Monday, September 29, 2008

Bailing out the bailout 

Rachel Maddow just asked perhaps the most insightful question of this bailout to date: Is this economic crisis global warming or the Iraq War? Is it a real crisis that builds slowly that people fail to acknowledge, or is it a bunch of hype and hysteria over what is, in the end, nothing.

Laura D'Andrea Tyson says that this credit crunch is real and real bad, and your job is at risk. Its not a bail-out, but a rescue of a broken market.

Therein lies the rub. I think there are two fundamental issues that have doomed the bailout bill earlier today.

First, this is a really complicated mess, and no one understands what is actually going on. Who among you actually understands credit-default swaps, or the leveraging of commercial paper for mortgage-backed securities? Not me. Probably not you. One of the major difficulties here is that there is no story to explain what is happening, leaving no reason to justify the extraordinary actions necessary to save the economic markets. There's a lot of assigning of blame, but there's little explanation of what actually is the problem. I'm not saying that there needs to be a blue-ribbon commission producing a report. Rather, what is needed is a narrative that makes sense of what is going on in such a way that people can actually understand what is happening and that justifies a response. All we have now is a series of bank failures, the biggest drop in the Dow ever, and a back and forth of Presidential politics.

So what has actually happened? Two items have broken through: 1) people can't pay mortgages and 2) wall street bankers made some poor bets. Neither of these really sounds all that drastic, and neither of these really calls out for action. People are annoyed with others who borrowed over their heads when they were responsible, but its hard to blame families for tough economic times. No one really has any sympathy for Wall Street.

The massive problems that remain--the credit crunch, the insolvency of key financial instruments, the potential lack of cash for business operations, this is much more significant but much less of the story. If a rescue operation is going to have any chance of success, its proponents need to develop a narrative on the crisis before they can sell the solution.

Second, this is a "bailout." Of Wall Street, no less. No one likes to bail-out fat cats who make poor decisions. Except that at this point its far beyond a bailout, its rescue of a broken financial system by extensive nationalization, regulation, and government intervention. This intervention needs another frame. FDR, who has re-emerged as everyone's favorite President these days, was an expert at this. The New Deal socialized large parts of the economy. Lend-Lease paved the way for entry into World War II. But Roosevelt was expert in telling the American People that, when your neighbor's house is on fire, you give them the hose now and worry about payment later.

This is more than a bailout, its a rescue of a broken system on the verge of collapse. Except that you wouldn't know that from the event itself. If Congress and the Administration are going to rescue the economy, they need a plausible narrative of what is going on to explain the seriousness of the problem and to form the basis of a political coalition. Then they need to start talking about a government rescue to save the economy, and drop all this Wall Street bailout jargon.


Wednesday, September 17, 2008

One decline in American intelectual leadership worldwide 

The NY Times has a very interesting article out today reporting that the influence of the US Supreme Court is waning--internationally. While the Court holds no jurisdiction beyond the US borders, for a long time it served as an intellectual leader in world judicial opinion. Other nations looking to develop a strong judicial system looked to the US Supreme Court as a model, and looked to the Court's opinions as cutting-edge legal thought that could--and did--shape legal arguments elsewhere.
The signature innovations of the American legal system — a written Constitution, a Bill of Rights protecting individual freedoms and an independent judiciary with the power to strike down legislation — have been consciously emulated in much of the world. And American constitutional law has been cited and discussed in countless decisions of courts in Australia, Canada, Germany, India, Israel, Japan, New Zealand, South Africa and elsewhere.

In a 1996 decision striking down a law that made it a crime to possess pornography, for instance, the Constitutional Court of South Africa conducted a broad survey of American First Amendment jurisprudence, citing some 40 decisions of the United States Supreme Court. That same year, the High Court of Australia followed a 1989 decision of the Supreme Court in a separation-of-powers case, ruling that a judge was permitted to prepare a report for a government minister about threats to aboriginal areas because the assignment did not undermine the integrity of the judicial branch.

Sending American ideas about the rule of law abroad has long been a source of pride. “The United States Supreme Court is the oldest constitutional court in the world — the most respected, the most legitimate,” said Charles Fried, a law professor at Harvard who served as solicitor general in the Reagan administration.
Interesting enough, while the US Courts serve as a source for other countries legal arguments, US judges don't often rely on International Law. Some, like recently retired Justice Sandra Day O'Conner or current Justice Anthony Kennedy, would like to see a greater use of international law. But, as one scholar observed
“We are used to encouraging other countries to adopt American constitutional norms, “ he wrote in an essay last month, “but we have never accepted the idea that we should adopt theirs.”

“It’s American exceptionalism,” Professor Posner added in an interview. “The view going back 200 years is that we’ve figured it out and people should follow our lead.”

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Friday, September 12, 2008

The Bailout 

The US bailout of Fannie Mae and Freddie Mac was a massive government intervention into the securities market. Why do this?

Dan Drezner gives some insightful instant analysis, noting how the fall-out has reverberated through the global economy, hitting China, Russia, Sovereign Wealth Funds, and many other key international actors. The US Government:
is also trying to soothe financial markets and-more important-please foreign creditors. China is far and away the largest foreign investor in long-term U.S. government agency debt-more than $375 billion. In the past month Chinese officials had warned about the implications of a collapse of the two housing giants.

Beijing was not the only foreign government to raise hackles about the status quo-other foreign officials voiced their concerns directly to Treasury Secretary Henry Paulson. Senator Chuck Schumer told the Wall Street Journal that, "There was a real fear that foreign governments would start dumping Fannie and Freddie...and not buy the bonds."

As long as the United States runs a current account deficit of more than $500 billion a year, it will need the trust of foreign capital and foreign governments. Judging by the global market reaction, seizing Fannie Mae and Freddie Mac helped preserve that goodwill abroad. One reason this happened on a Sunday was so that Asian stockmarkets would have the first opportunity to respond.
How necessary was this reassurance to international capital markets? The nightmare scenario Paulson faced was:
But let's say that the Treasury did not support the debt of the mortgage agencies. The Chinese bought over $300 billion of that stuff and they were told that it is essentially riskless. The flow of capital from them and from other central banks, sovereign wealth funds, and plain old ordinary investors would shut down very quickly. The dollar would fall say 30-40 percent in a week, there would be payments system gridlock, margin calls at the clearinghouses would go unmet, and only a trading shutdown would stop the Dow from shedding half its value. Most of the U.S. banking system would be insolvent. Emergency Fed/Treasury action would recapitalize the FDIC but we would lose an independent central bank and setting the money supply would be a crapshoot. The rate of unemployment would climb into double digits and stay there. Many Americans would not have access to their savings. The future supply of foreign investment would be noticeably lower. The Federal government would lose its AAA rating and we would pay much more in borrowing costs. The deficit would skyrocket.
Charles Kindleberger famously observed:
For the world economy to be stabilized, there has to be a stabilizer--one stabilizer.
Here you have the US acting to stabilize the international economy. It needed to be done, and no one else could do it.

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Saturday, September 06, 2008

One less base 

Ecuador has decided not to renew the lease the US has on its base there. The roughly 450 US personnel there had been very involved in anti-drug operations.

This move reflects two negative trends for US relations in Latin America. First, is the simple reduction in US influence. The Post reported that the millions the US pays each year no longer buy the influence that they once did, as more millions from other countries (ie Venezuela) and development infrastructure projects flow into the country.

Second, and more disturbing, is the wide-spread currency of anti-American politics. Part of this is a reaction to policies of the Bush Administration. But another part of it is structural. As the Ecuadoran Security Minister observed,
"This is a problem for us of sovereignty," [Security Minister] Larrea said. "It's as if we had a base in New York. This would be incomprehensible for North Americans."

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