John McCain’s Unworkable Plan to Deregulate and Insure Our Way Out of the Crisis
Tonight, John McCain, by tacitly lending his support to the House Republican revolt against the Grand Compromise Bailout Plan, succeeded (?) in causing the negotiations to fail, at least for the time being. Expect a very black Friday on the market.
In the meantime, I’m trying to figure exactly what the McCain-backed counter-proposal means. The center piece is private-party funded insurance, with the premium price set by the government. Here’s the key line in the proposal: “The Treasury Department can design a system to charge premiums to the holders of MBS to fully finance this insurance.” It can? How? Let’s explore three possibilities.
First, assume the government would just set the insurance premiums at some very high number. Let’s even call it extortionate, since that’s what the markets today would force you to pay to take on that kind of risk. Why would private companies agree to pay this rate? If the answer is that the companies will be forced to buy insurance, I don’t see how that wouldn’t immediately lead to those companies simply declaring bankruptcy. That, my friends, isn’t the kind of liquidity solution we’re looking for. Rather, it’s what we’ve got today.
Second, assume that the government tries to price insurance at a low rate. Everyone pays the premiums, happily, because as I understand the proposal the government will be on the hook for failure, and we’ve now just done the bailout without any meaningful governance reforms.
Third, assume the government tries to price the insurance accurately, i.e., to reflect the likelihood that it will have to pay-out claims. Super. But figuring out the default risk is exactly the problem that the market has tried, and failed, to solve over the last year. Tens of thousands of the brightest, most motivated, brains on Wall Street have thrown themselves at this sucker. And the House Republican Study Committee thinks that the Federal Government’s Treasury Department will be able to figure this out over the next few days.
Maybe I’m missing something, but the insurance plan seems, on its face, to be a joke, and not intended as a real solution to the liquidity crisis. There must be something else here.
Indeed, the McCain-backed-Republicans offered several governance reforms [with my comments in italics:]
(1) remove “regulatory and tax barriers that are currently blocking private capital formation”
I guess this means that the Republicans have decided that this problem is one of too much regulation, not too little. Repealing the CGT for two years is, of course, an old proposal of the republican study committee. In theory, it would result in up to $127B more in private hands annually (instead of government hands). But how can it possibly be that the RSC thinks that repealing the CGT have the same kind of liquidity effects as actually pumping money into the market. The repeal would be prospective, so only a small percentage of the $127B is at stake; and it isn’t at all clear that investors would take the money and plow it back into stocks. I wouldn’t. If I had extra cash, right now, I’d buy gold, like everyone else I know. Moreover, it would be less than the cost of the AIG bailout, which did nothing to halt market turmoil As for the idea that deregulating the financial institutions will unfreeze their lending behavior, I think I’d stand on Paulson’s (reported) response: incredulity.
2. Increase transparency by requiring firms to disclose the MBS assets on their books, recent bids, and audits; prevent the government from buying high risk loans; require the SEC to audit corporate books and review the credit rating agencies, and “create a blue ribbon panel with representatives of Treasury, SEC, and the Fed to make recommendations to Congress for reforms of the financial sector by January 1, 2009.”
Some of these solutions, like peering under the hood of the credit agencies, are good policy and ought to be enacted. Transparency too is a good thing. And blue-ribbon panels give reporters more substantive news to ignore, so I’m in favor of them too. But it’s obviously true that none of the suggestions, in any way, would alleviate today’s crisis. Transparency isn’t the issue, rather it’s that most of the MBS have no clear value (and perhaps no positive value) because (1) the housing market is in a meltdown; (2) the instruments are complex and leveraged; and (3) they are widely distributed. Transparency is a solution when the data are clear. When the water is muddy, glass bottom boats increase vulnerability without adding enjoyment to the trip.
I imagine that I’m missing something. But it seems like the House Republicans have put together a proposal that would almost certainly not fix the market crisis, and, would instead, deregulate the very firms that got us into this mess.
I know that I just recently ranted against political blogging. But John McCain’s willingness to disrupt a very fragile political compromise on a bailout, and support for this hashed-up plan, really makes me concerned both for his judgment, and the future of the country. In my view, given that he has no expertise in this area, and his presence makes politicians think about the November, instead of this week, the right thing for him to do is to announce tomorrow morning that in the interests of the country, he will support any bill that garners the support of the majority of representatives in the House. He should then leave town on the first available plane.
[Update: Just to be fair, the online-left is equally foolish about this. Chris Bowers has a post up that assumes that we have forty days to debate this issue, as if it were a normal political problem, the crisis being manufactured by a self-dealing industry and a captive Congress. Lunacy.]