Current Affairs

by hilzoy

I don’t know about you, but I find the news from Wall Street a tad unnerving:

“The American financial system was shaken to its core on Sunday. Lehman Brothers Holdings Inc. faced the prospect of liquidation, and Merrill Lynch & Co. was close to a deal to sell itself to Bank of America Corp.

“We have never seen anything like this,” said analyst Glenn Schorr, who covers the investment banks for UBS AG. “There have been tough situations like Long-Term Capital Management and the crash of 1987, but the problem here is there is leverage in the securities under the microscope and in the banks that own them. And to try and unwind it all at once creates a one-way market where there are only sellers, and no buyers.”

The convulsions could lead to even tighter credit, higher borrowing costs and moribund capital markets, as securities firms and commercial banks try to further limit risk and preserve capital. Those moves could cause the U.S. economy to slow further.”

And that’s not even the latest news: since that article was published, Merrill has decided to sell itself to BofA, Lehman Brothers seems to be about to file for bankruptcy, AIG has asked the Fed for help, though the WSJ adds that “it wasn’t clear what (the Fed) could do”, and the Fed, for its part, has expanded its lending facilities, prompting Yves Smith to comment:

“I guess it is now official. We no longer have functioning trading markets, at least in terms of serving their alleged purpose of giving companies access to capital.”

Nouriel Roubini is generally pessimistic, but he’s also generally right. Here’s his take*:

“It is now clear that we are again – as we were in mid- March at the time of the Bear Stearns collapse – an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system.”

I very much hope he’s wrong. But it looks to be a wild ride.

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by hilzoy

The news about Fannie Mae and Freddie Mac sounds terrifying to me:

“Shares of Fannie Mae and Freddie Mac, the beleaguered mortgage finance companies, plummeted again on Friday morning, as senior Bush administration officials consider a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, according to people briefed about the plan.

Fannie Mae stock was down 36 percent in early trading compared with Thursday’s closing price; Freddie Mac stock was down 41 percent.”

And that was after big previous losses. As of right now, Freddie Mac is down over 87% from a year ago; Fannie Mae is down over 85%.

The FT has a nice, short summary of the problem:

“As house prices have fallen and foreclosures have soared across the US, the two institutions have suffered deep losses, which they have tackled by raising more capital. Many observers believe that a collapse of Fannie Mae and Freddie Mac could bring the US mortgage market to a complete standstill, with severe repercussions for the financial sector and the economy as a whole.

Many investors in Fannie Mae and Freddie Mac have come to assume that the government would eventually come to their rescue because of their importance to the system. However, concern has risen recently that contingency plans for a government bail-out might involve wiping out public shareholders to minimise the cost to taxpayers, while confidence that senior debt would be protected has held up.”

Bringing “the US mortgage market to a complete standstill” does not sound like a very good idea. What are the alternatives? One is a conservatorship:

“Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.”

The shares that would be wiped out presently amount to about $18billion. But the liabilities we, the taxpayers, might have to assume are staggering:

“What Americans need to know is how damaging such a failure would be. This wouldn’t merely be a matter of the Federal Reserve guaranteeing $29 billion in dodgy mortgage paper, a la Bear Stearns. Fannie and Freddie are among the largest financial companies in the world. Their liabilities – mortgage-backed securities (MBSs) and other debt – add up to some $5 trillion.

To put that in perspective, consider that total U.S. federal debt is about $9.5 trillion, compared to a total U.S. GDP of $14 trillion. About $5.3 trillion of that debt is held by the public (in the form of Treasury bonds and the like), while $4.2 trillion is intragovernment debt such as Social Security IOUs. This is the liability side of America’s federal balance sheet, and its condition influences how much the government can borrow and at what rates.

The liabilities of Fan and Fred are currently not on this U.S. balance sheet. But one danger is a run on the debt of either company, putting pressure on the Treasury and Federal Reserve to publicly guarantee that debt to prevent a systemic financial collapse. In an instant, what has long been an implicit taxpayer guarantee for both companies would be made explicit – committing American taxpayers to honoring as much as $5 trillion in new liabilities. U.S. debt held by the public would more than double, and the national balance sheet would look very ugly.”

$5 trillion dollars in liabilities is a staggering amount, even when you consider that not all many of the loans we would guarantee would not go bad*, and so we would almost certainly not be on the hook for the entire amount. But if Fannie and Freddie become insolvent, it would beat the alternative, which is, as best I can tell, more or less shutting down the market for mortgages.

***

Which leads me to an important point. Unlike Bear Stearns, Fannie and Freddie really are too big to fail. What this means, as far as I’m concerned, is that we need to take steps to ensure that they won’t fail. This, to me, was one of the huge lessons of the S&L crisis (and, for that matter, of plain common sense): when the government is on the hook when things go bad, the government should take steps to ensure that things don’t.

Mark Thoma quotes Robert Reich:

“Here we have another example of socialized capitalism. The executives of Fannie and Freddie have been among the best paid in all of corporate America. We’re talking tens of millions a year in CEO pay alone. Fannie and Freddie are treated like giant investor-driven entities as long as they’re healthy and their investors and executives are doing well. But when they start to go down the tubes they become public entities with public responsibilities, the rest of us have to bail them out.”

And adds:

“If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral. In addition, they need to change the rules and regulations that allowed the problem to emerge in the first place, and add new rules and regulations as needed to lower the moral hazard worries going forward.”

Exactly.

(NB: it’s worth noting that the housing bill, which the Senate is considering today, would do just this. Better late than never. But it should have been done years ago.)

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by hilzoy

I was just going to ignore Pat Buchanan’s screed on the subject of Obama’s speech — in many ways, its title, “A Brief For Whitey”, tells you everything you need to know about it. However, on reflection, I did want to highlight one bit:

“First, America has been the best country on earth for black folks. It was here that 600,000 black people, brought from Africa in slave ships, grew into a community of 40 million, were introduced to Christian salvation, and reached the greatest levels of freedom and prosperity blacks have ever known.

Wright ought to go down on his knees and thank God he is an American.

Second, no people anywhere has done more to lift up blacks than white Americans. Untold trillions have been spent since the ’60s on welfare, food stamps, rent supplements, Section 8 housing, Pell grants, student loans, legal services, Medicaid, Earned Income Tax Credits and poverty programs designed to bring the African-American community into the mainstream. (…)

We hear the grievances. Where is the gratitude?”

I’m not going to focus on the idiocy of going on about how grateful blacks should be to whites without so much as mentioning the two centuries of slavery, the century of peonage and terrorism, and the fact that when blacks finally won civil rights, it was hardly due to a spontaneous surge of generosity on the part of whites. I take it that’s all too obvious to be worth saying. What I do want to focus on is the peculiar idea that things like “welfare, food stamps, rent supplements, Section 8 housing, Pell grants, student loans, legal services, Medicaid, Earned Income Tax Credits and poverty programs” constitute things whites did for blacks. Because that’s just false. Ta-Nehisi Coates:

“There is a lot wrong here, but one central thread of errant logic undergirds it all. Buchanan, like most racists, doesn’t actually believe that African-Americans are Americans. This isn’t an interpretation, Buchanan’s argument that white Americans, in the form of social programs, have done more for black people than any group (including presumably the entire Civil Rights Movement!) assumes that black people have never paid any taxes for those programs. He quite literally doesn’t categorize black people as Americans, but useless layabouts who’ve never contributed anything to the country.”

Taking Buchanan’s errors one by one:

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by publius

Let me heartily endorse Krugman and Herbert’s respective takedowns of David Brooks on St. Reagan and race. Even excluding Philadelphia (which shouldn’t be excluded), Reagan’s race-baiting is beyond dispute. It happened too often, for too long, and too systematically. The more interesting question is why modern-day defenders of the Order of St. Reagan (like David Brooks) continue to whitewash it. Why not just say, “Yes, that part was shameful, but that’s not the complete picture.” Let’s just be honest about it.

The answer, I think, hits upon a much larger and more interesting theme. Modern conservatives – the majority of which are certainly not racist – have successfully ignored the racist foundations of much of modern conservative political power and even thought. It’s not so much that the doctrines remain racist today – or that they lack non-racist interpretations. It’s that they are historically rooted in racist backlash. In this respect, Reagan’s dark side is simply one part of a much larger pattern.

The more conventional argument about ignoring race relates to the idea of race as “The Great Contradiction.” Quite literally, since the founding of this country, race has “contradicted” the American ideal. In 1776, we were the slave-holding nation that fought a war for liberty. In 1789, we created the most modern, rationalist, democratic government in history, but one that reduced black people to 3/5 of a person. We erect statues and monuments to great men, who happened to own slaves. In World War II, we rightly fought a war against hideous doctrines, while we tolerated Jim Crow. During the Cold War, we wrapped ourselves in rhetorical cloaks of freedom, while churches burned in Birmingham. Even today, we praise American markets and prosperity, while hurricanes (ever so briefly) force our eyes upon urban black poverty.

This is important stuff, but it’s not really what makes Brooks’ op-ed so significant. What’s significant is that Brooks – like so many before him – is trying to ignore the debt of modern conservatism to race. To be 100% clear on this, I am not accusing Brooks – or conservatives more generally – of being racist. I don’t think they are. The problem today is less racism, than an unwillingness to deal honestly with the consequences of prior racism (check out this old Legal Fiction piece on post-racism for more). Rather than coming to terms with this reality and moving on (like Mehlman did, to his credit), Brooks is pretending it didn’t happen.

Most obviously, Republican political power today rests on the race-based realignment that George Wallace first exploited. That’s why the term “Reagan Democrats” should actually be “Wallace Democrats.” Nixon and then Reagan both ruthlessly exploited white resentment to reshift the map. If you think these efforts don’t matter, check out how the bloc of Southern states voted in the 2000 and 2004 elections.

But more abstractly, much of modern conservative doctrine has foundations in racial issues. The clearest example is state rights and federalism. It’s true that progressives used states rights at times (e.g., to attack anti-labor federal judges in the early 20th century). But for pretty much all of American history (and certainly from 1948-88), it was code for race issues. Today, one can be a good federalist without thinking of race at all. But that doesn’t change the history of the ideology.

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