The OTHER Big News Today

It's been an eventful day, but one blip that isn't making it to the top of the radar screen concerns the still-plummeting housing market. The Case-Schiller Index shows prices falling rapidly in March, and the market tracking the more adverse scenario seen in the Treasury's stress tests.

Prices keep falling for one major reason - foreclosures remain extremely high, and homebuyers are picking up those foreclosed homes first at fire-sale prices. We're seeing a new wave of foreclosures due to job loss and the economy, and even prime loans are no longer safe.

With many economists anticipating that the unemployment rate will rise into the double digits from its current 8.9 percent, foreclosures are expected to accelerate. That could exacerbate bank losses, adding pressure to the financial system and the broader economy.

“We’re about to have a big problem,” said Morris A. Davis, a real estate expert at the University of Wisconsin. “Foreclosures were bad last year? It’s going to get worse.”

Economists refer to the current surge of foreclosures as the third wave, distinct from the initial spike when speculators gave up property because of plunging real estate prices, and the secondary shock, when borrowers’ introductory interest rates expired and were reset higher.

“We’re right in the middle of this third wave, and it’s intensifying,” said Mark Zandi, chief economist at Moody’s Economy.com. “That loss of jobs and loss of overtime hours and being forced from a full-time to part-time job is resulting in defaults. They’re coast to coast.”

It's the big problem that was not solved by the relatively puny housing bill, stripped of the cram-down option. Since practically all of these loans were sold and tied up in mortgage-backed securities, in addition to just losing the value of the mortgage, new assets become toxic with each passing day. Considering that the last guy at Treasury, Hank Paulson, whose investment firm Goldman Sachs profited mightily from the MBS market, didn't even understand it, I hold out little hope for his successor to get a handle on it.

We're supposed to be dazzled by "green shoots" and see the economy returning to normal. Sorry, I still see a dying housing market, and that still threatens to bring down the whole system. Thanks to relatively strong policy responses, the event of a depression has probably been averted in most of the world. But we're going to be treading water for quite a while.

This New York Review of Books symposium, on a related theme, is a good read.

Too Big, Period.

What will post-recession Wall Street look like? The President talks about a smaller financial sector as a function of a stronger economy.

And so I wonder if you would be willing to describe a little bit of your learning curve about finance, and what you envision finance being in tomorrow’s economy: Does it need to be smaller? Will it inevitably be smaller?

THE PRESIDENT: Well, first of all, I think that we should distinguish between finance as the lifeblood of our economy and finance as a significant industry where we have a comparative advantage — right? So in terms of just growing our economy, we’ve got to have enough credit out there to fund businesses, large and small, to allow consumers the flexibility to make long-term purchases like cars or homes. So that’s not going to change. And I would be concerned if our credit market shrunk in ways that did not allow for the financing of long-term growth.

What that means is not only do we have to have a healthy banking sector, but we’re going to have to figure out what we do with the nonbanking sector that was providing almost half of our credit out there. And we’re going to have to determine whether or not as a consequence of some of the steps that the Fed has been taking, the Treasury has been taking, that we see the market for securitized products restored.

I’m optimistic that ultimately we’re going to be able to get that part of the financial sector going again, but it could take some time to regain confidence and trust.

What I think will change, what I think was an aberration, was a situation where corporate profits in the financial sector were such a heavy part of our overall profitability over the last decade. That I think will change. And so part of that has to do with the effects of regulation that will inhibit some of the massive leveraging and the massive risk-taking that had become so common.

Now, in some ways, I think it’s important to understand that some of that wealth was illusory in the first place.

So we won’t miss it?

THE PRESIDENT: We will miss it in the sense that as a consequence of 25-year-olds getting million-dollar bonuses, they were willing to pay $100 for a steak dinner and that waiter was getting the kinds of tips that would make a college professor envious. And so some of the dynamic of the financial sector will have some trickle-down effects, particularly in a place like Manhattan.

But I actually think that there was always an unsustainable feel about what had happened on Wall Street over the last 10, 15 years, and it’s not that different from the unsustainable nature of what was happening during the dot-com boom, where people in Silicon Valley could make enormous sums of money, even though what they were peddling never really had any signs it would ever make a profit.

That doesn’t mean, though, that Silicon Valley is still not a huge, critical, important part of our economy, and Wall Street will remain a big, important part of our economy, just as it was in the ’70s and the ’80s. It just won’t be half of our economy. And that means that more talent, more resources will be going to other sectors of the economy. And I actually think that’s healthy. We don’t want every single college grad with mathematical aptitude to become a derivatives trader. We want some of them to go into engineering, and we want some of them to be going into computer design.

Rhetorically this is very right, but as I've said the policies being undertaken don't fit the rhetoric at all. They seem far more designed to reinflate the financial sector and allow them no consequence for their bad decisions. Maybe this comes later, with regulatory reform. That certainly seems to be the signal from the President.

Let's try to define the problem and work backwards. Clearly, the growth of finance in terms of salary and proportion of the overall economy has gone completely out of balance. The power of Wall Street financiers provides one reason for this, but so does the newfangled structure of the economy which rewards such behavior.

This wasn’t the first time that something like this had happened. There have been three big banking booms in modern U.S. history. The first began in the late nineteenth century, during the Second Industrial Revolution, when bankers like J. P. Morgan funded the creation of industrial giants like U.S. Steel and International Harvester. The second wave came in the twenties, as electrification transformed manufacturing, and the modern consumer economy took hold. The third wave accompanied the information-technology revolution. Each wave, Philippon shows, was propelled by the need to fund new businesses, and each left finance significantly bigger than before. In all these cases, it wasn’t so much that the bankers had changed; the world had.

The same can’t be said, though, of the boom of the past decade. The housing bubble was unique, and uniquely awful. Each of the previous waves had come in response to a profound shift in the real economy. With the housing bubble, by contrast, there was no meaningful development in the real economy that could explain why homes were suddenly so much more attractive or valuable. The only thing that had changed, really, was that banks were flinging cheap money at would-be homeowners, essentially conjuring up profits out of nowhere. And while previous booms (at least, those of the twenties and the nineties) did end in tears, along the way they made the economy more productive and more innovative in a lasting way. That’s not true of the past decade. Banking grew bigger and more profitable. But all we got in exchange was acres of empty houses in Phoenix.

The giant pool of money, the large chunk of investment capital from around the world, had to park itself somewhere, and suddenly US home sales became the preferred bet. And then mortgage securitization led to a complete rewriting of the rules for who qualified for loans, and you know the rest.

How can we counteract this? Well, making the financial sector operate without the massive amounts of leverage that encourage bad bets would be a start. Suroweicki thinks we can hope for Wall Street to "recognize that its proper role is, as it has been in the past, to follow the real economy, rather than trying to drive it." I just don't find that realistic, given their power and their mindset. And so we need the independent Pecora Commission that will apparently be chaired to have some real power to make real recommendations that would rein in Wall Street and ensure their growth gets stunted. And forgive me for quoting John Ashcroft, but we need some real accountability and charges filed against any companies that may have broken the law. Interestingly, Ashcroft doesn't believe in the same kind of accountability for torture.

The government must hold accountable any individuals who acted illegally in this financial meltdown, while preserving the viability of the companies that received bailout funds or stimulus money. Certainly, we should demand justice. But we must all remember that justice is a value, the adherence to which includes seeking the best outcome for the American people. In some cases it will be the punishing of bad actors. In other cases it may involve heavy corporate fines or operating under a carefully tailored agreement.

(Do you think the editorial page editors of the Times openly snickered when they accepted this op-ed, and were all too happy to give Ashcroft the rope to hang himself?)

Banks need to understand their core function of providing the swift flow of capital, not to create wealth markets for themselves. That can be achieved through responsible regulation.

It Comes Back To Housing

This was a really lucid article from Steven Gjerstad and Vernon L. Smith explaining the role of housing in the financial crisis, in case you're having trouble explaining this to your friends and family:

The 2001 recession might have ended the bubble, but the Federal Reserve decided to pursue an unusually expansionary monetary policy in order to counteract the downturn. When the Fed increased liquidity, money naturally flowed to the fastest expanding sector. Both the Clinton and Bush administrations aggressively pursued the goal of expanding homeownership, so credit standards eroded. Lenders and the investment banks that securitized mortgages used rising home prices to justify loans to buyers with limited assets and income. Rating agencies accepted the hypothesis of ever rising home values, gave large portions of each security issue an investment-grade rating, and investors gobbled them up.

But housing expenditures in the U.S. and most of the developed world have historically taken about 30% of household income. If housing prices more than double in a seven-year period without a commensurate increase in income, eventually something has to give. When subprime lending, the interest-only adjustable-rate mortgage (ARM), and the negative-equity option ARM were no longer able to sustain the flow of new buyers, the inevitable crash could no longer be delayed.

And that's where we are. The resets from all those ARMs could be foreseen pretty easily, but with rising prices, analysts who erred on the side of irrational exuberance thought people could just refi their way out of them and be saved by the price increase. It never was sustainable. And the securitization of the loans turned would could have been just a nasty problem confined to the specific sector into a global meltdown. When small towns in Tennessee and Alabama are swapping credit defaults and derivatives, you can see the problem clearly.

There's been a lot of talk about how we're saving the banks, but somewhat less on what we are doing at the root of the problem. There's a compelling argument to let this run its course and allow housing prices to revert back to the mean. That may be so, but rising foreclosures STILL destroy value in the market, because no buyers become willing to accept a property at anything but fire sale prices, constraining the ability of people who want to sell their home for other reasons and really upending the market. Today the President held a housing refinance roundtable and seemed to suggest that part of the solution lay in more refinancing:

What you've seen now is rates are as low as they've been since 1971. Three-quarters of the American people get their mortgages through a Fannie Mae-Freddie Mac qualified loan. And as a consequence of us being able to reduce the interest rates that are available, we have now seen some extraordinary jumps in the rate of mortgage refinancings.

And everybody here represents families who have saved hundreds of dollars a month, thousands of dollars a year in some cases, and that's money directly in their pocket. More importantly, what it's allowed them to do is to consolidate their loans in some cases, reduce the length of their mortgages in other cases. It has given them the kind of security and stability in their mortgage payments that a lot more people can take advantage of.

So the main message that we want to send today is, there are 7 to 9 million people across the country who right now could be taking advantage of lower mortgage rates. That is money in their pocket. And we estimate that the average family can get anywhere from $1,600 to $2,000 a year in savings by taking advantage of these various mortgage programs that have been put in place.

This makes sense in terms of economic stimulus but does absolutely nothing to restore the housing market, IMO. One can view pushing down mortgage interest rates and encouraging refinancing as a way to put money in the pockets of homeowners, money that they may be willing to spend. But the universe of people who just need a reduction in their interest rate to save their home is sadly pretty small. The loan modifications that have been interest-only frequently resulted in foreclosure down the road. Obviously this is not the only element of the Obama plan - and I see the point in highlighting it, because it could mean millions of dollars circulated into the economy, as well as a make-work plan for loan servicers - but it reflects a willingness to just tinker around the edges of housing policy instead of really attacking the problem.

Barney Frank's proposals to crack down on the types of loans servicers can offer by stopping 100% securitization and lots of subprime lending makes a lot of sense, but that's a second-order problem. The first-order problem is how to stop all these foreclosures. I'd like to see more attention paid to that.

The Housing Death Spiral

In fairness, the new Obama Administration housing policy has not had the time to work. But judging on past performance, and based on the fact that principal reductions aren't really part of the Obama plan, I would expect the same results:

Mortgages modified in the third quarter failed at a faster pace than those revised in the first, and the delinquency rate on the least risky loans doubled, signs of deteriorating credit quality, U.S. regulators said.

Loans modified in the first quarter to help borrowers keep their homes fell delinquent 41 percent of the time after eight months, and second-quarter loans had a 46 percent default rate, the Office of the Comptroller of the Currency and Office of Thrift Supervision said in a report today. Third-quarter trends “are worsening,” the agencies said.

“For the year and this quarter, we saw the same trend that we saw last time: quite high re-default rates, no matter how we measured them,” John Dugan, the U.S. Comptroller of the Currency, said in a conference call with reporters.

Lenders including Citigroup Inc. and loan-servicing companies are adjusting mortgages by lowering interest rates or crafting longer-term payment plans. The Obama administration is acting to help as many as 9 million struggling homeowners by using taxpayer funds to pay lenders such as bond investors, mortgage servicers for reworking the mortgages.

Dugan said higher re-default rates are likely related to stressful economic conditions and new loan plans are not producing significant reductions to make mortgages sustainable.

It's frustrating, considering that banks aren't even acting in their own best financial interest. Given the falloff in the market, foreclosing a home and reselling it would return less money than reducing principal and letting the homeowner stay in the home. But the loan servicers don't seem to want to deal with unwinding the securitization of the loans, and deal with potential lawsuits from writing down their security.

Why isn't that happening? Ah, those pesky securitizations. Although investors litigating to block mods is the oft-given reason for not taking this course of action (a presumed to be high number of securitizations either bar or restrict mods), my impression is servicers simply have not wanted to fight this fight (they have clearly defined compensation in the case of foreclosure versus no rewards for mods, save the fees under new government programs). Paying legal fees to fight investors is an even more dubious business proposition (it's a near certainty they can't charge those expenses to the securitization trust, and it would thus come out of their bottom line).

That is a long winded way of saying I doubt that there has been much study by legal talent as to how to overcome mod restrictions in servicing agreements. Given the high level of fraud (in a small sample, Fitch found evidence of fraud in every loan file it examined), there might be ways to persuade investors they have more to lose than gain by pursuing this line of legal action.

Major banks and financial firms won't even work with mortgage brokers anymore, suggesting that the entire market is hopelessly broken. New rules and standards for loans going forward are on the way, but that does nothing for those struggling to make payments right now.

The answer is, and has always been, to allow bankruptcy judges to modify the terms of the loan, which would encourage the loan holders to work out a deal. But while that passed the House, the Senate "moderates" have refused to move forward because the corporate interests holding the strings on them have refused to allow it.

Buying Off The Banksters

My college friends and I used to call anything this truly horrific a-good.

The Treasury Department is expected to unveil early next week its long-delayed plan to buy as much as $1 trillion in troubled mortgages and related assets from financial institutions, according to people close to the talks.

The plan is likely to offer generous subsidies, in the form of low-interest loans, to coax investors to form partnerships with the government to buy toxic assets from banks.

To help protect taxpayers, who would pay for the bulk of the purchases, the plan calls for auctioning assets to the highest bidders.

I don't have to rehash the arguments against this idea, just link to them. Basically, the government will subsidize investors to overpay for bad assets, meaning that cash will simply flow from taxpayers to banks. Instead of shrinking the wealth and value of the financial sector relative to the greater economy, this plan would keep it in place. The White House clearly sees paying off the banksters as equal to saving the economy, making the solution far more expensive than the problem, especially considering that this probably won't work. John Cole sums it up:

The Illness- reckless and irresponsible betting led to huge losses
The Diagnosis- Insufficient gambling.
The Cure- a Trillion dollar stack of chips provided by the house.
The Prognosis- We are so screwed.

At this point, the only thing we should offer a significant class of banksters is a plea deal. Instead Geithner will preserve the institutions.

If you want to truly fill yourself with dread, consider that the Federal Reserve started buying mortgage-backed securities as early as August 2007, bought up a bunch more in January, and just announced the purchase of even more THIS WEEK. And yet Treasury needs to eat some of this crap as well. That's how many of these little buggers are out there.

OK, I'm going to go watch college basketball and slowly rock back and forth.

...Me again. James Kwak hits on something, connecting for me the Geithner plan to modify loan terms, thus reducing the value of mortgage-backed securities by definition, and this TALF plan, which would overpay for them well above their true value. The investors of the MBS could actually sue under the Takings clause of the Fifth Amendment, if structured improperly. What a fucking mess.

The Gang That Couldn't Shoot Straight

The politicians in the Republican Party know they have a winning issue. John Boehner put Tim Geithner on notice today, saying "What happens over the next 24 to 48 hours will determine his future." Connie Mack (R-FL) called for his resignation. Chuck Grassley wants an Inspector General review into Treasury's contacts with AIG. Sure, they're being inconsistent, but that never bothered the GOP before.

What's more, they're right. Geithner and the Treasury Department struck the limit on compensation caps because he needed vonutary private partners to pull off his "TALF" plan.

Officials at the Federal Reserve and the Treasury Department are increasingly worried that the controversy could discourage investors from joining a new government effort to revive consumer lending as well as a separate plan that relies on private money to buy toxic assets from banks, sources familiar with the matter said.(...)

A senior executive at one of the nation's largest banks said he had heard from several hedge funds that they would not partner with the government for fear that lawmakers would impose retroactive conditions on their participation, such as limits on compensation or disclosure requirements.

There are differing arguments about the potential of the TALF plan (personally, I see it as the government putting up most of the risk and outsourcing the profits to hedge funds), but the debate has kind of been rendered moot by the Fed's announcement that they're just going to go ahead and buy up a ton more mortgage-backed securities on their own (along with long-term Treasury securities) without getting approval from Congress. This pushes the bailout numbers up by at least another trillion dollars. So the cunning Geithner plan to make the bailout slightly less costly has not only been made inoperable, but it facilitated these bonus payouts which just directly prove that the banks are bad-faith operators. And this is only going to get worse.

• Item 1: Citibank CEO lied to Congress about his own compensation package, which members of Congress are pursuing.

• Item 2: Generous retention bonuses at Fannie Mae and Freddie Mac will continue to cement the impression that the banks are taking advantage of the bailout money.

The Administration is becoming susceptible to the argument that they overly trusted banksters who are interested in personal self-aggrandizement and not fixing the economy. And the GOP knows it, and they're sticking the knife in.

Except their spiritual leaders are not being helpful.

GOP Congressional leaders have roundly condemned AIG and its executives, as part of a strategy to position themselves as heroic defenders of the taxpayers and to paint the Obama administration as weak and ineffectual. Mitch McConnell recently blasted AIG’s bonuses as an “outrage.” John Boehner said that the “American people are rightly outraged.” And Eric Cantor bemoaned the “stunning lack of accountability” on AIG’s part.

But increasingly, leading conservative media figures are moving in a different direction: Defending AIG.

Rush Limbaugh recently said: “I am all for the AIG bonuses” and attacked the Obama administration for trying to undo them. He also blasted Dem efforts to get the names of the AIG bonus recipients as “McCarthyism.”

Fox News followed suit, also comparing Dems to “Joe McCarthy.” And Sean Hannity has now derided efforts to tax the execs by saying: “In other words, we’re going to just steal their money.”

Hilarious. The White House tosses a softball right over the plate, and half the GOP wants to swing at it and the other half wants to take it.

Rep. Conyers On Why We Need Cram-Down

Yesterday, Nancy Pelosi announced that a housing bill which could come up for a vote this week would include the "cram-down" provision, which would allow bankruptcy judges to modify the terms of mortgages for borrowers on their primary residence (currently judges have the ability to do this on secondary residences). This is an important provision, which most economists believe will be the best tool homeowners can have for them to stay in their homes, and for lenders to agree to loan modifications. The banksters hate this idea, mainly because they know it would blow the whistle on their consistent violations of the spirit and the letter of the Truth In Lending Law, in their mania to lock as many people into mortgages as possible without regard for ability to pay, so they could sell those mortgages on as securities, and so on and so forth. This ultimately is the fault of the lender, who are clearly the irresponsible ones in the whole scenario.

Along with my friends at Brave New Films, I talked to Rep. John Conyers, the chair of the House Judiciary Committee and the author of HR 200, the cram-down bill, about this provision and why it's needed at this time.



We know that the housing bubble bursting was a major, if not the major, cause of the current financial crisis. And we have as many as 10 million homeowners at risk in the near future for foreclosure, or for being underwater on their homes as prices crash. With securitization slicing and dicing mortgages into tiny parts and selling them all over the world, it's nearly impossible for homeowners to bargain with their lender - it's hard for them to know who even owns the property. And while it costs lenders to have a home revert back to them in foreclosure, both on the defaulted mortgage and on continued upkeep of the house until resale, there are perverse incentives for them not to enter agreements with homeowners that will allow them to stay in their homes. Barack Obama's plan seeks to incentivize in the other direction to get loans modified, but only cram-down will really bring the lenders to the table. As Rep. Conyers says, this "levels the playing field" and gives homeowners a tool to bargain with the lenders. Currently they have none. While Obama's plan holds open the option for cram-down, and he has been supportive of the change in bankruptcy law, we really need legislation to define this specifically.

Mind you, practically every other asset that anyone who goes into bankruptcy has - second and third homes, yachts, cars, you name it - is eligible for a rewriting of terms by the bankruptcy judge. It's only the primary residence that is excluded. This is perverse and seeks to only benefit the wealthy. Far from encouraging bankruptcy among the poor, this bill would encourage the bankers to help them avoid it. As Conyers said:

The very people that prevented the bankruptcy judge from having this power in the first place are the ones now that are most seriously resisting us giving it to them, even while we're in a national crisis. You know, it's amazing how greed and self-interest makes people forget about the fact that we're in a recession that could get much worse. It could be a depression. And by the way, this helps not just the poor borrower who may be locked up or laid off or their job has moved away or anything may have happened, but what we're doing now is that we're saying the judge has the authority to help everybody. You know, the more houses that are put into foreclosure, the more run-down the neighborhoods become, and also the more property of everybody is involved. This provision is to keep you from going into bankruptcy.

This is a classic political argument, as Mike Lux argues, between those "rugged individualists" who think everybody should be out for themselves (except when their investment firms and giant insurance companies are about to go under), and those who think we are linked and we have a responsibility to our brothers and sisters, as surely as they do to us. Forcing everybody off a foreclosure cliff makes no sense to either those newly homeless or the property owners who will see their values plummet. And contra the Santelli revolution, the public basically gets this.

Schmucks At The Helm

At the rate we're going, we'll be lucky if the White House isn't in the middle of foreclosure by January 20th. Emperor Paulson and his merry band of geniuses are making the same bad bets with taxpayer money as the investment banks did to get us here in the first place.

Stock intended to eventually earn taxpayers a profit as part of the Bush administration's massive bank bailout has lost a third of its value — about $9 billion — in barely one month, according to an Associated Press analysis. Shares in virtually every bank that received federal money have remained below the prices the government negotiated.

Stocks dropped again Friday after the government reported a larger-than-expected number of job losses in November, but a top Treasury Department official told the Mortgage Bankers Association that the tax dollars are being invested in "very high-quality institutions of all sizes."

"We're not day traders, and we're not looking for a return tomorrow" said Neel Kashkari, the director of Treasury's Office of Financial Stability, which oversees the $700 billion financial rescue fund. "Over time, we believe the taxpayers will be protected and have a return on their investment."

That would be more reassuring if I believed you had the first clue what you were doing, Neel (also if your name wasn't "Neel"). I mean, this latest plan to reinflate the housing bubble in a desperate attempt to get out of the Treasury Department alive is completely absurd.

Treasury Secretary Henry Paulson is considering a new plan to reduce mortgage rates in another bid to revive the U.S. housing market, a government official said.

The Treasury, which already has a program to buy mortgage- backed securities issued by Fannie Mae and Freddie Mac, could step up those purchases to drive down interest rates on some loans to 4.5 percent, the official said on condition of anonymity. The plan is preliminary and could change.

Note the words "some loans". Anyone that would qualify for these rates would not need the rate reduction, and there's no indication that those rates would be fixed. What's more, this would not apply to those who are upside down in their homes and looking to restructure their payments. While some homeowners have been able to refinance, in the main that is largely not those homeowners at risk, which is why you're seeing defaults at stratospheric levels, something like 10% of the market. And anyway, this just prolongs the inevitable. Running the US economy on home-buying is unsustainable. Houses are in most cases still overvalued.

(By the way, I'm also very concerned that Treasury Secretary nominee Tim Geithner, who's been in on a lot of the decisions made by Paulson and others, may be trying to force out Sheila Bair, practically the only person in the government who's focusing on the foreclosure side of the equation. The article contains a bit of hearsay, but I hope it's wrong and Bair is retained at the FDIC.)

Thankfully, some members of Congress are figuring out that Paulson and his cadres don't know what the hell they're doing and need to be swiftly separated from any future taxpayer funds:

Dec. 4 (Bloomberg) -- Senate Banking Committee Chairman Christopher Dodd said he opposes giving the Bush administration the second half of the $700 billion financial rescue plan, joining Republicans upset with how it is being managed.

“I would be a very hard person to convince that this crowd deserves to have their hands on the next $350 billion,” Dodd, a Connecticut Democrat, told reporters today in Washington after a hearing on whether automakers should get government aid. “I am through with giving this crowd money to play with.”

Good. There are about 299,999,999 million other people I could think of that would manage this bailout money better. Instead of rebuilding the same failed institutions and putting no new restrictions on them, we need to restore competition to the marketplace, break up the concentrations of financial sector wealth, significantly reduce the leverage that these behemoths take on, and never again get ourselves in a situation where companies are too big to fail. We're in this mess because the financial industry was allowed to play all kinds of games with our collective future. Now the Treasury Department is doing virtually the same thing in restoring them.

We have to break this cycle.

The Old "That Thing You Didn't Say Isn't True" Trick

Marc Danzinger writes at Winds of Change under the name "Armed Liberal." In my scattered meetings with him, I've found him to be neither armed nor liberal, but maybe I caught him on a bad day. A few weeks ago, we appeared on a radio show together, and we got into a discussion over whether or not Fannie Mae and Freddie Mac could be blamed for the financial meltdown, which is a tautological discussion at the outset, because the idea that there's one simplistic answer for something so complex isn't an argument worth having. But I made my points, and he made his, and then a week or so later he wrote this long piece on his website that I imagine he considered the definitive takedown of moi.

Now, I was fully prepared to let this go, but this "Fannie and Freddie did it!" meme has shown no sign of letting up, with House Republicans calling for a special counsel to investigate the GSE's role in the crisis, and in particular the conduct of former Clinton Administration officials (Man, that old Whitewater magic has some kind of pull). They desperately want to push this off onto any organization that has ties to Democrats to absolve themselves. So I'm compelled to respond.

In his post, Armed Liberal cites the conversation we had on the radio.

Dave and Marcy Wheeler were taking the "Fannie had nothing to do with this" position. I countered with "I've got this 92-page Powerpoint from the Milken Institute that says otherwise..."

Dave immediate dismissed it, saying "Did Fannie or Freddie make subprime loans?" And while I went to get the appropriate slide from the deck to show him, we moved the conversation along - because according to Brad, no one cares.

But I do, and I'll suggest that we all should. because they did, and further because of who they were and their position in the financial ecology, what they did was dramatically more important than what any other single institution chose to do.

Well, let's stop right there, because that's a misstatement of what I actually said. I never said "Did Fannie or Freddie make subprime loans?" I said "Did Fannie or Freddie guarantee or securitize subprime loans?" And I know that's what I said for two reasons. One, he has the damn mp3 on the site. And two, I was quoting a post I had written that very day which contained that very specific language:

• Fannie and Freddie did not guarantee and securitize subprime loans. Such loans didn’t meet their conforming loan standards. In fact, as the subprime market was building, Fannie and Freddie lost market share because they were under stricter standards. Thus, their participation in the secondary market did not assist in the creation of the subprime market.

• It’s true, however, that Fannie and Freddie were damaged by the subprime crisis because everyone in the housing sector was damaged by falling home prices and, more significantly, the two companies branched out into a broader investment portfolio. In that portfolio were included mortgage-backed securities that hurt all of those who purchased them. Fannie and Freddie weren’t the biggest players in this and, most importantly, started this practice very late in the game. In fact, the subprime market had already started to go bad when they started their purchases (which speaks poorly for Fannie and Freddie’s decision making, but precludes them from responsibility for the crisis).

• Fannie and Freddie were supposed to be more closely supervised than other lenders—with their own regulator, which was supposed to keep a special eye on them because they are important institutions. Those regulators, who were part of the Bush administration, failed along with the rest of the Bush regulatory apparatus to stop the problem.

In the first paragraph, you see that Fannie and Freddie were losing market share, and were basically forced into a subprime market that was already created and well underway. In fact, it was their foot in the free market that forced them into that. This weird hybrid of a "government-sponsored entity," still responsible to shareholders, demanded that Fannie and Freddie chase the market.

Now, Armed Liberal uses the quote of mine he fabricated to "prove me wrong." But there is a major difference between what I said and what he thinks I said. Fannie and Freddie "made" subprime loans, after the market was in place and the bubble was set (Armed Liberal even quotes a WaPo piece saying that they didn't get into the market until 2006), but they didn't guarantee and securitize them. They bought mortgage-backed securities as part of a broader investment portfolio. That was stupid, as they were under-capitalized. But they wanted to show their shareholders that they were going where the mortgage market was going and finding a way, despite their loan conforming standards, to be a part of it.

The problem with the mortgage market was that these shaky loans were sliced and diced into securities that were sold off to others. Fannie and Freddie did not and could not perform that. They got involved when the market was already collapsing. There's a difference between dumb and responsible. If they didn't purchase MBS's, there was a giant pile of money (Big Shitpile) ready to do the same.

When Armed Liberal pulls out the main slide that proves all this (here's an excerpt of his text):

Now if you'll recall, this all started when I suggested, arguing with Marcy Wheeler, that Fannie and Freddie did have something to do with the meltdown. Dave Dayen countered with "do Fannie and Freddie make subprime loans?" And I was flipping through the deck, looking for this slide:

You'll note that 61% of the loans Freddie had in its retained portfolio in 2006 were subprime, and a further 25% were Alt-A.

It's the kind of thing you wish you'd had at your fingertips when you're arguing in public...

As to Fannie, in 2006 the ratios were 46% subprime and 35% Alt-A.

I'll send this link over to Marcy and Dave (as well as Brad) and see what they have to say.

What I'll say is that you're looking at their stock protfolio. This lists the percentages in the mortgage-backed securities they purchased, and that has been ably spun by the Milken Institute (where this guy's "proof" comes from) into Fannie and Freddie being solely responsible for them. That's just silly, for reasons described above.

You don't really have to believe me on this one. You can go ahead and look at the reporting:

Federal housing data reveal that the charges aren't true, and that the private sector, not the government or government-backed companies, was behind the soaring subprime lending at the core of the crisis.

Subprime lending offered high-cost loans to the weakest borrowers during the housing boom that lasted from 2001 to 2007. Subprime lending was at its height from 2004 to 2006.

Federal Reserve Board data show that:

More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.

Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.

Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that's being lambasted by conservative critics.

Or the United States Treasury Department:

The PWG found that the principal underlying causes of the turmoil in financial markets
were:

• a breakdown in underwriting standards for subprime mortgages;
• a significant erosion of market discipline by those involved in the securitization process, including originators, underwriters, credit rating agencies, and global investors, related in part to failures to provide or obtain adequate risk disclosures;
• flaws in credit rating agencies’ assessments of subprime residential mortgage-backed securities (RMBS) and other complex structured credit products, especially collateralized debt obligations (CDOs) that held RMBS and other asset-backed securities (CDOs of ABS);
• risk management weaknesses at some large U.S. and European financial institutions; and
• regulatory policies, including capital and disclosure requirements, that failed to mitigate risk management weaknesses.

(You won't see Fannie and Freddie referenced in there, with the possible exception of the regulatory policies that failed to mitigate risk management, where I completely agree. But of course this is because they were forced by their quasi-private status to operate like everyone else in the market. My remedy for that comes later.)

... or former Treasury Secretary John Snow, SEC Chair Chris Cox, and former Fed chairman Alan Greenspan, and believe me, if there was a scapegoat to be had, they would have no problem using it.

Today in a House Oversight Committee hearing with former Fed chairman Alan Greenspan, SEC chairman Christopher Cox, and former Treasury secretary John Snow, Rep. John Mica (R-FL) revived that argument. He also tried to tie the crisis to Sen. Barack Obama (D-IL), holding up a chart called “Follow the Money Trail.” He pointed that Obama has been the largest recipient of donations from Freddie and Fannie. (Actually, he’s the second highest.)

Committee chairman Henry Waxman (D-CA) chastised Mica for trying to turn the financial crisis into a political issue. He noted that Freddie and Fannie “certainly played a role” in the current situation, but then asked the witnesses, “Do any of you believe that they were the cause of this financial crisis?” All three men said no. Watch it:

I don't know why Armed Liberal has such a hard-on to blame Fannie and Freddie, and I'm not going to go all Matt Taibbi on him and ridicule him for not knowing what the hell he's talking about. Instead I'll try to find some common ground. This was a private sector problem, a failure of regulation and a failure of overwatch on the runaway securitization of loans and the insurance and bets made behind the loans. To the extent that Fannie and Freddie were a part of that, late in the game, it was because they were part of the private sector. I see absolutely no reason to have government-sponsored entities that are partially public and partially private. I imagine this makes it easier to perform poor risk management because the risk is taken away from you. So I would take them permanently off the private market so they could stick to their core function instead of chasing wealth. If this were the case, no lobby shop would be available to press Republicans and Democrats alike to back off any meaningful regulation.

So we need to re-regulate the market and make Fannie and Freddie what they always should have been - backstops. As for Armed Liberal, the next time he wants to argue with me, it'd be nice if he quoted me accurately.

...just to elaborate on this a bit, I'm always skeptical of anyone who leads this off with "subprime loans." The problem of them was not their existence but the securitization. There are also regular loans in those MBS's, and there are loans to people who qualified above subprime but were given one of the more exotic loans. The securitization made everyone generally feel confident, that even if a bunch of loans failed they were a small subset of the total market and so lending standards could be acceptably thrown out. Fannie and Freddie were on the other side of that transaction. They shouldn't have bought them in 2006 and beyond, but they simply weren't responsible for creating the instruments, and their absence from the market wouldn't have collapsed it at all - the dot-com bubble flowed very naturally into the housing bubble, and all the global money went nicely with it.

Also, I associate myself with Ezra Klein's remarks about how we can actually find blame in all of this and use that evidence to create new solutions, essentially a new oversight structure that treats banks for what they do and not who they say they are, and treats insurance like insurance (I'm talking about CDS's here). Do read them.

It Must Be Homes And Investment

We are in a world of hurt right now economically. Job losses are increasing, and I predict we'll go an entire calendar year without one month of gains. This will likely lead to more foreclosures in the year ahead, as restructuring and refinancing isn't going to help the unemployed. Consumer spending will plummet and the holiday shopping season is probably going to be bleak, though some disagree. Most unnerving is the looming crisis in credit card defaults, because that's really all that workers who can't take equity out of their home and whose wages are flat have left to keep up with rising costs.

The question is what we do about this. Perhaps this plan from the FDIC chair will help.

Sheila Bair, chairman of the Federal Deposit Insurance Corp., told the same Senate panel that the government needs to do more to help tens of thousands of home borrowers avert foreclosure, including setting standards for modifying mortgages into more affordable loans and providing loan guarantees to banks and other mortgage services that meet them.

"Loan guarantees could be used as an incentive for servicers to modify loans," Bair said. "By doing so, unaffordable loans could be converted into loans that are sustainable over the long term."

The FDIC is working "closely and creatively" with the Treasury Department on such a plan, she said.

As I said, recently unemployed folks aren't going to be able to refinance. And the loans have been so securitized that you'd have to negotiate on multiple fronts just to cover every piece of the mortgage. But if they can make it work, this is very desirable. The cost to the greater economy of a foreclosure, both in upkeep and falling home prices in the immediate area et al, is close to $250,000. If there are likely to be a million foreclosures next year, you're talking about a number approaching that of the bailout package. We have to do something to get homes under control. Keeping people inside them, too, is both an economic and a moral imperative.

The other thing we must do is public investment, in infrastructure and job-creating engines. The neo-Hooverites in the media who are proscribing belt-tightening during a recession are writing up a recipe for disaster. Republican allies to such a "head in the sand" approach include Saxby Chambliss and Norm Coleman:

“I would be very cautious if a stimulus plan becomes another excuse to simply spending more dollars,” the Republican senator said in an interview after a campaign rally Tuesday in Bemidji.

These two need to be defeated. It's totally absurd to advocate for austerity budgeting at this time. It threatens a longer and deeper recession than we've ever seen in our lifetimes. The government has the ability to step in where private investment can't to provide stimulus that CREATES, whether it's jobs or infrastructure or a move to a green economy. Speaker Pelosi is talking about freezing Bush out of the measure and waiting for a new President, and she should. But immediately thereafter, we need a serious stimulus (more than she's willing to admit, actually).

Pointing One Finger Outward Means Three Are Pointing Back At Yourself

The wingnuts are really ramping up this blame of the Community Reinvestment Act of 1977 (I always like to put the date in there, just to show how ridiculous it all is) for the current financial crisis. It's bunk. What actually happened is that the tech bubble popped and there was a lot of global investment money that needed a place to go, so the financial industry packaged these mortgages and created a demand for them, which led to lax lending regulations, so they could give out more mortgage-backed securities, which led to more demand, etc., to create a new bubble. And now we're seeing this one pop. Despite the complexity of the financial instruments, it's pretty simple. But the wingnuts don't want simple. They want to muddy the waters and reduce the blame to the darkies.

In fact, even if this was about loaning to the "wrong" people the Bush Administration was in the position to stop it. But the "homeownership rates are high" talking point was valuable in a struggling economy with stagnating incomes, and their Wall Street friends were making bank, so they let it happen.

But it wasn't. The CRA has nothing to do with this crisis.

• The CRA was passed in 1977—over 25 years before subprime loans came into vogue. So the timing is wrong.

• The CRA only covers commercial banks and savings-and-loan institutions—not other forms of mortgage-offering enterprises. Fact is, most subprime loans weren’t made by the lenders subject to CRA.

Fannie and Freddie aren't to blame either:

• Fannie and Freddie did not guarantee and securitize subprime loans. Such loans didn’t meet their conforming loan standards. In fact, as the subprime market was building, Fannie and Freddie lost market share because they were under stricter standards. Thus, their participation in the secondary market did not assist in the creation of the subprime market.

• It’s true, however, that Fannie and Freddie were damaged by the subprime crisis because everyone in the housing sector was damaged by falling home prices and, more significantly, the two companies branched out into a broader investment portfolio. In that portfolio were included mortgage-backed securities that hurt all of those who purchased them. Fannie and Freddie weren’t the biggest players in this and, most importantly, started this practice very late in the game. In fact, the subprime market had already started to go bad when they started their purchases (which speaks poorly for Fannie and Freddie’s decision making, but precludes them from responsibility for the crisis).

• Fannie and Freddie were supposed to be more closely supervised than other lenders—with their own regulator, which was supposed to keep a special eye on them because they are important institutions. Those regulators, who were part of the Bush administration, failed along with the rest of the Bush regulatory apparatus to stop the problem.

Of course, it's a lot easier to blame the victims of predatory lending instead of the predators themselves. It's easier to cast blame instead of taking the hard look inward. In this brilliant essay, Thomas Frank says that the GOP instinct for blame-evasion is world class:

This is a movement, after all, that blandly recasts its greatest idols as traitors once their popularity has crashed; that routinely sloughs off responsibility for . . . well . . . anything since, by its logic, conservatism has never really been tried in the first place. Consider in this respect Mitt Romney's remarkable speech to the Republican convention a few weeks ago, in which he rallied his party against Washington -- a place his party has controlled, to one degree or another, for nearly three decades -- by listing the city's various institutions and crying, "It's liberal!"

Or consider the way the House Republicans torpedoed the bailout bill a few days ago. The real reason they did it was almost certainly to evade responsibility for an unpopular measure but the announced reason seemed designed to convince the nation's 7-year-olds -- because Nancy Pelosi said something mean.

On economic questions the standard exculpatory maneuver is even simpler. When some free-market scheme blows up, one needs only find an institution of government in close proximity to the wreckage and commence accusing.

And the reaction to being called on this lie on the right is to stick their fingers in their ears and pretend they never heard it.

It's entirely possible, indeed probable, that nothing proposed is a solution to this crisis we face - if housing values continue to plummet, which they should in a functioning economy to deflate the bubble, all the trickery in the world won't be sufficient. But the key conservative goal here is to elude responsibility, for responsibility might mean having to actually change their practices and have their free-market fundamentalism collapse upon them.

Y'All Fuckin' With My Money Now. And My Money Don't Like Being Fucked With

Apparently the line from the White House that is being snuck into news reports about this bailout plan is that the US could turn a neat little profit on it at some time in the future. There is one paragraph from the LA Times front-pager on the topic that put the lie to that:

The only limitations would be that Treasury's stock of troubled assets could not total more than $700 billion at any one time, that the buying program would end after two years, and that Paulson or his successor would regularly report to Congress. Moreover, though the proposal says Treasury's new authority would expire after two years, the history of past grants of emergency power suggests that Congress finds it hard not to renew them.

And so you see how this would go. President Paulson spends $700 billion on crap assets in about a week and a half. Whenever one is sold, the government can buy another one. And if it's the banks in association with the guy who used to run Goldman Sachs deciding what constitutes an "illiquid asset," you can pretty much be sure that the government will be out $700 billion at all times. They can even buy assets that have nothing to do with the mortgage crisis, or in other words, whatever they want. And given the difficulty stopping "emergency" programs like this, that will continue in virtual perpetuity. This is a direct addition to the national debt, and no profit will ever be made.

As Calculated Risk says:

Think of a drunk gambler at a slot machine. He starts with $100 and slowly loses. Every now and then he wins some money, but he keeps putting the coins back into the slot until he has lost everything. That is how this plan will work.

Unless there is a dramatic changes, there will be no upside participation in the financial companies for taxpayers, and the taxpayers will recapitalize the banks by, in Krugman's words, "having taxpayers pay premium prices for lousy assets".

Of course, the other issue is that there are virtually no reforms to safeguard the taxpayer from having to do this again down the road, and the Big Money Boyz have deployed their assets to keep it that way. The White House is making explicit that trying anything like making CEOs foot some of the bill for their own terrible decisions would be a poison pill. The PR machine is actually trying to make you feel sorry for these clowns.

"A lot of those people will have to sell their homes, they're going to cut back on the private jets and the vacations. They may even have to take their kids out of private school," said Frank. "It's a total reworking of their lifestyle."

He added that it's going to be no easy task.

"It's going to be very hard psychologically for these people," Frank said. "I talked to one guy who had to give up his private jet recently. And he said of all the trials in his life, giving that up was the hardest thing he's ever done."

It's pretty clear what's going on here, and none of it is any good. "Shock doctrine" is not a sufficient phrase to deal with what President Paulson wants.



The 110th Congress has had a number of defining moments and failed every time. Some of them are talking a good game anonymously but that needs to translate into constructive action. President Paulson is desperate to get his friends off without a scratch, and so he ought to be made to eat whatever Democrats want to feed him.

Call your member of Congress today, later today and on Monday morning and let them know how you feel.

...Obama is going to say this today in Charlotte:

As of now, the Bush Administration has only offered a concept with a staggering price tag, not a plan. Even if the U.S. Treasury recovers some or most of its investment over time, this initial outlay of up to $700 billion is sobering. And in return for their support, the American people must be assured that the deal reflects the basic principles of transparency, fairness, and reform.

First, there must be no blank check when American taxpayers are on the hook for this much money.

Second, taxpayers shouldn't be spending a dime to reward CEOs on Wall Street.

Third, taxpayers should be protected and should be able to recoup this investment.

Fourth, this plan has to help homeowners stay in their homes.

Fifth, this is a global crisis, and the United States must insist that other nations join us in helping secure the financial markets.

Sixth, we need to start putting in place the rules of the road I've been calling for for years to prevent this from ever happening again.

Sounds OK in the main, but the question is whether he's willing to fight for it. Or rather, signal to his party to fight.

All Cox' Fault?

Looks like the GOP has found a scapegoat for the financial meltdown. John McCain said today that he would fire Chris Cox as the chairman of the SEC. Now, Presidents don't have the power to do that, but clearly that showed a lack of trust in Cox on the part of the Republican nominee, and now CNBC is reporting (no link) that Cox will resign at the end of President Bush's term. In a way, McCain got what he wanted. And expect lots of articles about how lax SEC oversight was the proximate cause of this mess.

But how true is that? McCain tried to lay the blame at Cox' feet for the practice of naked short selling, which is when you can bet on a stock to go down without owning it, sort of like playing the ponies without owning the horse. This isn't exactly the best thing for the market, and Andrew Cuomo is launching an investigation to see if it's fully compliant with current law.

New York on Thursday began a probe into possible illegal short-selling in the stocks of Wall Street companies such as Goldman Sachs Group Inc and Morgan Stanley, Attorney General Andrew Cuomo said.

Cuomo said on a conference call with reporters: "I want the short-sellers to know today that I am watching. If it is proper and legal then there is nothing to worry about." [...]

The New York State prosecutor said his office also would look back into illegal short-selling that may have occurred in stocks of Lehman Brothers Holdings Inc and American International Group Inc, two companies at the heart of the crisis.

In the past week, Lehman has gone bankrupt and the insurance giant was rescued by the U.S. government.

Cuomo has asked the SEC for a freeze on short-selling.

But to suggest that this is why the markets are in turmoil is crazy. It's like blaming the guys betting on the horse for the horse carrying 200 extra pounds and stumbling to the finish line. The banks lent money to people who couldn't pay them back, and then hid the debt in all sorts of tricky new assets and securities that they tried to shovel out the door. That's the main problem, and no change in short-selling would alter that. The other problem is leverage, which may or may not be the SEC's fault.

As we learn this morning via Julie Satow of the NY Sun, special exemptions from the SEC are in large part responsible for the huge build up in financial sector leverage over the past 4 years -- as well as the massive current unwind.

Satow interviews the above quoted former SEC director, and he spits out the blunt truth: The current excess leverage now unwinding was the result of a purposeful SEC exemption given to five firms.

You read that right -- the events of the past year are not a mere accident, but are the results of a conscious and willful SEC decision to allow these firms to legally violate existing net capital rules that, in the past 30 years, had limited broker dealers debt-to-net capital ratio to 12-to-1.

Instead, the 2004 exemption -- given only to 5 firms -- allowed them to lever up 30 and even 40 to 1.

Who were the five that received this special exemption? You won't be surprised to learn that they were Goldman, Merrill, Lehman, Bear Stearns, and Morgan Stanley.

You can credibly charge Cox with failing to conduct meaningful oversight and indeed encourage over-leveraging, but that's not what McCain said.

He talked about short selling, which is perfectly legal, thanks to the masters of the universe like Phil Gramm, who encouraged and supported the casino-like atmosphere on Wall Street that led to this mess.

If you want to know what happened to blow up the financial markets, it's relatively simple. The banks let anyone buy a house, securitized the mortgages, and over-speculated and over-leveraged themselves, so that investors were buying worthless pieces of paper that they thought were valuable. The fixes are also simple:

Reform One: If it Quacks Like a Bank, Regulate it Like a Bank. Barack Obama said it well in his historic speech on the financial emergency last March 27 in New York. "We need to regulate financial institutions for what they do, not what they are." Increasingly, different kinds of financial firms do the same kinds of things, and they are all capable of infusing toxic products into the nation's financial bloodstream. That's why Treasury Secretary Hank Paulson has had to extend the government's financial safety net to all kinds of large financial firms like A.I.G. that have no technical right to the aid and no regulation to keep them from taking outlandish risks. Going forward, all financial firms that buy and sell products in money markets need the same regulation and examination. That will be the essence of the 2009 version of the Glass-Steagall Act.

Reform Two: Limit Leverage. At the very heart of the financial meltdown was extreme speculation with esoteric financial securities, using astronomical rates of leverage. Commercial banks are limited to something like 10 to one, or less, depending on their conditions. These leverage limits need to be extended to all financial players, as part of the same 2009 banking reform.

Reform Three: Police Conflicts of Interest. The conflicts of interest at the core of bond-raising agencies are only one of the conflicts that have been permitted to pervade financial markets. Bond-rating agencies should probably become public institutions. Other conflicts of interest should be made explicitly illegal. Yes, financial markets keep "innovating." But some innovations are good, and some are abusive subterfuges. And if regulators who actually believe in regulation are empowered to examine all financial institutions, they can issue cease-and-desist orders when they encounter dangerous conflicts.

The SEC could have handled reform 2, but that's about it. There are also reforms that we can do to ensure that people stay in their homes, which would be novel, protecting ordinary people instead of the executives who caused this. AND, we could actually tax hedge fund managers on their income the way we do any other income-generating American, increasing federal revenue and having the people at least somewhat responsible for this mess partially finance the bailouts, as they are no longer creating public wealth.

This remains a scary time. China could decide that holding US dollars doesn't make any sense and divest, which would lead to what Michael Bloomberg has called a next wave crisis.

But you'll see that short-selling, which actually doesn't affect the market as much as claimed, because on the way down you have to buy the stock to cover the sale, isn't on anyone's reform list. The bottom line is that simple regulation that is actually implemented is much cheaper and more efficient than bailing out everyone on Wall Street with phantom money that is just created out of thin air and ends up becoming debt for our children and grandchildren. John McCain is out of touch with what is needed to soothe the markets, but it sounds manly to "strike forth" and fire a guy you decide is responsible. The responsibility lies with Republican love of deregulation, not any one person. You can scapegoat Chris Cox all you want, but it's a smokescreen.

...funny, too, how McCain can stand up to Chris Cox but not George Bush.

In private late Tuesday evening, the McCain campaign circulated a draft statement on the Wall Street crisis that attacked the Bush administration for a slow and "inconsistent" response, and charged that executives at several financial firms had made "misleading and false" statements.

But the criticism never appeared. After being circulated not only among McCain aides but also major campaign donors who have worked in the investment industry, the language was softened.

Congratulations, You Just Bought An Insurance Company

Johnny, tell them what they've bought 80% of:

Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben S. Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

Yes, that's right, you've got a troubled insurance giant with billions of dollars tied up in worthless pieces of paper masquerading as securities. Yours for the low low price of $85 billion dollars!

You know, if this was Bolivia, the State Department would put out a strong statement declaiming the nationalization of industry and the stifling of private enterprise. But of course, in this case, industry made horrible decisions, so that justifies the Communism. It's unclear to me that it's even legal for the government to structure this absent legislation, but we're in a brave new world.

To be clear, AIG perhaps was too big to fail. And the hash that has been made of the financial markets cannot plausibly be worked out without government intervention. But can this be the end of the "drown government in the bathtub" rhetoric we've heard from conservatives since Goldwater? They eliminated regulation and oversight, ignored the maddening decisions made by the big banks who gambled with borrowed money and lost, and then obliged as the corporations came begging for a handout.

By the way, this could have been handled for $45 billion less three days ago. The shorts battered AIG's stock so mercilessly that they put taxpayers on the hook for twice as much.

I've said it before, but given the circumstances I don't know why anyone would want to be the President right now. But whoever gets the job is going to have to roll back all the deregulation initiatives that caused this mess. This has cost taxpayers and investors dearly, and the ones responsible are largely getting away with it; the CEO got a $47 million dollar severance package back in July.

Their debt, the result of their horrible choices, is now our debt. The risk has been socialized. And to top it off, this is an INSURANCE company who couldn't manage their own risk.

...by the way, in 50 days we may be giving the keys to the White House to the guy who called himself the biggest deregulator in America, who agrees with President Bush that we should put Social Security funds in the stock market. How's that make you feel?

...Pelosi:

The Bush Administration's eight long years of failed deregulation policies have resulted in our nation's largest bailout ever, leaving the American taxpayers on the hook potentially for billions of dollars. An $85 billion loan is a staggering sum and is just too enormous for the American people to bear the risk; Congress will demand answers to prevent this from happening again.

I have asked Chairman Barney Frank of the Financial Services Committee and Chairman Henry Waxman of the Oversight and Government Reform Committee to hold a series of hearings that will examine the Bush Administration's mismanagement of financial market regulation and how it led us to this remarkable failure. The questions we need answers to are whether fraud played a role in AIG's failure; why foreign stakeholders are not contributing to help pay for the bailout; and why the Bush Administration didn't use its existing regulatory authority effectively and sooner.

The American people deserve to know how eight years of Republican government failed to protect their homes, pensions, college saving plans, and other long-term investments. We cannot afford four more years of the Bush Administration's mismanagement of our economy.

The Federal Reserve Discovers Regulation

Exactly. The Fed had the ability to regulate the loan industry years ago. They neglected because everyone was getting rich. Now that they're bailing the whole industry out, NOW they go ahead and restrict loans to consumers that might be able to repay them.

The investors had their fun, now the taxpayers will bail them out. And I'm sure this will never, ever happen again.

UPDATE: Add me to the chorus of those who think that Freddie and Fannie should be government agencies and not a "government-sponsored entity" with stockholders but also the government running the business. If they were government agencies they wouldn't have to be rescued and their need for capital to bump up their stock price would be eliminated.

AG Brown Sues Countrywide

Here's a statement from the Attorney General's office:

California Attorney General Edmund G. Brown Jr. today sued Countrywide Financial, its chief executive Angelo Mozilo, and president David Sambol, for engaging in deceptive advertising and unfair competition by pushing homeowners into mass-produced, risky loans for the sole purpose of reselling the mortgages on the secondary market.

“Countrywide exploited the American dream of homeownership and then sold its mortgages for huge profits on the secondary market,” Attorney General Brown said. “The company sold ever-increasing numbers of complex and risky home loans, as quickly as possible. Countrywide was, in essence, a mass-production loan factory, producing ever-increasing streams of debt without regard for borrowers. Today’s lawsuit seeks relief for Californians who were ripped off by Countrywide’s deceptive scheme.”

It is certainly true that lenders like Countrywide had to feed the beast of mortgage-backed securities, which investors were gobbling up at the height of the housing boom. They absolutely valued getting a mortgage into the secondary market over securing a mortgage that the buyer could actually pay back. The question is the level of criminality here. Atrios, an economist who's been following "Big Shitpile" for quite a while, isn't fully convinced:

We do know that at some point the product that mortgage companies were selling essentially flipped. They went from providing mortgages to people, to providing bundled mortgage securities to Wall Street. While it's quite possible that there was actual fraud going on with respect to mortgage borrowers, the greater fraud might have been perpetrated against the investors which eagerly bought up their chunks of big shitpile. Obviously I sympathize less with the latter who are paid big money to, you know, have some idea what they're doing.

Tanta at Calculated Risk is similarly unimpressed with a similar lawsuit out of Illinois, saying that it it trying to sue over established industry practice.

Volume-based compensation structures? There have been volume-based compensation structures in this business since long before Tanta got into it. Does it create perverse incentives? Sure. Do we have to like it? No. Has it operated all these years in plain sight of regulators, investors, and the public? Yes. Is CFC's pay structure all that different from anyone else's? I profoundly doubt it.

And if anyone who has ever underwritten a loan in 30 minutes has to go to jail, the jails will be full indeed. I wonder if they'll let me take my new Kindle. Jesus H. Christ on a Process Re-engineering Consultant Binge, folks, anybody who didn't tell the analysts on the conference calls that they'd got their average underwriting time down to 30 minutes was Nobody back in 2000. Not to mention the AUS side of the business where underwriting had gotten down to 30 seconds.

The problem with Countrywide valuing volume over quality is that they appear not to have to pay the price for that. In a traditional system, Countrywide getting stuck with a lot of bad loans would hurt them, creating a disincentive. Now, they're passing on that pain to investors, and the feds are swooping in to bail the financial institutions out anyway, so it's guilt-free. I don't know that the remedy here is a lawsuit, other than allowing the market to punish bad actors, something we never do in this country, because for decades we have socialized risk and privatized profits.