Kevin Drum

Mark To Movement

| Wed Oct. 1, 2008 6:13 PM EDT

MARK TO MOVEMENT....Yesterday the SEC modified mark-to-market accounting rules. I have a question about this, but it's not the one you might think it is. First, though, here's the background.

M2M itself is a simple concept: it means that banks have to value the securities they hold at their actual market price. If those prices plunge, as they have recently, it means the bank's asset base also plunges. This is obviously bad for banks, so it's understandable that bankers don't like M2M.

The alternative is to allow banks to value securities at their face value until they're sold, or to use sophisticated models to project their value upon maturity. The problem is that this allows banks (and corporations like Enron) huge leeway to cook their books and paper over real losses. Eventually, when the check comes due, everything collapses.

Now, there are legitimate arguments about M2M on both sides. In a panic, for example, the market for some securities can become very thin. How can you mark to a market that barely exists? This is especially a problem with complex modern instruments like CDOs, which are all custom built and might end up with a market price of zero if no one wants your particular CDO at this particular instant of time. (Yesterday's SEC action was in response to just this situation.)

In the end, I come down on the side of M2M. Yes, it can cause balance sheet volatility in a turbulent market, but overall it's the most accurate and least exploitable way of truly valuing assets. Allowing model-based games just puts us where Japan was in the 90s, where accounting gimmicks allowed firms to continue to exist like zombies for years even though everyone knew they were really bankrupt. It's better to write down losses honestly and then deal with the fallout than it is to keep desperately hoping that maybe values will return when things turn up.

That said, here's my question: why have movement conservatives suddenly made a fetish out of suspending M2M? I know this isn't unusual: movement wingnuts frequently find obscure topics that they're convinced hold the key to economic salvation. But of all things, why M2M? Even if you think mandating M2M was a mistake in the first place, you can't possibly think that suspending it now, after prices have collapsed, would help anything — can you? Sure, it would technically take some pressure off banks to recapitalize, but it would be such an obvious accounting game that it would simply make investors even more paranoid. Any bank that took advantage of a suspension of M2M to pretty up its balance sheet would surely end up instantly on every investor's permanent shitlist, wouldn't it?

One of my readers suggested that maybe there was a tax angle to M2M that explained this. In other words, the movement folks didn't really care about suspending M2M itself, it was just a stealth method to cut taxes. That doesn't sound right to me (M2M has tax consequences for individuals, but not banks, as far as I know), but maybe I'm missing something. Anyone know?

UPDATE: Just for the record, I should add something. In an email to a friend a few minutes ago I said this: "Despite what I just wrote, I'm hardly dead set against modifying M2M on a temporary basis. If it helps in an emergency, maybe we swallow hard and do it. Just like we're swallowing the bailout. But the idea that this is somehow a positive good, not a temporary and desperate band aid, seems crazy."

I'd need to be talked into suspending M2M, of course, and there are other temporary emergency measures that I could be talked into too. But in any case, let's not fool ourselves into thinking they're anything other than what they are.

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Debate Fundraising

| Wed Oct. 1, 2008 1:59 PM EDT

DEBATE FUNDRAISING....Tomorrow is another debate, and you know what that means. Fundraising! We can make do with a lot less than $700 billion, but good journalism still costs a lot of money and we could use your help.

So if you can spare a few dollars, hop on over to our fundraising page, leave a donation, and then download our debate drinking game. Believe me, if you thought you needed it for McCain-Obama, you're really going to need it for Palin-Biden. I predict many alcoholic stupors in houses around the country tomorrow night.

Quote of the Day - 10.01.08

| Wed Oct. 1, 2008 1:27 PM EDT

QUOTE OF THE DAY....From Brad DeLong, making the same point about Henry Paulson that I did yesterday, but much more colorfully:

My belief is that if Paulson were to stay on he would treat undercapitalized banks like a Goldman-Sachs honcho treats counterparties in trouble: strip them of everything and send them naked into the blizzard to live or die on their own — that's what he and Bernanke have done to the preferred and common shareholders of Freddie, Fannie, AIG, WaMu, Wachovia, Bear-Stearns, Lehman, and to the bondholders and counterparties of Lehman...

It's worth noting that when Paulson submitted the initial 3-page bailout bill that gave him czarlike authority to do anything he wanted with his $700 billion, it was a huge tactical mistake. He was treating Congress the way he'd treat a Wall Street adversary, and that was a very bad move. But it doesn't mean that he wanted unfettered authority to make sweetheart deals. It's actually more likely that he wanted unfettered authority to rape and pillage. Nor does it mean he wouldn't have demanded equity stakes in the companies he bailed out. He demanded 80% of AIG, after all, and no one forced him to do that.

But it was still a very, very bad misjudgment. Hopefully he's learned from his mistake.

Debate Impressions

| Wed Oct. 1, 2008 1:13 PM EDT

DEBATE IMPRESSIONS....From the latest Pew poll, John McCain doesn't seem to have done well in the first debate. The good news for both candidates is that the top impression they left was a positive one: 50 respondees thought Obama was "confident" and 61 thought McCain was "experienced." The bad news for McCain is that noticeable minorities also thought he was old, condescending, aggressive, and angry. Obama, by contrast, left audiences with only two negative impressions.

Easy come, easy go. That's the price you pay for acting like a jerk, I guess. In other Pew news, Obama's stock has gone up almost across the board. Not only does he lead McCain in their general election polling by seven points, but he's improved his standing in the areas of crisis judgment, personal qualifications, and handling the economy. McCain has dropped in all three areas.

UPDATE: The "Impressions" part of the Pew survey measured raw numbers, not percentages. I've corrected the text to reflect this.

Selling the Bailout

| Wed Oct. 1, 2008 12:26 PM EDT

SELLING THE BAILOUT....One of the ongoing mysteries of the bailout plan is why the Bush administration did such a lousy job of selling it. As Ezra Klein points out, if this were the first term crew, the plan would have been rolled out with some kind of snazzy, disingenuous name (how about the Financial Reconstruction and Emergency Employment Act, or FREE?) and accompanied by a blizzard of fact sheets that completely misrepresented what the Act would cost and what it would do. Opponents would have been demagogued, talk radio would have been harnessed, and Bush would have been giving speeches and press conferences daily. So what happened?

Well, who knows? But I'll take a few guesses:

  • This is no longer the White House of Karl Rove, Andy Card, and Dan Bartlett, and it shows.

  • Bush's heart was never in this. He didn't want to sponsor a bailout and only signed on under extreme duress when Paulson and Bernanke convinced him we were facing a genuine emergency. (This is ironic, of course, since some of the opposition to the bill has compared the administration's "fearmongering" of the financial crisis to the runup of the Iraq war. This is 180 degrees backward. Bush has spent the last year desperately trying to ignore the financial crisis, not selling the country on a solution. If anything, distrust of Bush ought to convince you that maybe this bill is necessary after all.)

  • The main impetus behind the bailout bill was Henry Paulson and Ben Bernanke, who may be conservative but who aren't hacks. A typical Bushian razzle-dazzle sales campaign just isn't their style.

  • The events of the week of September 19th were so catastrophic that Paulson honestly didn't think there would be any serious opposition to the bill. He figured it was like the Pearl Harbor Resolution: just draft up something short and simple, hand it over to Congress, and it would be approved 434-1 the next day. He and Bernanke simply had no idea that it would get the reception it did.

  • On a political note, Democrats are now in charge of Congress, which means the bailout bill had to pass through the Democratic leadership. The Bushies just aren't used to that and didn't really know what to do. So they flailed.

  • Bush and his staff still have no clue about just how low their political capital has fallen. They simply didn't realize that even their own party would laugh in their faces even when faced with a genuine emergency. (On the other hand, I'll bet they know now. This has been a very rude wakeup call for them.)

One way or another, this has been a monumental cockup. For more, check out David Colker and Tom Hamburger's piece in the LA Times today. Nickel summary: they just totally screwed the pooch on this.

Debate Preview

| Wed Oct. 1, 2008 11:54 AM EDT

DEBATE PREVIEW....The LA Times heads to Alaska to find out how Sarah Palin is likely to do in tomorrow's debate:

As she began her run for governor of Alaska, Palin repeatedly proved difficult to prep for a debate, recalled her two former political aides, who had pivotal roles during her campaign but declined to be identified because of their continuing involvement in Alaska politics.

Palin, the former aides said, had a sharply limited attention span for absorbing the facts and policy angles required for all-topics debate preparation. Staffers were rarely able to get her to sit for more than half an hour of background work at a time before her concentration waned, hindered by cellphone calls and family affairs. "We were always fighting for her attention," said one of the aides.

But — you knew there was a but coming, didn't you? — apparently she's a fast learner:

By the final key televised debate in late October, Palin had grown used to the format, her aides and rivals recalled. Still using index cards, she was breezily confident in her back-and-forth with Halcro and former Alaska Gov. Tony Knowles.

....Larry Persily, a panelist questioner in the campaign's final televised debate, said Palin flummoxed her rivals "like Muhammad Ali dancing around the ring." She avoided statements and tough questions that could have impaled her and repeatedly stung her opponents. And Palin, a former sportscaster, was easily the most comfortable in front of the camera. "She knows television," said Persily, who participated in other debates and has watched Palin closely for years. "She knows how to look at her interviewer."

The good news for Joe Biden, then is (a) she doesn't prep very well, and (b) she doesn't get a series of debates this time, just the one. So if she stumbles out of the gate there's no time for her to improve. The bad news is that she might just wow everyone with her index cards anyway.

Bottom line: Tomorrow we'll either see Dr. Jekyll or Mrs. Hyde. Should be an edge-of-your-seat performance either way.

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The Next Step on the Bailout

| Wed Oct. 1, 2008 12:40 AM EDT

THE NEXT STEP ON THE BAILOUT....It looks like the Senate will be taking up the bailout bill on Wednesday. How can they do this when revenue bills are required to originate from the House? Easy!

Apparently Harry Reid found some ancient mental health bill that the Senate had never acted on, dusted it off, and grafted the bailout legislation on top of it. Then he tossed in an increase in FDIC insurance limits to $250,000 (a bipartisan winner), loaded up a bunch of tax cuts that had already been approved by the Senate but hadn't yet passed in the House, and voilà. Instant bailout bill.

So will it pass? Maybe so. After Wall Street's reaction to the failure of Monday's bill, public sentiment seems to be shifting:

On the morning after the sell-off, Congressional offices reported a shift in angry calls from constituents, with some demanding that lawmakers take some corrective action — a distinct change from the outpouring of public opposition that contributed to the defeat of the plan.

"I started hearing from a lot of people who lost money on their investments thanks to the big drop on Wall Street yesterday," said Representative Steven C. LaTourette, Republican of Ohio, who voted against the plan.

This is not entirely unexpected. The original opposition, after all, probably didn't reflect widespread sentiment so much as it did a narrow slice of highly motivated talk radio and Lou Dobbs fans. Nor is it unjustified. It's true that the stock market isn't a good proxy for the economy as a whole, but a plunging market does have an effect on the real economy. First, since corporations finance their operations partly through share offerings, dropping stock prices make it harder for companies to raise money. Second, although lots of rich people own stock, two-thirds of all stock is held in mutual funds and pension funds, which means a stock market plunge hurts a lot of very ordinary people too. Third, even though the market may not be a great proxy for the entire economy, it's a pretty good proxy for the panic level among bankers.

And the current panic is hardly unwarranted. Our real problem is in the credit markets, and the credit markets are blinking fire engine red right now. Overnight bank lending rates have skyrocketed. Municipal bond markets have cratered. The two biggest providers of short-term credit to restaurant franchises, GE Capital and Bank of America, have exited the market. Rates on overnight commercial paper are up two points. This stuff doesn't hit you or me in the pocketbook immediately, but it does eventually as spending drops, companies can't get financing, and jobs get cut. You wouldn't ignore a speeding truck just because it was still a few hundred yards away, and you shouldn't ignore this either.

So sure: we should all hope that after the election we can pass legislation that attacks the roots of the financial crisis. This includes financial market regulatory reforms, macroeconomic stimulus, and broad relief measures. Maybe it even includes a better bailout program if this one isn't enough. But right now, we have what we have, and complaining about it is like refusing to turn a fire hose on a burning building because you're afraid the water is flouridated. It's time to pass the bill.

Cleaning Up the Rot

| Tue Sep. 30, 2008 7:03 PM EDT

CLEANING UP THE ROT....Atrios on the credit crisis:

CNBC just said what most aren't: the reason why interbank lending rates are so high is because banks don't trust each other. The reason they don't trust each other is they don't know how much and which pieces of big shitpile they own.

Yep. That's why having the Treasury Department buy up all those toxic assets is probably a good idea. Recapitalization isn't enough if it leaves banks still owning securities with values so variable that it's too risky to lend to them anyway. We need to get that stuff off their balance sheets in order to make their financial position more transparent and we need to increase their capital base (which the Paulson plan accomplishes by paying above-market prices for the toxic sludge in return for a guarantee of equity down the road if the sludge eventually has to be sold at a loss). That combination has a better chance of working than either one alone.

And why is the toxic sludge so hard to value? Can't we just make banks open their books and provide detailed information on all this stuff? Sure. But you've still got two problems. First, in the later days of the mortgage free-for-all, mortgages were packaged up with no documentation at all. So no one, not even the banks, knows for sure just how good or bad their mortgage portfolios are. Second, even if we knew that, their value would still depend on how much farther down home prices have to go. And that's anyone's guess.

So: get this crap out of the banking system, where it's causing systemic rot. Recapitalize the financial industry. Get equity guarantees in return to protect against future losses. And then hold your breath and hope it's enough.

More Notes on the Bailout

| Tue Sep. 30, 2008 5:39 PM EDT

MORE NOTES ON THE BAILOUT....Nathan Newman has a pretty good post over at TPMCafe defending the bailout legislation. Take a look. Among other things, he notes that we're bailing out Wall Street on an ad hoc basis already and creating an exclusive troika of megabanks in the process. Whatever its weaknesses, the bailout legislation is probably a better deal than allowing this to continue.

And while we're on the subject, here's a question: assuming the bailout eventually passes, how good a deal are taxpayers likely to get when Henry Paulson starts doling out his $700 billion? The conventional wisdom across a remarkably wide ideological spectrum is that Paulson is a creature of Wall Street and will end up offering sweetheart deals to all his old pals when he begins buying up their troubled assets. But this deserves a closer look.

See, Paulson is a creature of Wall Street. And the way you become successful on the Street is not just by being the smartest guy in the room, but by being the toughest guy in the room; the guy who drives harder bargains than anyone else and always comes out on top. The top execs on Wall Street might be arrogant, they might be crazy, and they might be greedy, but they play a testosterone-fueled game to win. This is practically their religion.

Paulson now works for the United States Treasury, but his instincts are the same as always: even if for no other reason than to boost his own ego, he's going to want to drive the hardest bargains possible — and the weaker the opponent, the harder he'll push.

Don't believe it? Take a look at the Fed/Treasury actions so far. Was the Bear Stearns rescue a sweetheart deal? No. In fact, the original $2 per share terms were so onerous that JP Morgan, which bought Bear, eventually raised the offer voluntarily. And what about Lehman Brothers? Would a Wall Street crony have let Lehman fail? Nope. The next day AIG was rescued, but read this and tell me if you think AIG got any kind of break in return for its $85 billion loan. They didn't. AIG got hammered.

Now, these have been a combination of Fed and Treasury actions, and their track record on other bailouts has been mixed. And I'd be happier if the bailout bill had even more oversight and tighter restrictions on equity sharing than it does. But that aside, the evidence suggests that the Treasury and the Fed are hardly a bunch of pushovers. They deserve to be watched like hawks, but when everything is said and done, I wouldn't be surprised to see them demanding some pretty harsh terms.

Quote of the Day - 9.30.08

| Tue Sep. 30, 2008 4:06 PM EDT

QUOTE OF THE DAY....From Barack Obama, speaking in Nevada today about the financial crisis:

For the rest of today and as long as it takes, I will continue to reach out to leaders in both parties and do whatever I can to help pass a rescue plan. To the Democrats and Republicans who opposed this plan yesterday, I say — step up to the plate and do what's right for this country. And to all Americans, I say this — if I am President of the United States, this rescue plan will not be the end of what we do to strengthen this economy — it will only be the beginning.

Good. That's what he should be saying. Is it politically risky to take a more active role in congressional negotiations — and with it, possibly more responsibility for an unpopular bailout? Maybe slightly. But if you want to be president of the United States, that's what you need to do. And you need to do it for real, not just for the cameras.

The rest of the speech isn't bad either. It could stand to have a little bit punchier explanation of what's going on, but overall, not bad at all.