Oops. Turns out the GOP was right on the bailout before they flip-flopped:

Not that anyone pays attention to party platforms, least of all McCain, but a reader spots this rather unambiguous section of the platform just passed by the GOP:

We do not support government bailouts of private institutions. Government interference in the markets exacerbates problems in the marketplace and causes the free market to take longer to correct itself.

[University of Chicago economics professor Luigi Zingales on why Paulson is wrong.]

When a profitable company is hit by a very large liability, as was the case in 1985 when Texaco lost a $12 billion court case against Pennzoil, the solution is not to have the government buy its assets at inflated prices – the solution is Chapter 11. In Chapter 11, companies with a solid underlying business generally swap debt for equity. The old equity holders are wiped out and the old debt claims are transformed into equity claims in the new entity which continues operating with a new capital structure. Alternatively, the debt holders can agree to trim the face value of debt in exchange for some warrants.

Even before Chapter 11, these procedures were the solutions adopted to deal with the large railroad bankruptcies at the turn of the twentieth century. So why is this well-established approach not used to solve the financial sectors current problems?  

The obvious answer is that we do not have time.

Chapter 11 procedures are generally long and complex, and the crisis has reached a point where time is of the essence. The negotiations would take months, and we do not have this luxury. However, we are in extraordinary times, and the government has taken and is prepared to take unprecedented measures. As if rescuing AIG and prohibiting all short-selling of financial stocks was not enough, now Treasury Secretary Paulson proposes a sort of Resolution Trust Corporation (RTC) that will buy out (with taxpayers’ money) the distressed assets of the financial sector.

But at what price?

If banks and financial institutions find it difficult to recapitalise (i.e., issue new equity), it is because the private sector is uncertain about the value of the assets they have in their portfolio and does not want to overpay.

Would the government be better in valuing those assets?  No. In a negotiation between a government official and banker with a bonus at risk, who will have more clout in determining the price?

The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich – at the taxpayers’ expense. If this subsidy is large enough, it will succeed in stopping the crisis.

But, again, at what price?

The answer: billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses. Remember that in the Savings and Loan crisis, the government had to bail out those institutions because the deposits were federally insured. But in this case the government does not have do bail out the debtholders of Bear Sterns, AIG, or any of the other financial institutions that will benefit from the Paulson RTC.

Since we do not have time for a Chapter 11 and we do not want to bail out all the creditors, the lesser evil is to do what judges do in contentious and overextended bankruptcy processes. They force a restructuring plan on creditors, where part of the debt is forgiven in exchange for some equity or some warrants. And there is a precedent for such a bold move.

During the Great Depression, many debt contracts were indexed to gold. So when the dollar convertibility into gold was suspended, the value of that debt soared, threatening the survival of many institutions. The Roosevelt Administration declared the clause invalid, de facto forcing debt forgiveness. Furthermore, the Supreme Court maintained this decision.

My colleague and current Fed Governor Randall Koszner studied this episode and showed that not only stock prices but bond prices as well soared after the Supreme Court upheld the decision. How is that possible? As corporate finance experts have been saying for the last thirty years, there are real costs from having too much debt and too little equity in the capital structure, and a reduction in the face value of debt can benefit not only the equity holders, but also the debt holders.

If debt forgiveness benefits both equity and debt holders, why do debt holders not voluntarily agree to it?

·     First of all, there is a coordination problem.

Even if each individual debtholder benefits from a reduction in the face value of debt, she will benefit even more if everybody else cuts the face value of their debt and she does not. Hence, everybody waits for the other to move first, creating obvious delay.

·     Second, from a debt holder point of view, a government bail-out is better.

Thus, any talk of a government bail-out reduces the debt-holders’ incentives to act, making the government bail-out more necessary.
As during the Great Depression and in many debt restructurings, it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for-equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture.

 

But if it is so simple, why has no expert mentioned it?

The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt-forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few. Since the many (we, the taxpayers) are dispersed, we cannot put up a good fight in Capitol Hill. The financial industry is well represented at all the levels. It is enough to say that for 6 of the last 13 years, the Secretary of Treasury was a Goldman Sachs alumnus. But, as financial experts, this silence is also our responsibility. Just as it is difficult to find a doctor willing to testify against another doctor in a malpractice suit, no matter how egregious the case, finance experts in both political parties are too friendly to the industry they study and work in.  

The decisions that will be made this weekend matter not just to the prospects of the US economy in the year to come. They will shape the type of capitalism we will live in for the next fifty years. Do we want to live in a system where profits are private, but losses are socialised? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalised and prudent behavior rewarded?

For somebody like me who believes strongly in the free market system, the most serious risk of the current situation is that the interest of few financiers will undermine the fundamental workings of the capitalist system. The time has come to save capitalism from the capitalists.

Today’s Washington Post contains a must read from George Will. here’s the key passage:

The political left always aims to expand the permeation of economic life by politics. Today, the efficient means to that end is government control of capital. So, is not McCain’s party now conducting the most leftist administration in American history? The New Deal never acted so precipitously on such a scale. Treasury Secretary Paulson, asked about conservative complaints that his rescue program amounts to socialism, said, essentially: This is not socialism, this is necessary. That non sequitur might be politically necessary, but remember that government control of capital is government control of capitalism. Does McCain have qualms about this, or only quarrels?

On “60 Minutes” Sunday evening, McCain, saying “this may sound a little unusual,” said that he would like to replace Cox with Andrew Cuomo, the Democratic attorney general of New York who is the son of former governor Mario Cuomo. McCain explained that Cuomo has “respect” and “prestige” and could “lend some bipartisanship.” Conservatives have been warned.

Will then goes on to note what I too have observed that the case for McCain often relies on him being better on judges:

Conservatives who insist that electing McCain is crucial usually start, and increasingly end, by saying he would make excellent judicial selections. But the more one sees of his impulsive, intensely personal reactions to people and events, the less confidence one has that he would select judges by calm reflection and clear principles, having neither patience nor aptitude for either.

But temperament aside, claims about superior judge picks are still suspect.

Here Brad Smith (a victim of McCain’s notorious temper himself) explains why the McCain-Finegold free speech law doesn’t project “conservative” justices:

McCain is likely to make support for McCain-Feingold - an issue he has said is “of transcendent importance” to him - a litmus test for judges. It is very hard, however, to find judicial candidates who think McCain-Feingold is constitutional yet who are also are anti-Roe v. Wade and generally respectful of the Constitution. For anyone with a coherent judicial philosophy of federalism and limited government, the two just don’t go together. When McCain says he wants to appoint justices like Thomas and Scalia, we must consider that Thomas and Scalia would overrule all of McCain-Feingold, indeed all pre-existing campaign finance law except perhaps some disclosure. It is almost impossible to believe that Senator McCain would appoint Thomas or Scalia to the bench, let alone the Supreme Court.

In fact every indication is that had Justices Alito and Roberts been on the court when McCain-Finegold was decided they too would have been against it, meaning they too would have failed a litmus test on McCain’s issue of “of transcendent importance.”

McCain supporters may reply that campaign finance regulation is a dead issue, but McCain’s own actions suggest that this is not the case. After all, as recently as this Spring McCain says he doesn’t regret refusing to shake Bradley Smith’s hand at a Congressional hearing in 2004.

Leaving us to believe that he still stands by his name calling of Smith, when the Senator said: “You’re a bully and a coward. You have no regard for the Constitution. ” (Apparently consistently opposing campaign finance regulations on free speech grounds means one has “no regard for the Constitution.”)

Such a comment makes the incident with Smith a perfect example of the convergence the two issues: (1) the poor prospects for solidly conservative judicial selections by McCain, and (2) his notorious temper.

Over at the American Conservative’s blog, Daniel McCarthy observes some of the same things I did about the Barr campaign’s actions regarding Ron Paul’s September 10th presser before concluding that Barr has only himself to blame for losing Dr. Paul’s endorsement to Chuck Baldwin (along with Barr’s own campaign manager Russ Verney).

By the way, also checkout Daniel’s coverage of the Rally for the Republic and maybe even take advantage of the 3 month free trial of the American Conservative Magazine. (I did)

Today the TSA unveiled new uniforms, with dark blue shirts and shiny gold badges (that replace an embroidered patch).

According to the TSA site, the new costume is designed to make TSA employees look more like an “officer” and less like a security “screener.”

Rasmussen Polling asks:

Should the Supreme Court make decisions based on what’s written in the Constitution and legal precedents or should it be guided mostly by a sense of fairness and justice?

60% What’s written in the constitution
30% It should be guided by fairness and justice
11% Not sure.

Also of note is the crosstabs:

While 82% of voters who support McCain believe the justices should rule on what is in the Constitution, just 29% of Barack Obama’s supporters agree. Just 11% of McCain supporters say judges should rule based on the judge’s sense of fairness, while nearly half (49%) of Obama supporters agree.

As I noted yesterday, sending Phil Gramm to ask Ron Paul for his endorsement doesn’t seem like a very smart move by the McCain camp.

Today in the Wall Street Journal’s Political Diary, John Fund observes the same thing:

No Cigar

The McCain campaign could have picked a better ambassador to convince GOP Rep. Ron Paul to endorse the ticket.

Mr. Paul, who won some two million votes during the Republican presidential primaries, held a news conference yesterday in Washington to announce he would not support the McCain-Palin ticket and instead urge his followers to vote for any of an eclectic group of third-party candidates. These ranged from Bob Barr, the Libertarian Party candidate, to consumer advocate Ralph Nader.

During the news conference, Mr. Paul revealed that the McCain campaign had gotten former Texas Senator Phil Gramm to call him and urge him to back the GOP ticket. Mr. Paul said he told Mr. Gramm such a move would alienate many of his core supporters and he wouldn’t do it. Mr. Paul didn’t have to add that he and Mr. Gramm fought a bitter primary for the U.S. Senate in Texas back in 1984. Mr. Gramm won, forcing Mr. Paul to give up his House seat. Mr. Paul didn’t return to Congress until a dozen years later.

Even though Mr. Paul has clear disagreements with Senator McCain on the Iraq War and civil liberties issues, he seems more forgiving towards his running mate Sarah Palin. “She said nice things about me on MTV,” he told me at last week’s GOP convention. “I hear nice things about her from my supporters in Alaska.”

Mr. Paul is referring to an MTV interview in which Mrs. Palin referred to Mr. Paul as “a good guy” who was “independent of any party machine” — much as she was during her own climb from the Wasilla City Council to the governor’s office in Juneau.

Even though Mr. Paul has spurned the GOP ticket, I suspect a fair number of his voters will plump for McCain-Palin in the fall. So far, she has shown the rare ability to attract support from all strands of the GOP coalition — from social conservatives to the more libertarian acolytes of Mr. Paul. It’s quite a hat trick, and we’ll see if she can maintain the enthusiasm all the way to November.

– John Fund

I didn’t attend the press conference(s) today, but I’ve read reports from a variety of sources (with varying points of view). Here are some random observations:

• Did the McCain campaign really think that having Phil Gramm ask Ron Paul to endorse McCain was a good idea? (From what I can gather it was the dirty tactics by Republicans in favor of Graham over Dr. Paul, when they both ran for the same Senate seat from Texas in 1984, that was a significant factor in Ron Paul running for President as a Libertarian in 1988.)

• Bob Barr’s campaign did itself a great disservice today.

• Because of the Barr campaign’s last minute pullout, the point of the “We Agree” statement will be missed. That point, in my view, is that there are four fundamental principles that most Americans agree on, but the the two major candidates we have to choose from largely or completely reject.

• The big winner today was the Baldwin campaign.

• I was surprised that Nader and McKinney signed on to the statement, but I’m pleased that they did.

• I am always skeptical of “strange-bedfellows”projects for the reason that Richard Spencer aptly points out: “in all these Left-Right, “strange-bedfellows” coalitions, the Left always ends up on top.”

• If Bob Barr was willing to offer Ron Paul his VP slot, why not offer him the top of the ticket? (Barr could then take the VP slot.)