John McCain’s Unworkable Plan to Deregulate and Insure Our Way Out of the Crisis
posted by Dave Hoffman
Tonight, John McCain, by tacitly lending his support to the House Republican revolt against the Grand Compromise Bailout Plan, succeeded (?) in causing the negotiations to fail, at least for the time being. Expect a very black Friday on the market.
In the meantime, I’m trying to figure exactly what the McCain-backed counter-proposal means. The center piece is private-party funded insurance, with the premium price set by the government. Here’s the key line in the proposal: “The Treasury Department can design a system to charge premiums to the holders of MBS to fully finance this insurance.” It can? How? Let’s explore three possibilities.
First, assume the government would just set the insurance premiums at some very high number. Let’s even call it extortionate, since that’s what the markets today would force you to pay to take on that kind of risk. Why would private companies agree to pay this rate? If the answer is that the companies will be forced to buy insurance, I don’t see how that wouldn’t immediately lead to those companies simply declaring bankruptcy. That, my friends, isn’t the kind of liquidity solution we’re looking for. Rather, it’s what we’ve got today.
Second, assume that the government tries to price insurance at a low rate. Everyone pays the premiums, happily, because as I understand the proposal the government will be on the hook for failure, and we’ve now just done the bailout without any meaningful governance reforms.
Third, assume the government tries to price the insurance accurately, i.e., to reflect the likelihood that it will have to pay-out claims. Super. But figuring out the default risk is exactly the problem that the market has tried, and failed, to solve over the last year. Tens of thousands of the brightest, most motivated, brains on Wall Street have thrown themselves at this sucker. And the House Republican Study Committee thinks that the Federal Government’s Treasury Department will be able to figure this out over the next few days.
Maybe I’m missing something, but the insurance plan seems, on its face, to be a joke, and not intended as a real solution to the liquidity crisis. There must be something else here.
Indeed, the McCain-backed-Republicans offered several governance reforms [with my comments in italics:]
(1) remove “regulatory and tax barriers that are currently blocking private capital formation”
I guess this means that the Republicans have decided that this problem is one of too much regulation, not too little. Repealing the CGT for two years is, of course, an old proposal of the republican study committee. In theory, it would result in up to $127B more in private hands annually (instead of government hands). But how can it possibly be that the RSC thinks that repealing the CGT have the same kind of liquidity effects as actually pumping money into the market. The repeal would be prospective, so only a small percentage of the $127B is at stake; and it isn’t at all clear that investors would take the money and plow it back into stocks. I wouldn’t. If I had extra cash, right now, I’d buy gold, like everyone else I know. Moreover, it would be less than the cost of the AIG bailout, which did nothing to halt market turmoil As for the idea that deregulating the financial institutions will unfreeze their lending behavior, I think I’d stand on Paulson’s (reported) response: incredulity.
2. Increase transparency by requiring firms to disclose the MBS assets on their books, recent bids, and audits; prevent the government from buying high risk loans; require the SEC to audit corporate books and review the credit rating agencies, and “create a blue ribbon panel with representatives of Treasury, SEC, and the Fed to make recommendations to Congress for reforms of the financial sector by January 1, 2009.”
Some of these solutions, like peering under the hood of the credit agencies, are good policy and ought to be enacted. Transparency too is a good thing. And blue-ribbon panels give reporters more substantive news to ignore, so I’m in favor of them too. But it’s obviously true that none of the suggestions, in any way, would alleviate today’s crisis. Transparency isn’t the issue, rather it’s that most of the MBS have no clear value (and perhaps no positive value) because (1) the housing market is in a meltdown; (2) the instruments are complex and leveraged; and (3) they are widely distributed. Transparency is a solution when the data are clear. When the water is muddy, glass bottom boats increase vulnerability without adding enjoyment to the trip.
I imagine that I’m missing something. But it seems like the House Republicans have put together a proposal that would almost certainly not fix the market crisis, and, would instead, deregulate the very firms that got us into this mess.
I know that I just recently ranted against political blogging. But John McCain’s willingness to disrupt a very fragile political compromise on a bailout, and support for this hashed-up plan, really makes me concerned both for his judgment, and the future of the country. In my view, given that he has no expertise in this area, and his presence makes politicians think about the November, instead of this week, the right thing for him to do is to announce tomorrow morning that in the interests of the country, he will support any bill that garners the support of the majority of representatives in the House. He should then leave town on the first available plane.
[Update: Just to be fair, the online-left is equally foolish about this. Chris Bowers has a post up that assumes that we have forty days to debate this issue, as if it were a normal political problem, the crisis being manufactured by a self-dealing industry and a captive Congress. Lunacy.]
September 26, 2008 at 12:05 am
Posted in: Corporate Law
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Responses (8)
JP - September 26, 2008 at 10:56 am
This is way out of my depth, and I’m someone who generally supports a repeal of the capital gains tax. That said, wouldn’t repealing it now have terrible consequences? In addition to everyone selling stocks at a loss, wouldn’t eliminating the lock-in effect cause anyone with unrealized gains to sell as well?
JP - September 26, 2008 at 11:18 am
Also, I think referring to this as McCain’s plan is pretty close to partisan dishonesty. You call it “McCain backed” by linking to a story that cites an unidentified source claiming that “McCain vaguely brought up the [House GOP] proposal.” To say the least, your post title is a stretch.
It appears that McCain is playing all sides, waiting for a popular coalition to emerge. (In my opinion this is worse than backing an imperfect proposal, and clearly makes his trip to Washington as a political stunt rather than a demonstration of leadership.)
I greatly appreciate this blog, and particularly analysis like this. It just becomes harder to read and less persuasive when seemingly used to score tenuous political points.
dave hoffman - September 26, 2008 at 11:45 am
JP,
I appreciate your point, but I respectfully disagree that I’m engaged in partisan spin. McCain’s in the room. He’s given the opportunity to endorse the plan -the bailout plan that is the only solution on the table- and instead he mentions that there is a republican alternative. There are confirming press reports that he’d made vaguely positive gestures toward the RSC earlier in the day, and after the conference, he mentioned that not everyone was on board, because of the public-nature of the solution.
I agree that he’s not coming out and saying that the RSC plan is a good one, but his tacit support gives significant comfort to the RSC, suggesting that they, like he, should put politics first. I appreciate that in ordinary times, offering a nonconstructive plan to show that you don’t believe in big government would be useful – it’s important for the opposition to actually oppose. But clearly this deal isn’t going to happen unless the politicians all heard together (and here I include Obama and the rest of the Dems, who seem not to believe that they can convince the country to take its medicine).
Under these circumstances, saying that there are two plans on the table, is the same as saying that the second plan is a good one that McCain endorses. It is dangerously risky, ideological, and stupid.
JP - September 26, 2008 at 12:21 pm
So McCain is not even going so far as to say “that the RSC plan is a good one,” and yet this makes it “John McCain’s Unworkable Plan?”
Your claim that McCain’s reference to an alternative plan is bad is only true if 1) the Compromise Plan is the best politically feasible alternative in the short term, 2) the Compromise Plan had to be passed quickly (i.e., speed is more important than broad bipartisan support), 3) McCain actually believes both 1 and 2, and 4) McCain’s endorsement of the Compromise Plan would have caused it to have majority support.
I don’t know whether any of these are true, but I’m skeptical of # 4, at least.
dave hoffman - September 26, 2008 at 12:28 pm
JP.
I am convinced of #1 and #2. #3 is unclear, but I don’t know why it matters. I think his stance is more agnostic. He doesn’t care, or care to know, much about the financial crisis except as it effects his political chances. (I think Obama’s in the same boat. It’s human nature.) #4 is right, in my view, except that I don’t think McCain needs to endorse for majority support. Majority support is there, but they won’t pass the bill unless they have overwhelming votes, including enough republicans so that the dems can’t have it hung on them in five weeks. That is, McCain’s active endorsement is necessary for the bill to pass. That, I think, he knows.
JP - September 26, 2008 at 12:36 pm
Also, why don’t any of your criticisms apply to Obama? Granted, he didn’t “pretend suspend” his campaign, but surely he would have if it would have helped his campaign (e.g., he was behind in the polls, Republicans controlled Congress, etc.) (and for those who protest that Obama is “different,” remind me which candidate reneged on his pledge to accept public funding?).
Obama was also in the room, and I haven’t seen any report that he endorsed the Compromise Plan. Why come to DC instead of just saying he supports a particular proposal, or any proposal that commands a majority, or that he supports his Party’s congressional leadership?
JP - September 26, 2008 at 12:52 pm
Thanks Prof. Hoffman,
McCain’s active endorsement of the Compromise might be necessary, but I’m not sure it’s sufficient. I’m not sure, but I think it’s plausible that the House Republicans would still oppose the Compromise (causing Pelosi, et al, to withdraw support). House Republicans may want McCain in the White House, but more importantly they want to keep themselves in Congress, and the bailouts seem to have stirred up some pretty clear voter hostility.
Without trying to tell you what you should blog about, I would love to hear your reasons for believing 1 & 2. I think the point of my original comment was simply to express my (unsolicited) opinion as one long-time reader that the policy debates on this blog are generally more edifying than the partisan ones.
Jonathan Lipson - September 26, 2008 at 1:57 pm
Great post, Dave.
A few things to fuel the fire.
First, about $160Bn in short term commercial paper–you know, the stuff that GMAC used to use to finance its business when it had one–is scheduled to turn over next Tuesday. If the banks won’t lend to themselves overnight, I have no idea what they would charge the nation’s best credit risks for short term loans, if they would lend at all. Tuesday, it seems to me, may be D-Day.
Second, in addition to the points you raise, the Republican proposal appears to be especially hypocritical on executive compensation. While I have real doubts about the value of cutting future compensation–I am happy to give executives an economic incentive to do a good job–the Republican plan, so far as I can tell, says nothing at all about it. So, whereas the modified Paulson proposal would constrain it, this does nothing to address the “greed” about which McCain fulminates. Maybe it’s in there somewhere, and it wasn’t in the news. But if the Republicans really want to at least appear to address the greed that angers mainstreet, this would seem not to do it.
Third, neither proposal deals with two things that I think are very important. (i) Dealing with the underlying mortgages (whether through adjustment in bankruptcy, government purchase, chaperoned renegotiation, etc); and (ii) where all the money went.
My overarching concern in this is that the reason a real bailout is needed–and no market mechanism could work–is because lots of the paper (the CDO flavor in particular) is “vapor paper”–it’s really backed by nothing at all. Yet, I am reasonably confident that the investment bankers who floated it took large fees, as did the hedge fund managers who bought it. Getting that money back–through a fraudulent transfer-type mechanism–could go a long way toward the real sort of justice people want when they scream about Wall Street.
Finally, I too am wary of politics on this. But McCain’s behavior has really been outrageous. According to McCain: Eleven days ago there was no problem at all. Nine days ago we needed only a 9-11 style commission. Eight days ago it was suddenly a crisis–and it was Obama’s fault.
I have no idea what value McCain added to the process by declaring dramatically that this crisis required him to suspend his campaign, cancel the debate and lead the charge to salvation (only to, uhm, decide that he actually could fly his private jet 90 minutes to Mississippi).
His presence certainly coincided with the implosion of what a good number of people thought was a deal–troubling though it was, clearly better than proposed alternative.
Character and judgment are supposed to be his selling points. His behavior on this does not give me great comfort on either score.
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