture.)

This is the theory behind recapitalizing banks rather than buying up their bad assets, as the Paulson plan does. If the government buys a bunch of preferred shares in Acme in return for $1 billion, then its capital is, once again $2 billion. They still need to deleverage, but that's going to happen regardless. The happy news is that even at 10:1, the extra capital expands their lending capacity by $10 billion.

Now, fear is obviously still a part of the picture. That capital injection doesn't do any good if Acme has so many toxic assets that it barely knows what its capital base is in the first place. Maybe it's so close to insolvency that it's going to go bust next week regardless. And even if that's not the case, they still won't want to lend money to other banks if they don't know how strong those banks are.

Still, one is primary and one is secondary. If capitalization is the fundamental problem, then calming down the markets won't do any good. There still won't be any money to loan out. If it's not, then confidence building measures are obviously of some value. Most likely, the story is somewhere in between. But it's kind of scary that nobody really seems to know for sure, isn't it?

UPDATE: Why do banks like high leverage? Because it allows them to make lots of loans, and therefore lots of money, with only a little bit of capital at stake. In good times, high leverage is a great way to make fantastic investment returns.

In bad times, though, it's not so great. The problem is that even small losses on a highly leveraged portfolio can wipe out your capital completely and make you insolvent. This is what's happening now, and it's why more stringent regulations on allowable leverage ratios are a good idea. Good times never last forever, after all.

Attack Ads vs. Attack Debates

| Wed Oct. 8, 2008 5:46 PM EDT

ATTACK ADS vs. ATTACK DEBATES....A lot of people seem to be surprised that John McCain didn't pull out all the stops last night and lay down a barrage of attacks against Barack Obama for palling around with terrorists, taking loans from crooks, abandoning our troops, and so forth. But I think this misses something important: debates are a terrible place to do this.

TV ads are a different story. In fact, they've been practically conventionalized over the years with their grainy photos, creepy music, and scary sounding announcers. Sure, at the end you have to say "I'm John McCain and I approve this message," but that's not much. The ad still seems almost completely impersonal. It's an attack, but it's not really an attack from anyone.

But a debate is a whole different story. The stage is a small, intimate setting, and if you want to attack somebody, it has to come straight out of your mouth and it has to be directed against someone standing just a few feet away. People react way differently to that than they do to an ad, and for the most part they react badly. It's like watching married friends arguing with each other: it makes you uncomfortable and edgy. You just want it to stop.

That's probably why McCain didn't light into Obama last night. Despite what I said yesterday, it's not that he didn't want to, but that he's smart enough to know that unless you pull it off perfectly, all you accomplish is to make yourself unsympathetic. And whatever else you can say about him, John McCain is very much not a guy who can pull this off perfectly.

Lies, Damn Lies, etc.

| Wed Oct. 8, 2008 4:07 PM EDT

LIES, DAMN LIES, ETC....Does intellectual property infringement really cost the United States 750,000 jobs and $250 billion? Where do these frequently cited estimates come from, anyway?

Julian Sanchez and Ars Technica investigated, and the answer turns out to be: (1) an offhand and completely unsupported estimate from Commerce Secretary Malcom Baldridge in 1986, and (2) an offhand and completely unsupported estimate from Forbes in 1993. For the full story on how these two figures have managed to achieve iconic status anyway, click the link.

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The McCain Bailout Plan

| Wed Oct. 8, 2008 3:34 PM EDT

THE McCAIN BAILOUT PLAN....If Brad DeLong is right, John McCain's new plan for bailing out homeowners is actually a bailout of the banks who originated the housing bubble's most reckless loans: option ARMs, teaser packages, NINJAs, no-docs, and all the rest. Basically, McCain plans to buy up bad mortgages at full face value and then restructure them into cheaper FHA mortgages. Homeowners are indeed helped, but the banks who made the loans are paid off for the full amount of the loan.

Roughly speaking, Brad figures that out of the $300 billion McCain wants to dedicate to his program, a full third would go to mortgage lenders. "It means that John McCain wants to give $100 billion of taxpayers' money to America's worst-behaving mortgage financiers." This is worse than the Paulson bailout approach and far worse than recapitalizing troubled banks, as many liberals think we ought to do. Brad again:

There's a big difference here: Democrats want to prevent depression and support the financial markets by investing taxpayer money in banks with troubled assets. Republicans want to give taxpayers money away to the shareholders and managers of banks with troubled assets.

I would say that this is unbelievable, but I do believe it.

Somebody needs to ask McCain some very hard questions about the details of this plan.

Bailing out Homeowners

| Wed Oct. 8, 2008 1:50 PM EDT

BAILING OUT HOMEOWNERS....Last night, when John McCain mentioned his plan to directly rescue homeowners facing foreclosure, I wasn't paying attention. To be honest, I'm so hardwired to assume that presidential debates are just rehashes of old talking points that I thought McCain was merely tossing off another platitude — we need to protect the taxpayer, we must help distressed homeowners, we will focus on job creation, blah blah blah. I didn't realize he was serious about the homeowner part, complete with an actual new policy proposal and everything.

And apparently I wasn't the only one. Marc Ambinder reports that "The proposal certainly seemed to have caught even McCain's surrogates off guard; they had not been prepped to answer questions about it. The media didn't quite know what to think, and there hasn't been too much attention paid to this yet, even though it's a bold and expensive idea." So I don't feel quite so bad about missing this.

Of course, the devil is in the details in a plan like this. Who do you rescue? Everyone who's underwater? Everyone with a subprime loan? Everyone in foreclosure? Only people who are victims of fraud? How do you figure out who that is? And what does "rescue" mean? Restructuring their loan? Putting a halt to all repos? How do you prevent people from gaming the system? Will it prevent house prices from settling back to their natural level? Etc. etc.

Technically, most of those details can probably be worked out. But what interests me is that there's another potential hurdle: the public might not actually buy it. The only comment I did make in real time about McCain's proposal was an observation that CNN's focus group "against expectations, really didn't like McCain's idea of bailing out homeowners directly." And the reason for that appears to be straightforward: cautious, responsible homeowners who took out cautious, responsible loans and bought cautious, responsible houses, are not necessarily thrilled at the idea of their idiot profligate neighbors getting a federal bailout for the idiot profligate loans they took out on their idiot profligate house/remodel/HELOCs. After all, the bulk of the people who need help are not old friends who bought their houses 20 years ago, it's brand new neighbors who swept into the neighborhood in 2006 on a rising tide of debt and shiny new cars. Sympathy for these folks may not be nearly as high as many of us suppose.

Now, this may seem perverse in some ways. Obviously not everyone in foreclosure acted recklessly. And in any case, is bailing out a neighbor who acted recklessly really any worse than bailing out a bunch of Wall Street fat cats who acted recklessly? Maybe not, but the public is none too thrilled about bailing out the fat cats either. And let's face it: your next door neighbor is.....next door. If he seems like an undeserving sort, bailing him out might cause your blood pressure to go up way more than bailing out a bunch of distant banks. For better or worse, that's just human nature. Especially if your next door neighbor has a dog that drives you nuts by barking all night. Just take a look at the now-famous Irvine Housing Blog for a daily helping of exactly this schadenfreude-filled attitude.

So, technical issues aside, it's quite possible that this is not the political winner McCain thinks it is. I note that Obama hasn't really picked up on it, even though his speech today in Indianapolis was a perfect opportunity to do so. I wonder if he understands something the rest of us don't?

UPDATE: Brad DeLong points out that on a technical basis, the McCain plan sucks very, very badly because it directly bails out the banks that made all the bad loans. Details here.

Real Conservatism

| Wed Oct. 8, 2008 12:58 PM EDT

REAL CONSERVATISM....NRO's Andy McCarthy is seriously pissed that John McCain didn't turn last night's debate into a slugfest over Obama's terrorist/socialist/UN loving ways. Ross Douthat comments:

You know, part of me actually wishes that John McCain had started talking about Bill Ayers, the Annenberg Challenge, Rashid Khalidi, and how the Global Poverty Act will line the pockets of Hugo Chavez. (Maybe in his answer to one of the questions about the economy — why not?) Because that way we wouldn't have to hear — as we will hear, from McCarthy and others, for months and years to come — that the biggest problem with the McCain campaign was that it just wasn't willing to really takes the gloves off and call Barack Obama the terrorist sympathizer that he is.

Actually, it's worse than that. If McCain loses, as he's almost certain to, we're going to see two reactions. First, Steve Schmidt wasn't nasty enough. In the future, Republicans need to return to their Lee Atwater roots and really teach Americans what liberal treachery is all about. Second, we told you a RINO couldn't win. The conservative base will be convinced for years that the big problem with McCain was that he was trying to be a pale shadow of liberal Democrats. (Sarah Palin will be conveniently forgotten, or else finally seen for the tokenism she really is.) The nation still hungers for genuine conservatism, they'll say, and they knew McCain was a phony all along. If only the party had nominated a Romney or a Huckabee the public would have swarmed to their cause.

This is delusional, but it's probably good news for Democrats. It means the GOP is going to be riven by factional warfare for years, with moderates unable to get a purchase on the party apparatus because of the McCain albatross hanging around their necks. Eventually, like Britain's Labor Party in the 80s, they'll find their Tony Blair, but in the meantime they're likely to double down on the most strident possible social conservatism, convinced that the heartland will respond if only they regain the true faith. Ronald Reagan, who was more pragmatic about these things than any of them ever give him credit for, will be rolling in his grave. And Democrats, at least for a while, will go from strength to strength.

Feedback Pedantry

| Wed Oct. 8, 2008 12:34 PM EDT

FEEDBACK PEDANTRY....Vikas Bajaj of the New York Times explains the financial crisis:

The technical term for it is "negative feedback loop." The rest of us just call it a panic.

I know that a lot of people use this term during a crash because "negative" is the same thing as "down," but I don't think this is right. It's a positive feedback loop he's talking about, where every action in a particular direction feeds back to cause even greater action in the same direction. In a bubble, it means that the market going up causes buyers to get ever more excited, causing the market to go up even more. In a panic, it means that the market going down causes sellers to get ever more hysterical, causing the market to go down even more. It's bad news in both directions, and it's a positive feedback loop whether that direction is up or down.

Unless, of course, this is some kind of weird term of art in the finance biz. Which would probably serve me right. Anyone know?