RUNNING A RIFF THAT SEVERAL MEMBERS of Congress had reduced to one paragraph, while Treasury Secretary Henry Paulson groped for the right mix of money and policy to keep a recession from spiraling into a depression, Rep. Carolyn Maloney (D-NY) described the state of the nation:
“We are facing what has been called the most serious financial crisis since the 1930s, and the potential cost to tax payers is staggering: $29 billion to JP Morgan to buy Bear Stearns; $85 billion to AIG, $200 billion to Fannie and Freddie; $700 billion rescue package, $300 billion to the Fed window, opening it up to investment banks, $50 billion to stabilize the money market fund, a staggering $1.7 billion [sic] potential cost to tax payers.” (I’m certain she meant trillion, not to mention the loss of more than a trillion dollars in stock market wealth.)
That’s the bad news.
The good news is that what Carolyn Maloney described at an October 6, 2008, U.S. House committee hearing, as quoted above, is also the terminal crisis of the Ronald Reagan era. Reagan and his British counterpart, Margaret Thatcher, prevailed in lowering taxes, reducing regulation, and cutting the size of government. Their disciplesincluding the current Republican presidential candidate, who describes himself as “a foot soldier in the Reagan revolution”dedicated their careers to cutting taxes, limiting government, and slashing regulation.
John McCain, to be fair, was once a critic of the Bush tax cuts he now promises to keep in place if he becomes president. So there was one occasion when the old foot soldier was out of step with the Reagan-era army as it advanced one of its inviolable policies. Back then, Grover Norquist excoriated McCain for his tax heresy. For the past fifteen years Norquist has been the intellectual luminary of the political right in Washington, making the case for “starving the beast” until the federal government is so small that he can drown it in his bathtub.
He succeeded. More precisely, they succeeded.
At least it seemed like a success, until the financial crisis, which began with the unregulated marketing and “securitization” of subprime home loans, pushed the economy close to a systemic meltdown. At that point, the same corporate executives who for a decade had battened on unregulated markets, and the millions of Americans whose wealth they destroyed, looked to their government for help. Even Norquist, the high priest of the “small-government” theocracy, was desperately offering up measures that might encourage Republican members of Congress to vote for the Bush-Paulson bailout bill. (Measures such as suspending the capital gains tax.) Norquist was also swallowing his pride and principle to embrace John McCain.
Funny how things turn out.
There is more good news.
The perilous economic situation is increasing and solidifying public support for Barack Obama and Joe Biden, while dragging down the poll numbers of McCain and Sarah Palin in the presidential race. Obama’s position has improved steadily since Treasury Secretary Paulson euthanized Lehman Brothers in September. It could be that this single decision, which triggered the economic meltdown, provided Obama with the momentum that will make him president. As the Obama campaign focused on the economy, McCain grew more erratic, squandering weeks and critical points in the polls by engaging in vituperative attacks on Barack Obama’s character. (Norquist enthusiastically joined the Republican rabble, arguing that “the McCain campaign should be saying, ‘Let’s take this guy’s head off. He is a crook.'”)
Now, Republican Party leaders are openly criticizing McCain and warning that his loss might be large enough to affect down-ballot races and expand the Democratic control of Congress. Unless the dynamic of the election is upset by a (late) October surprise, it now appears that Norquist will be left to regroup, perhaps dedicating himself to the Republican Restoration taking shape as Newt Gingrich positions himself for a run for the presidency in 2012. McCain’s loss will be attributed to the fact that he is not a genuine conservative and was never a legitimate heir to the Reagan-Gingrich revolution. The fight within the Republican Party will be ugly.
That Democrats, independents, and many disaffected Republicans have found ample reasons to vote for Obama and down-ballot Democrats who offer the best prospect of re-regulating markets, is borne out in polling trends. Shortly after Obama’s lead in composite national polls surpassed ten points, analyst Nate Silver (www.fivethirtyeight.com) had the Democratic ticket winning 351 to 187 in the Electoral College. Silver also assigned McCain a 6.2 percent chance of winning the election.
To support his number-crunching, Silver pointed to a story published in the New York Times before Obama moved into a double-digit lead:
In the latest Gallup tracking poll, Mr. Obama leads Mr. McCain 50 percent to 43 percent among registered voters. Mr. McCain’s deficit in that survey has remained seven percentage points or more for most of the last two weeks.
Since Gallup began presidential polling in 1936, only one candidate has overcome a deficit that large, and this late, to win the White House: Ronald Reagan, who trailed President Jimmy Carter 47 percent to 39 percent in a survey completed on Oct. 26, 1980.
Six years ago Karl Rove and former Republican Majority Leader Tom DeLay predicted that the Republican Party would establish “a permanent majority.” At the time, their predictions seemed logical and were vindicated by election results. George W. Bush and Dick Cheney deserve considerable credit for accelerating the decline of their party.
But it ain’t over yet.
While the political bear market confronting Republicans seems insurmountable, what remains, of course, is an election. With the stakes as high as they are and the distinction between the two candidates at the top of the ticket so stark, it would be akin to treason to sit this one out. (What follows includes several reasons to voteeither early or at the polls on November 4.)
A MAN, A PLAN—Two weeks ago in these pages, I disagreed with Congressman Dennis Kucinich’s suggestion that Treasury Secretary Henry Paulson went in the tank for his former employer when Paulson allowed the Lehman Brothers investment bank to fail in September.
I was not, however, suggesting that Paulson does not have an egregious and apparent conflict of interest. Not only is Paulson a Golden Sachsman. His net worth was estimated to be somewhere around $700 million before the markets went south, much of it acquired while he was the CEO of Goldman. He has surrounded himself with his former colleagues, and his policy decisions are informed by years of working as an investment banker.
Kucinich addressed Paulson’s conflict of interest, while questioning witnesses at the first of a series of hearings Congressman Henry Waxman (D-CA) has scheduled to examine the causes of the economic crisis.
“My question is why Secretary Paulson decided to bail out AIG and other companies but not Lehman,” Kucinich said. “Gretchen Morgenson of the New York Times wrote a column about the decision to rescue AIG. She said Secretary Paulson, a former CEO of Goldman Sachs, made this decision after consulting with Lloyd Blankfein, the current CEO of Goldman Sachs. She also wrote that Goldman Sachs could have been imperiled by the collapse of AIG because Goldman was AIG’s largest trading partner. She said Goldman had a $20 billion exposure to AIG.”
Indeed, Blankfein was the only Wall Street chief executive participating in the Treasury meeting that occurred between the date the government refused to bail out Lehman Brothers and the date it offered insurance giant AIG an $85 billion bridge loan. An unnamed Goldman spokesman told Morgenson that “Mr. Blankfein participated in the Fed discussions to safeguard the entire financial system, not his firm’s own interest.”
In response to Kucinich’s question about what happened with Lehman, University of Chicago finance professor Luigi Zingales responded, “It’s clear that Goldman Sachs benefits from Lehman going under.”
Kucinich asked another witness, corporate consultant Nell Minow, about Paulson’s conflict. “What we’re confronted with is that the bailout legislation gives Secretary Paulson the ability to direct assets over the entire economy, changing forever the idea of a free market and putting him in a direct position where he can benefit the people that he worked with while he was CEO of Goldman Sachs. Does that concern you?”
Minow, an editor and cofounder of the Corporate Library, is a persistent critic of the high salaries paid to Wall Street executives, so it was no surprise that she answered yes.
“The implementation is going to tell the story here,” Minow said of the $700 billion bailout. As it is, the story will be told by Goldman Sachs.
As we reported in the October 15 issue, Paulson has surrounded himself with his former Goldman Sachs colleagues and appointed thirty-five-year-old former Goldman wunderkind Neel Kashkari, now assistant Treasury secretary for International Economics and Development, to administer the bailout program. These may be honorable men all, with the best of intentions. Yet they were working members of the plundering class that put the global economy at risk. All of them made their bones at Goldman, while the company was engaged in the very practices that wreaked havoc with the economy.
Kucinich’s line of questioning at the U.S. House Committee on Government Oversight and Reform hearing provides a perfect predicate for recusal. Paulson and the Goldman cabal at Treasury should step away from the bailout program and he should appoint an administrator who has no interest in the parties who stand to win or lose by the distribution of $700 billion.
FIXING PAULSON’S PLAN—Free-market Republicans (and Democrats) must sense that it’s the end of the world as they know it. Consider the news that Paul Krugman was awarded the Nobel Prize for Economics. The Princeton economics professor used his New York Times column to warn about the impending disaster hidden within the housing bubble four years ago, when homeowners were refinancing and using their houses as ATMs and investment bankers were slicing up those loans and selling them in collateralized debt obligations.
In our previous issue, we quoted Krugman’s prediction that the Bush administration would return to Congress prior to January 20, 2009, to ask for more money to continue the bailout of our financial institutions. Krugman also argued that the most effective way to recapitalize banks is for the government to buy bank shares, which quickly provides institutions with liquidity. It took only a few days for British Prime Minister Gordon Brown to decide that Krugman was right. Treasury Secretary Paulson fell in line when it was evident that banks and markets weren’t responding to his original plan.
New York University economist Nouriel Roubini has made the same argument, also quoted in these pages. I have become a careful reader of Roubini’s on-line newsletter, the RGE Monitor. Like Krugman, Roubini described the bailout plan as flawed and inadequate. To complement the government purchase of bank shares, he advocated completely eliminating the FDIC cap on insurance of bank accounts, which in response to the crisis was increased from $100,000 to $250,000 per account. Roubini described a “silent run” on banks by account holders with accounts larger than even the new FDIC limit, who fear their money will be lost if their banks fail. The bank runs exacerbate the liquidity crisis faced by some banks and encourage banks to hold on to their cash reserves, which further discourages lending. Almost a month after the Lehman bankruptcy, which sparked the current crisis, the FDIC was considering insuring all bank deposits—at least as a temporary measure.
What has been lost by allowing a small group of investment bankers to shape the bailout policy was time. Roubini predicts that the crisis will grow worse and require much larger public investment because too little was done too late.
For the record, it has been thirty-two years since Chicago School economist Milton Friedman, one of the architects of Reaganomics and the scholar who took tough-love economics to Augusto Pinochet’s Chile, was awarded the Nobel Prize for Economics. (Okay, Reagan’s hero Arthur Laffer drew his famous supply-side graph on a cocktail napkin, but any bet that he’s on the Nobel shortlist is riskier than holding on to your shares of Lehman Brothers stock until after the bankruptcy.)
Fundamental changes, it appears, are unfolding even before the November election.
FIRE AWAY—“If I were president today, I would fire him,” John McCain said in September of Securities and Exchange Commission Chair Chris Cox. When McCain was informed that the president can’t actually fire the SEC chairman, he said he would ask for his resignation.
McCain was right about Cox. The former California Congressman, whom George Bush appointed to the SEC in 2005, has been a passive deregulator, presiding over a reduction of staff and decreased penalties as the markets the agency regulated became more complex, more challenging, and more corrupt. Since Cox arrived at the agency, 146 employees have been cut from the Enforcement Division, which is down from 1,338 to 1,192. “The Office of Risk Management had been reduced to an office of one,” the SEC’s Lynn Turner told the U.S. House Committee on Oversight and Government Reform. Turner was the chief accountant at the SEC from 1998 to 2001.
Turner also told the Oversight Committee that the Office of Risk Management is responsible for risk evaluation of $62 trillion in so-called credit default swaps. These swaps are intended to be insurance policies that protect against the default of instruments such as collateralized debt obligations, or CDOs. Collateralized debt obligations, in today’s market, are securitized and sliced-up mortgages bundled for sale as investments. It is the spread of CDOs that caused the global market crisis. (Fifty percent of domestic CDOs were sold outside the United States, making the crisis virally global.)
“When you have only one person, there’s no way on God’s green Earth, anyone, Chairman Cox or anyone else, could have even imagined that this person could do the job,” Turner said. “When you cut it down to one, you know what you’re doing. You know that you’re basically saying, ‘we’re not going to do the job.'”
Penalties assessed by the SEC, which was established during the New Deal to protect shareholders, fell by half in 2007, to $1.6 billion. “There has been less emphasis on investor protection and more on this issue of the competitiveness of markets,” Senator Jack Reed (D-RI) told the New York Times in April. The decline in enforcement seems to have been programmatic, as Chairman Cox has cut the enforcement budget from $316.3 million in 2005 to $298 million today.
Cox fit the mold of George Bush appointees to regulatory agencies that lose their regulatory zeal as soon as the new boss shows up for work. The SEC chair’s lack of enthusiasm for shareholder interests wasn’t a state secret. In 1995 Cox had been the sponsor of a House bill that limited shareholders’ rights to sue corporations and stockbrokers. At the time, consumer advocate (and current presidential candidate) Ralph Nader told the Washington Post that Cox’s bill “is full of provisions that either immunize or limit sharply the liability of financial crooks and those professionals who aid and abet them.”
Lobbying for the bill were brokerage firms looking for protection from investors who had lost millions in the derivatives market. And accountants and lawyers exposed to lawsuits in the wake of the savings-and-loan crisis.
On the floor of the Senate, McCain voted for the bill but then changed his “yes” vote to a “no.” President Clinton’s veto of the bill was overridden by the Congress.