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September 2008

The McCain Health Care Plan

Robert Carroll writes:

I read Brad Delong’s posting on my recent piece, “McCain’s Health Credit: The Intersection of Health Policy and Tax Policy,” The Tax Foundation, Fiscal Fact No. 144, September 16, 2008 (, with great interest. In my piece I tried to make it clear that the McCain health credit proposal was not a panacea. It addresses important problems with the current tax treatment of employer-based health insurance. Improved incentives can help control health care costs. But the policy also increases the tax subsidy for health care from its current level of about $3.6 trillion over ten years to about $5.0 trillion over ten years. This large increase in the aggregate subsidy increase might well work in the opposite direction.

There are also concerns about the effect of the policy on the employer market. This is partly mitigated by keeping the payroll tax exclusion for employer-based health insurance (i.e., not completely leveling the playing field between the group and non-group markets). Usually, proposals to change the tax treatment of health care are accompanied by other proposals to reform insurance markets to ensure sufficient pooling and to increase subsidies for those with high risk/poor health status. But these proposals also more often than not take the form of objectives rather than well defined or articulated policies.

The main point Brad is making is that he does not see how the McCain health credit could possibly increase the number of newly insured by 15 million or more. The idea is simply that some, perhaps many, would have the means to purchase health insurance under the McCain health credit. Let’s consider the size of the full subsidy under the McCain proposal. First, McCain provides the $5,000 and $2,500 credits for family and individual coverage. Second, he does not completely replace the existing tax subsidy for employer-based insurance. While repealing the income tax exclusion, he retains the payroll tax exclusion, which is about one-third of the existing $3.6 trillion subsidy (over ten years). The payroll tax exclusion lowers the price of health insurance purchased through one’s employer from $1 to about 85 cents for those below the Social Security wage cap (and to just 97 cents for those above the wage cap). Consider a family purchasing a $6,000 policy. After-tax payroll taxes, the cost of this policy would be $5,100. The McCain health credit would cover another $5,000, leaving the family with a $100 after-tax cost for the policy. Presumably the family would place at least some value on the policy and might be willing to spend the $100 on the insurance.

Now, the more important question is whether someone really can find family policies with premiums in this range. Let’s stipulate that the insurance policy is not likely to be a generous plan with first dollar coverage or low deductibles. It is much more likely to be a plan with higher deductibles that is more focused on providing insurance rather than covering routine and predictable medical expenses. Indeed, this is one of the objectives of the policy: to reduce the current tax bias that encourages people to funnel routine health expenses through insurance policies.

Searching, I found that the annual premium for the top ten picks for family coverage with two adults born in 1970 (i.e., their late thirties), and two children, ranged from $2,208 to $6,048 in Berkley’s zip code of 94720. The deductibles ranged from $500 to $7,000. The plans with a $3,000 and $5,000 deductible had annual premiums of $5,304 and $3,828, respectively. Obviously, this casual observation is not meant to suggest that everyone can get these rates, because clearly they cannot. Those with poor health status, with high risk profiles or in high cost areas would undoubtedly pay more, and possibly a lot more. The point, however, is that the level of subsidy provided by the McCain health credit is not ridiculously low. Rather, it actually would provide a substantial benefit to many. So, now, lets to turn to where the estimate of 15 million came from.

The estimate of 15 million comes from work on similar proposals about the time the Administration put forward its proposal back in early 2007 for a new standard deduction for health insurance (SDHI) to replace the existing income and payroll tax exclusions for employer-based health insurance. At the time, estimates were produced from various sources for the original SDHI proposal and related credit proposals.1 Estimates for the SDHI proposal were prepared by the Congressional Budget Office (CBO), the Joint Committee on Taxation (JCT), the U.S. Treasury Department of the Treasury, and the Lewin Group.

These organizations estimated that the SDHI proposal would increase the number of newly insured (net of any effects related to the group market) by between 6 million to 9.2 million. The JCT and Lewin Group were at the high end with estimates of 8.5 and 9.2, respectively. The Treasury came in with a more conservative estimate of 6 to 7 million (to the chagrin of the Administration, I might add).

Estimates were also produced by the Treasury for various proposals to replace the income and payroll tax exclusions for ESI with a credit. The estimates for the credit proposals’ effect on the newly insured ranged from about 11 to 15 million. The estimates at the higher end of this range were for versions of the proposal with fewer strings attached to the excess credit (i.e., the credit amount in excess of the cost of health insurance). (Incidentally, another problem with the McCain health credit is that is requires the excess of the credit to be deposited into an HSA. I am not sure why this string needs to be attached. It would decrease the take-up and means that the link between the tax subsidy and health care spending is not completely broken, which seemed to be a key merit of the approach.)

Now, the McCain health credit differs from the proposals analyzed by the Treasury Department in one critically important respect: the McCain health credit retains the current exclusion for employer-based health insurance. This difference should have two effects on the estimates of earlier credit proposals, both of which should lead to higher estimates.

First, by retaining the payroll tax exclusion, the McCain proposal does not fully level the playing field between the group and non-group markets. Indeed, roughly speaking, and pointed out in my piece earlier this week, it retains about one-third of the existing tax subsidy for employer-sponsored health insurance. Thus, the effects of the proposal on the group market should not be as great under the McCain proposal as compared to the earlier proposals analyzed by the Treasury Department.
Second, the credit proposals analyzed by Treasury were roughly revenue neutral, but the McCain credit is not. Because the proposal retains the payroll tax exclusion, it provides a large tax cut. This tax cut, in effect, increases the federal tax subsidy for employer-based health insurance from the current $3.6 trillion over ten years to $5.0 trillion over ten years. Indeed, as shown in Chart 1 in my piece earlier this week, the value of the McCain health credit exceeds the tax value of the current income tax exclusion (where I assumed an average family premium of $14,000, not the lower $12,000 as suggested by Brad in his posting) at most income levels. The greater generosity of the McCain health credit relative to the earlier credit proposals analyzed by the Treasury should translate into the McCain health having a larger effect on the number of uninsured.

Of course, these are very difficult estimates to make (as suggested by the large variance in the estimates cited above for the Administration’s SDHI proposal), so it is difficult to put a precise number on the McCain health credit. But, it does stand to reason that if one finds the earlier estimates believable, then the McCain health credit should have more potent effects because it is simply a more generous proposal and does less harm to the employer market.

Another point to emphasize in an analysis of the McCain health credit is that it is highly redistributive. That is, it rechannels a significant portion of the current tax subsidy for health care to the low and moderate income, which is where a lot of the insured happen to reside in the income distribution. I would think that those on the left would find this aspect of the proposal, plus spending another $1.4 trillion (over ten years) on health care, to be somewhat attractive.

Given the interest among some on the left for the credit alternative to the Administration’s SDHI proposal at the time, I was a bit surprised that Senator Obama did not propose the credit himself. Indeed, a paper analyzing the Administration’s SDHI proposal co-authored by Jason Furman (Policy Director for Senator Obama’s Presidential campaign) and others saw some merit in the original SDHI proposal and suggested that a credit alternative would address some of its limitations.

John McCain Is Not Qualified to Be President

Paul Krugman writes:

McCain on banking and health: OK, a correspondent directs me to John McCain’s article, Better Health Care at Lower Cost for Every American, in the Sept./Oct. issue of Contingencies, the magazine of the American Academy of Actuaries. You might want to be seated before reading this. Here’s what McCain has to say about the wonders of market-based health reform:

Opening up the health insurance market to more vigorous nationwide competition, as we have done over the last decade in banking, would provide more choices of innovative products less burdened by the worst excesses of state-based regulation.

So McCain, who now poses as the scourge of Wall Street, was praising financial deregulation like 10 seconds ago — and promising that if we marketize health care, it will perform as well as the financial industry!

I Call for the Resignation of John McCain

Reality-based Republicans deserve a more honest, honorable, and qualified candidate to vote for this November.

The Anchorage Daily New:

Partisan diversion: Palin counterattacks instead of answering Troopergate questions

Gov. Sarah Palin’s handling of Troopergate is getting more and more troubling. She has reneged on her pledge, made before becoming the Republican vice-presidential nominee, to cooperate with the Legislature’s investigation. While stonewalling the independent inquiry, she is trying her side of the case in the press. Working on her behalf Monday, McCain-for-president operatives ripped into Walt Monegan and the legislators overseeing the inquiry.

Whatever happened to the “open and transparent” administration she promised Alaskans?


What Alaskans and the rest of the country need from Gov. Palin is simple. They need an honest accounting on two questions:

  • Did Gov. Palin force out public safety commissioner Walt Monegan because he would not fire her ex-brother-in-law from the troopers?
  • In pursuing Gov. Palin’s concerns about trooper Mike Wooten, did she, Todd Palin or her staff improperly obtain confidential information about him?


The McCain campaign apparently fears honest answers to those questions. Monday, two campaign operatives held a press conference to stir up partisan hysteria about the investigation and assail Monegan as “insubordinate” and a “rogue.” It was the kind of full-frontal personal attack that is so common in Washington, D.C. While pledging to clean up the nation’s capital, the McCain campaign has brought Washington’s repulsive tactics here to us in Alaska. The McCain-Palin attack on Monegan left key questions unanswered.

  • If he was so insubordinate, why did she offer him a different job in her administration?
  • Why is aide Frank Bailey on a recording telling a trooper lieutenant, “she really likes Walt a lot,” before going on to say the lack of action on Wooten is “very, very troubling to her and the family.”
  • How did Bailey get the information from Wooten’s workers’ compensation claim, as he stated on the recording?


Gov. Palin’s defenders have tried to discredit the Legislature’s investigation as a partisan witch hunt, even though it was launched with unanimous bipartisan support. The investigation’s project manager, Sen. Hollis French, gave them an opening by sharing accurate, but politically ill-advised observations about potential outcomes with reporters. Though a Democrat, French was one of Republican Gov. Palin’s most reliable supporters in her victories on ethics reform, oil tax reform and the gas line partnership with TransCanada. With his remarks, Sen. French lit a match and handed it to the McCain camp, which is trying to ignite a partisan firestorm that wipes out the whole investigation until after the election.


All the allegations about partisanship, though, are a typical political distraction. Sen. Hollis French is not the one interviewing witnesses, checking documents and issuing the findings. The investigation is being conducted by a retired prosecutor with a solid professional reputation, Steven Branchflower. Branchflower enjoyed significant Republican support in the Legislature when he ran the Office of Victims Rights and proposed laws to help crime victims. It’s just not credible to claim that all of a sudden, he’s a partisan hack being manipulated by Team Obama.


In Gov. Palin’s defense, she can fairly point out that Monegan has changed his account of why he thinks he was fired. Initially, he said he didn’t know why. Later, he said he felt pressured to fire Wooten and his failure to do so could be part of the explanation. He now says he thinks the refusal to fire Wooten “was a significant factor if not the factor.”

Of course, the charge of changing stories can be leveled against Gov. Palin. First she said she wanted a “different direction” for the department. Then she criticized Monegan’s management because he failed to fill vacant trooper positions — even though he could not single-handedly change the salary and working conditions that hinder recruitment. Now, she says Monegan was an insubordinate rogue.

Alaskans and the rest of the country need to know the truth of what happened in Troopergate. And to get the truth, they need answers from Gov. Palin, her staff and her husband — before the November election.

BOTTOM LINE: Palin and McCain are trying to ignite a partisan firestorm that wipes out the Troopergate investigation until after the election.

John McCain Is Dishonorable and Dishonest (Yet Another VP Vetting Edition)

Sarah Palin Was For Her Brother in Law Mike Wooten Before She Was Against Him

If John McCain's choice of the unvetted Sarah Palin for his vice-presidential running mate, was not dishonest and dishonorable, I do not know what honesty and honor are.

You remember how Sarah Palin says that the unwillingness of Alaska Public Safety Director Moneghan to fire her brother in law Mike Wooten had absolutely nothing to do with her decision to fire Moneghan--but that Mike Wooten is a psychotic creep.

Back in 2000 Sarah Palin expressed a different view of Mike Wooten. And please note how she does not begin her letter: "It is my pleasure to provide a character reference for my brother-in-law Mike Wooten..." Oh no. She doesn't do that at all:


Sarah Palin
City of Wasilla
290 E. Henning Ave.
Wasilla, Alaska 99654-7091
Phone: (907) 373-9055
Fax: (907) 373-9096

Jan. 1, 2000

To Whom It May Concern:

It is my pleasure to provide character reference examples for Mr. Mike Wooten. Since I have become acquainted with Mike I continue to be impressed with his integrity, work ethic, community spirit and tmstworthiness.

Mike has assisted the City of Wasilla with community events including Wasi1laʻs 25th anniversary celebration, 4th of July parade, and other community-oriented activities. Mike has shown interest and initiative in furthering his involvement with our community in the area of law enforcement and public safety, and he is awaiting future opportunities to assist the public by joining the efforts of opublic safety officials in our area, including potential opportunities with the Volunteer Police Reserve activities, to assist the Mat-Su Valley.

Mike is a strong supporter of the youth in our community, as evidenced by his willingness to jump right in with our youth football program and successfully coach the seven- to nine-year old boys' team during the 1999 season. Mike gained respect for his patience and dedication to the young men in his care during the season. On a personal note, I have witnessed Mikeʻs gift of calm and kindness towards many young kids here in Wasilla. I have never seen him raise his voice, nor lose patience, nor become aggitated in the presence of any child. Instead, Mike consistently remains a fine role model for my own children, and other young people in Wasilla. I wish America had more people with the grace and sincerity that mirrors the character of Mike Wooten... we would have a much kinder, calmer, trustworthy nation as a result.

I beleive the United States Air Force has been fortunate to have the services of Mike these past 10 years. His work ethic, his American patriotism, his obvious dedication to traditional values, and his strong faith in God and truth is witnessed in Mike's everyday living.

It is an honor to know Mike and I am confident he will continue to grow in character and internal strength as he moves through life. I do not hesitate in praising this man and I am happy to provide more information to you if you so desire.


Sarah Palin

John McCain Is Dishonest and Dishonorable (Real Estate Lobbying Edition)

Liz Wolgemuth:

McCain's Campaign Manager Was for It Before He Was Against It: A note on the work that you're doing now: It will be remembered. Unless you're in politics, that is. Why is it that résumé matters so much in the private sector and memories are so short in the public sector? As John McCain said in remarks today:

The financial crisis we're living through today started with the corruption and manipulation of our home mortgage system. At the center of the problem were the lobbyists, politicians, and bureaucrats who succeeded in persuading Congress and the administration to ignore the festering problems at Fannie Mae and Freddie Mac.

It seems a little bizarre then that McCain's campaign manager Rick Davis was hired—after running McCain's failed 2000 presidential campaign—to head up a group called the Homeownership Alliance, a Fannie Mae and Freddie Mac advocacy group, which the Wall Street Journal reported (in August 2000) had a website creed of being dedicated to: "exposing and defeating trends that would harm consumer access to the lowest-cost mortgage option." The group viewed as threats those who are "seeking to spread unfounded fears about risks to the housing system." From Institutional Investor in September 2000:

"You can say what you want about free-market distortions, but people like the system because it gets them into houses cheap," notes [Rick] Davis, who will run an advocacy group called the Homeownership Alliance out of his Alexandria, Virginia, lobbying firm. He was recruited by Fannie Mae senior vice president John Buckley, whom he met while working on Ronald Reagan's 1984 reelection campaign. Says Davis, "What we tried to do in the McCain campaign parallels what we want to do here—protect the consumer"...

John McCain Is Dishonorable and Dishonest

For picking a vice-presidential candidate when he did not know whether she was qualified for the job, and claiming that he did know. Outsourced to Hilzoy:

Obsidian Wings: Palin And The Bush Doctrine: I watched the first clip of Sarah Palin's interview with Charlie Gibson, and to me, the most striking part was her complete inability to answer the question: "Do you agree with the Bush Doctrine?" Here's what she said:

"Do you agree with the Bush Doctrine?" "In what respect, Charlie?" "The Bush -- well, what do you interpret it to be?" "His world view?" "No, the Bush Doctrine, enunciated in September 2002, before the Iraq war." "I believe that what President Bush has attempted to do is rid this world of Islamic extremism, terrorists who are hell-bent on destroying our nation. There have been blunders along the way, though. There have been mistakes made. And with new leadership -- and that's the beauty of American elections, of course, and democracy, is with new leadership comes opportunity to do things better." "The Bush Doctrine, as I understand it, is that we have the right of anticipatory self-defense; that we have the right to a preemptive strike against any other country that we think is going to attack us. Do you agree with that?"

The transcript doesn't really do it justice; the video is here, and it makes it pretty clear that she has no idea what the Bush Doctrine actually is. It also makes it clear that she is very quick on her feet -- she almost succeeds in getting Gibson to tell her....

This matters not because I think a whole lot turns on whether or not someone can correctly identify the Bush Doctrine, in particular, but because it is not a hard question to anyone who has been following foreign policy for the last few years. I want someone who might end up being President to have a reservoir of background knowledge to draw on in times of crisis. And Sarah Palin just doesn't have one.... The big deal about the Bush Doctrine was that it changed our position radically. We used to affirm... a right of what has normally been thought of as preemptive war... to respond to an imminent attack.... The point of the Bush Doctrine was to change that: to say, as Bush said at West Point: "If we wait for threats to fully materialize, we will have waited too long." It was, basically, the acceptance of preventive war....

For that reason, one of the most striking things about Palin's response, to me, was this: in answering Gibson's question, she seemed to think that she was accepting the Bush Doctrine, but what she actually said just restated the old doctrine of preemption.... The good news, I guess, is that when she's forced to make up an answer out of whole cloth, she goes with preemption, not prevention.... The bad news is that this makes it pretty clear that the problem isn't just that she doesn't know what the name "Bush Doctrine" refers to. She doesn't seem to know that there was a debate about preventive vs. preemptive war, in which the Bush administration came down decisively on the side of prevention. And that's a pretty important thing to be unaware of.

John McCain Is Not Qualified to Be President

Since before 1844 central banks have been in the business of managing financial crises. That's what they do. Milton Friedman is spinning in his grave. The prevention of large-scale bank failures--"bailouts," in McCain's terms--is an essential part of responsibly managing the money supply.

John McCain does not know that. And nobody working for John McCain knows that:

John McCain: Finally, the Federal Reserve should get back to its core business of responsibly managing our money supply and inflation. It needs to get out of the business of bailouts. The Fed needs to return to protecting the purchasing power of the dollar. A strong dollar will reduce energy and food prices. It will stimulate sustainable economic growth and get this economy moving again...

Thoughts on the Big Buyout

I think the federal government is much more likely than not to make money off of AIG, Fannie, Freddie, and whatever else it winds up buying. The underlying goal is to recapitalize the banking system--where a "bank" is anything that borrows short thus promising liquidity and lends or invests long--and to reduce the outstanding stock of risky assets to a level where the private sector is happy holding them at a reasonable price.

Can the government do this? Can it, by buying risky assets, simply extinguish risk? Isn't the risk simply transferred to Treasuries?

The answer is no. First of all, the size of the equity and risk premia we see in normal times tells us that the private market is really lousy at mobilizing the risk-bearing capacity of the economy. The government--or at least a government that balances its budget--mobilizes that risk-bearing capacity automatically, spreading it out via the tax system rather than having risk-bearing concentrated on equity, junk debt, and derivative holders.

The question, I think, is on what terms to do the nationalization, and on what terms thereafter to run the financial markest. I believe that we have to see a substantial expansion of the government's role. Organizations that promise liquidity--whether commercial banks, money market funds, insurance companies, investment banks, hedge funds, whatever--that do not match their assets and liabilities in duration need to be buying some kind of government-provided insurance. Thus not only the level of short-term interest rates becomes an administered, government-determined price, but the price of lower tail risk becomes the government's business to set as well.

Paul Krugman:

Crisis Endgame: On Sunday, Henry Paulson, the Treasury secretary, tried to draw a line in the sand against further bailouts of failing financial institutions; four days later, faced with a crisis spinning out of control, much of Washington appears to have decided that government isn’t the problem, it’s the solution. The unthinkable — a government buyout of much of the private sector’s bad debt — has become the inevitable.

The story so far: the real shock after the feds failed to bail out Lehman Brothers wasn’t the plunge in the Dow, it was the reaction of the credit markets. Basically, lenders went on strike: U.S. government debt, which is still perceived as the safest of all investments — if the government goes bust, what is anything else worth? — was snapped up even though it paid essentially nothing, while would-be private borrowers were frozen out.... [B]anks are normally able to borrow from each other at rates just slightly above the interest rate on U.S. Treasury bills. But Thursday morning, the average interest rate on three-month interbank borrowing was 3.2 percent, while the interest rate on the corresponding Treasuries was 0.05 percent. No, that’s not a misprint. This flight to safety has cut off credit to many businesses, including major players in the financial industry — and that, in turn, is setting us up for more big failures and further panic. It’s also depressing business spending, a bad thing as signs gather that the economic slump is deepening.

And the Federal Reserve, which normally takes the lead in fighting recessions, can’t do much this time because the standard tools of monetary policy have lost their grip. Usually the Fed responds to economic weakness by buying up Treasury bills, in order to drive interest rates down. But the interest rate on Treasuries is already zero, for all practical purposes; what more can the Fed do?... There’s only one bright spot in the picture: interest rates on mortgages have come down sharply since the federal government took over Fannie Mae and Freddie Mac, and guaranteed their debt. And there’s a lesson there for those ready to hear it: government takeovers may be the only way to get the financial system working again....

We don’t know yet what that “comprehensive approach” will look like. There have been hopeful comparisons to the financial rescue the Swedish government carried out in the early 1990s, a rescue that involved a temporary public takeover of a large part of the country’s financial system. It’s not clear, however, whether policy makers in Washington are prepared to exert a comparable degree of control. And if they aren’t, this could turn into the wrong kind of rescue — a bailout of stockholders as well as the market, in effect rescuing the financial industry from the consequences of its own greed.

Furthermore, even a well-designed rescue would cost a lot of money. The Swedish government laid out 4 percent of G.D.P., which in our case would be a cool $600 billion — although the final burden to Swedish taxpayers was much less, because the government was eventually able to sell off the assets it had acquired, in some cases at a handsome profit.

But it’s no use whining (sorry, Senator Gramm) about the prospect of a financial rescue plan. Today’s U.S. political system isn’t going to follow Andrew Mellon’s infamous advice to Herbert Hoover: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” The big buyout is coming; the only question is whether it will be done right.

John McCain Is Dishonest and Dishonorable

And lacks the judgment to be president. Joe Klein:

Diplomacy - Swampland - TIME: As reported here earlier, John McCain seemed to diss Spain's leader Jose Luis Rodriguez Zapatero--or maybe confuse him with a Latin American leader--in a radio interview the other day. Now Randy Scheunemann, McCain's ninja neocon foreign policy adviser, is saying that McCain meant exactly what he said: "The questioner asked several times about Senator McCain's willingness to meet Zapatero (and id'd him in the question so there is no doubt Senator McCain knew exactly to whom the question referred). Senator McCain refused to commit to a White House meeting with President Zapatero in this interview."

Does that mean Spain's membership in the League of Democracies is on hold? Seems to me that putting a chill in the relationship with one of our NATO allies simply because McCain misheard a question is going a bit far.

Understanding the Three Ways of Dealing with Financial Crises

As I have said before, I find it helpful to group all the things the Fed and Treasury have done, are doing, and might do into three baskets, each corresponding to a different stage of the seriousness of the financial crisis and the soundness of the financial system.

Stage I policies: dealing with a liquidity panic These are the "Bagehot rule" policies: the central bank acts to keep the economy at the "good equilibrium" in a panic when multiple equilibria--a good "confidence" equilibrium and a bad "panic" equilibrium--are possible. It does so lending freely to solvent but illiquid institutions at a penalty rate on collateral that would be good in normal timrs. Emergency discount window operations are of this kind. The conventions that the discount rate should be higher than the bank-to-bank federal funds market rate and that borrowing from the discount window should create a stigma and a presumption of a higher degree of future regulatory and counterpary scrutiny are part of the "penalty rate" charged for asking for such help from the central bank. The idea is that institutions that have gotten themselves short of reserves and need emergency liquidity should feel some pain as a result of the systemic risk they caused.

Stage II policies: These the are conventional consensus monetary policies--the central bank as central planner making the price in the short-term money market an administered price in the interest of maintaining full employment and price stability. It raises and lowers the market rate of interest to keep it near the Wicksellian natural rate of interest. It uses open-market operations to buy Treasury securities for cash to flood or drain the market with liquidity, and so push down or up real borrowing costs (thus encouraging or discouraging investment) and push up or down the cash values of all kinds of debt. In the case of a financial crisis, if there was worry about the liquidity or solvency of the system before, the hope is that stage II policy open-market purchases will drive such worry away by boosting the asset values and reducing the debt carrying costs of "banks"--that is, any financial intermediary that lends long and promises liquidity by borrowing short. The idea behind these policies is to keep the good equilibrium at the right place as far as employment and price stabilization is concerned--and, in an emergency, to do what it can to make sure that the good near full-employment equilibrium exists.

Stage III policies: These come after stage I policies aimed at curing a temporary inability to turn assets into cash at any but fire-sale prices have failed to repair matters have been exhausted. These come after the stage II policies of using normal tools of monetary stabilization to lower interest rates across the entire spectrum--flooding the system with liquidity--have failed to ease worries that one's counterparties are still insolvent or still at risk of becoming illiquid at an awkward moment.

The purpose of stage III policies is to boost demand relative to supply for risky assets, and thus to operate on the margin that is the spread in prices and yields between safe assets like Treasury securities and the risky assets whose falling prices are threatening the stability of the financial system and the macroeconomic flow of investment. It is not enough for the central bank to turn the short-term safe interest rate into an administered price, and set it at a low value (stage II). It is not enough to provide unlimited liquidity at a penalty rate (stage I). Instead, the Fed or the Treasury or both must make the price of risk or the quantity of risky assets or both an administered price. Just as for more than half a century there has been a consensus that the level of the short-term interest rate is too important a price to be left to a market full of easily spooked and not very rational financiers, so stage III leads us to the conclusion that the price of risk is also too important a price to be left to the market.

How are we to model these three stages?

Start with a version of Bernanke-Gertler: financial intermediaries can operate in one of two modes: well-capitalized or poorly-capitalized. When financial intermediaries are well-capitalized, they themselves have little problem borrowing on a large scale and serving as conduits for the flow of funds between savers and investors. Thus market demand for risky financial assets is relatively high:

And, given the (fixed in the short run) supply of risky financial assets like mortgages and private-sector bonds, the prices of such financial assets are relatively high as well--which gives businesses an incentive to expand their capital stocks and thus put people to work in the investment-goods industries:

But there is another mode of operation: if financial intermediaries are poorly-capitalized they themselves will have great problems borrowing--savers will fear the moral hazard problems that arise when those who manage their money don't themselves have a large stake in the game, and a financial intermediary without a large equity cushion leads savers to ask the American question "if you're so smart, why aren't you rich?" and shy away. So if financial intermediaries are poorly-capitalized, supply and demand looks very different:

with low demand for financial assets, a low equilibrium price of financial assets--and no incentive for businesses to expand their capital stocks, and mass unemployment, and depression.

The kicker is that large declines in the prices of financial assets--a panic--can switch financial markets from one mode to the other, because their is a large range over which declining prices do sufficient damage to financial intermediaries' capital and reputation to cause the demand curve to slope the wrong way--in what I was taught to call the "Krugman Backwards-S" demand curve:

which produces two stable equilibrium--a good, high-price, high-investment, full-employment one, and a bad, low-price, low investment depression one. The task of central banking is to keep the financial markets and the economy at the good equilibrium, and keep it from jumping to the bad one. These are crisis stage I policies--the good equilibrium is where it should be; monetary policy is appropriate; the problem is that some shock has destroyed confidence and the economy is threatening to jump to the bad, low-value, high-unemployment equilibrium. The correct response is "Bagehot rule" policies: lend freely to financial institutions that are caught short of cash so they don't have to liquidate good assets at fire-sale prices, but lend at a penalty rate so they do feel the pain appropriate to the amount of systemic risk that we have had.

Now let's jump back in time to 2001-2002. It is the aftermath of the collapse of the tech boom and of 911. The Federal Reserve has lowered interest rates to try to forestall deflation and keep the economy near full employment. By lowering interest rates it made safe assets less attractive, and thus pushed demand for risky assets outward--raising the prices of (which is the same thing as lowering the interest rates of) risky financial assets:

The outward push became larger because of two additional factors: Asia's policy of low-currency valuation and thus of providing interest-rate subsidies to America's borrowers, and relaxed lending standards coupled with real estate exuberance. In an environment in which any newly-created financial asset could be sold for a high price, construction companies undertook to build lots more houses--and thus pushed the supply of financial assets out to the right between 2002 and 2006 as all of these new houses--5 million more than trend construction--needed mortgages:

Now comes 2007: an end to irrational exuberance and a little bit of bad macroeconomic news pushes demand for financial assets back to the left. At first--last summer--the Federal Reserve thinks that its job is simply to maintain confidence, to keep the economy at the good equilibrium by making everybody understand that the Fed was not going to let the economy get to the bad, depression equilibrium. But over the fall it became clear that such "Panic Stage I" policy wasn't going to be enough:

Providing liquidity to the market in order to maintain confidence--following Bagehot's rule of lending freely at a penalty rate to organizations that could offer collateral that would be acceptable in normal times--wasn't going to be enough to avoid a depression because it was no longer a matter of maintaining confidence that banks and other financial intermediaries were and would remain well-capitalized. Why wasn't it enough? Because they weren't well capitalized. The good equilibrium was in the wrong place--had too low a price of financial assets and thus too low a level of economic activity and too high a level of unemployment. And perhaps the good equilibrium did not exist at all.

So over the winter the Federal Reserve moved on to "Panic Stage II" policy: fight the possibility of deflation and depression by doing what they did in 2002, and lowering safe interest rates in order to boost private-sector demand for risky assets. Banks borrow short and lend long. Reduce interest rates and you boost the value of their long-term assets by more than the value of their short-term liabilities. With more of a net worth cushion and with a lower cost of borrowing, their demand for risky assets will expand--the good equilibrium will move to the right place for the macroeconomy, or the good equilibrium will reappear (we hope).

That gets us to last spring, when the Federal Reserve had done almost all that it could do in the way of reducing interest rates on safe assets, of trying to recreate the good equilibrium. Yet as we see now financial markets were still not calmed, were still not confident that the good equilibrium exists.

So the Fed moved on to Stage III policies. We do two things. First, we have the Federal government reduce the supply of risky financial assets by having the government buy or guarantee (thus making the assets no longer risky, you see). Second, we have the Federal government "encourage" the financial sector to recapitalize itself, thus pushing the demand up and to the right, like so:

And so pushing up the prices and reducing the interest rates charged on financial assets, making the good equilibrium reappear, and keeping us out of depression, like so:

That, in a nutshell with simple graphs, is what we are doing.

Five more notes:

First, last spring Larry Summers had good arguments that we had then set in motion enough policy moves to resolve the crisis and save the world economy from depression. We had implicitly guaranteed the unsecured debt of every large investment bank in the United States. And we had greatly strengthened the implicit guarantee of Fannie and Freddie. That should have been enough. But clearly it wasn't.

Second, I don't believe that after this the price of risk will ever again become a free-market price, just as after the Great Depression the short-term price of liquidity--the short term interest rate--ever became a free-market price. The federal government, in one form or another, is going to be in the business of insuring debt securities against steep declines in value. Securities that are not so insured will simply not be traded. What Fannie Mae did for "conforming" home loans, the Treasury or some other government agency will do for derivative securities. It will offer insurance, charge for that insurance, and supervise and oversee financiers much more strictly.

Third, the market fundamentalists in other sectors will need to be quiet for quite a while. We have just seen financial markets rife with moral hazard, agency, and adverse selection problems crash spectacularly. Is this a situation in which we should move health care--also rife with moral hazard, agency, and adverse selection problems--toward a free market configuration? No. Market regulation needs to be smart. But first market regulation needs to be.

Fourth, there is now no time for tolerance of the three objections to this analysis and this plan of action, roughly: (1) it's immoral, (2) it's unfair, and (3) it can't work in the long run. To expand a bit:

  1. It's immoral because people have a right to be treated like adults--which means that they have a right not to be rescued by the government from the consequences of their bad judgment, and we are violating that right.

  2. It's unfair because feckless greedy financiers who caused the problem ought to lose money and aren't--or aren't losing enough money--and because feckless greedy imprudent thriftless borrowers who caused the problem ought to lose money and aren't--or aren't losing enough money.

  3. It won't work--at least not in the long run.

I dismiss objection (1). It is made, mostly, by those who speak for the Princes of Wall Street. Note that the Princes of Wall Street themselves are not opposed to what the Federal Reserve and the Treasury and the congress doing--anything, anything at all that promises to raise asset prices is something that each of the Princes of Wall Street would trade at least one of their organs of generation for. But those who speak for the Princes of Wall Street--well, they really believed that the Princes earned their fortunes by virtue of their virtue--their intelligence, their nerve, their skill, and their willingness to run great risks for great rewards. The idea that there is a public safety net to catch the Princes when they all fall off the tightrope at once--that they are not actually rugged Randite individualists running great risks--that they are people in the right place at the right time with enough low animal cunning to cover themselves with glue and then step outside at 57th and Park or on Canary Wharf as the money blows by so that a bunch of the money sticks to them--well, this strikes those who speak for the Princes of Wall Street on the editorial page of the Wall Street Journal or in Investors' Business Daily as a betrayal of the moral order.

The response to objection (1) is that the people who make it need to grow up. There is no more a John Galt or a Jane Galt than there is a Santa Clause. There are no Randites in a financial crisis--or no even quarter-sane Randites. The fact that there is a safety net in a financial crisis is something that has been obvious to everything with a spinal column for at least a century and a half--that's what central banks are for, for Jeebus's sake! The Princes of Wall Street did not earn their fortunes by virtue of their virtue, their intelligence, their nerve, their skill, and their willingness to run great risks, et cetera, et cetera, low animal cunning, glue, money sticks as it blows by.

The response to objection (2) is "tough." Yes, it is important to design the elements of the rescue package in such a way as to give as few windfalls as possible to the undeserving feckless, greedy, imprudent, thriftless, et cetera. We will do what we can within the law to make sure as few gains ill-gotten survive going forward. But as Federal Reserve vice chair Don Kohn says, it is bad public policy to hold the jobs of tens of millions hostage in an attempt to teach a few feckless financiers (or even somewhat more thriftless borrowers) even a much-deserved lesson.

The response to objection (3) is that it was first made by Karl Marx at the end of the 1840s: that the problem is not overspeculation but rather overproduction, and cannot for long be solved by paliatives that address overspeculation only:

Karl Marx and Friedrich Engels: Neue Rheinische Zeitung Revue (1850): Speculation regularly occurs in periods when overproduction is already in full swing. It provides overproduction with temporary market outlets... but then precipitating the outbreak of the crisis and increasing its force.... What appears to the superficial observer to be the cause of the crisis is not overproduction but excess speculation, but this is itself only a symptom of overproduction. The subsequent disruption of production does not appear as a consequence of its own previous exuberance but merely as a setback caused by the collapse of speculation...

Marx was wrong then--the business cycles of the 1850s were not the harbingers of a world-wide communist revolution and not the expression of the dialectical contradictions of capitalism. "Overproduction" does not necessitate a crash. "Overproduction" simply means that the economy has built a lot of capital, and that a bunch of that capital is not going to be worth what the rich people who invested in it had hoped, and in the aftermath the economy's real interest rate will be low. Big whoop--a low long-term real interest rate. All historical evidence suggests that stage III policies can work. And that avoiding them definitely for reasons of ideological purity does not work.

Fifth, later on we should talk more about the corollary to the refutation of objection (1)--the fact that there has always been a safety net for the rich makes it an obvious matter of simple justice that there be a safety net for the poor and the middle class as well. But for the present the important thing is to make sure that people who argue for tax cuts for the rich or for welfare-state program cutbacks for the poor should not be allowed to disrupt the formulation of public policy when there is serious public busienss to be done

Mark Thoma Is a Leading Indicator

An excellent call by Mark Thoma last March:

Economist's View: Risk Absorbtion as a Last Resort: I’m starting to think that the Fed should drop the term part of the TSLF and instead trade permanently for risky assets (with the haircut sufficient to provide some compensation for the risk), bonds for MBS, money for MBS, or whatever, and don’t limit trades to banks.

The Fed would act as “risk absorber of last resort.” Why should it do this? There has been an unexpected earthquake of risk, a financial disaster on the scale of a natural disaster like Katrina, and the government can step in and sop some of it up by trading non-risky assets (money, bonds, etc.) for risky assets at an attractive risk-adjusted price. To limit the amount, this could also be done through auction with a ceiling on how much will be traded, except unlike the current auction it wouldn’t be a repo and it wouldn’t be as limited in terms of who can trade and what can be traded.

What am I missing? Moral hazard and worries about the next time? I’d still fix this first, worry about moral hazard later, perhaps through regulatory changes down the road that (hopefully) limit the opportunities for such behavior...

Deborah Solomon and Damien Pauletta of the WSJ tonight:

U.S. Drafts Sweeping Plan to Fight Crisis: WASHINGTON -- The government is working on a sweeping series of programs that would represent perhaps the biggest intervention in financial markets since the 1930s, embracing the need for a comprehensive approach to the financial crisis after a series of ad hoc rescues. At the center of the potential plan is a mechanism that would take bad assets off the balance sheets of financial companies, according to people familiar with the matter, a device that echoes similar moves taken in past financial crises. The size of the entity could reach hundreds of billions of dollars, one person said.... Another proposal would be the creation of federal insurance for investors in money-market mutual funds, coverage akin to the insurance that currently safeguards bank deposits. The move is designed to stem an outflow of funds as consumers start to worry about even the safest of investments, a sign of how the crisis is spreading to Main Street. There is $3.4 trillion in money-market funds outstanding....

Word of the plan came the same day as the Federal Reserve and other major central banks offered hundreds of billions of dollars in loans to commercial banks to alleviate a deepening freeze in the world's credit markets. That step appeared to have moderate impact on lending among banks. Meanwhile, a wave of redemptions continued hitting money-market funds, causing a second large fund to shut to investors....

[W]ord of a possible U.S. plan to address the crisis sent the stock market soaring, in one of its sharpest reversals in recent memory. The Dow Jones Industrial Average ended up 3.9%, the index's biggest percentage gain in nearly six years, on record New York Stock Exchange volume. The blue-chip index finished more than 560 points above its intraday low and reclaimed about 90% of its Wednesday losses. Nasdaq composite trading also saw trading volume set a new single-day high at 3.89 billion shares....

A big question still to be answered is how the government will value the assets it takes onto its books. One possible avenue could be some sort of auction facility, so that the government would not have to be involved in negotiating asset values with companies. Financial companies would likely take big losses.... House Financial Services Committee Chairman Barney Frank, the Massachusetts Democrat, said his panel could hold a vote on the package as soon as Wednesday. "They said they would like legislation to do it, and there was virtually unanimous agreement that there would be legislation to do it," said Mr. Frank.... According to a top congressional aide, the Treasury department wants authority to either control the program or have it be a separate division of the government...

The Lost Honor of Elizabeth Drew, Richard Cohen, Stephen Chapman, Michael Kinsley, Thomas Friedman, Sebastian Mallaby, Joe Klein, E.J. Dionne, Jr., Ruth Marcus, Mark Halperin, Bob Herbert, and David Brooks

Duncan Black comments on Steve Benen:

Eschaton: Hack: The sad thing is that few of these [village] people [journalists] will acknowledge that they simply got played, and instead want to cast McCain as a character in a play about a man's tragic downfall. He was always an unprincipled hack, but for a very long time his political fortunes were the result of his understanding of and willingness to cater to the desires of elite Villagers. Now he has a different target.

As I have said before, John McCain was a man who liked journalists to think of him as a man of honor, but never was a man of honor--or even a man who liked to think of himself as a man of honor. A man of honor--or even a man who likes to think of himself as a man of honor--does not dump his wife, run around with a sleazy and corrupt S&L baron, and turn down John Kerry when John Kerry asks him to help save America from the Bushies.

But these journalists cannot come straight with even themselves, even now.

Steve Benen:

The Washington Monthly: DREW JOINS THE ENOUGH CLUB.... It seemed unlikely that Elizabeth Drew, an accomplished journalist and author, would join the ever-growing "Enough" Club. She did, after all, write a glowing book about John McCain as recently as 2002, praising him as a principled, honorable man of conscience.

But now, Drew's done. After noting McCain's shift to the hard right, away from the 2000 persona that made him a hero to many, Drew explains that McCain "morph[ed] into just another panderer -- to Bush and the Republican Party's conservative base."

[S]ome very smart political analysts believed from the outset that McCain could win the nomination by sticking with his old self. And they still believe that McCain won the nomination not because he gave himself over to the base but as a result of a process of elimination of inferior candidates who divided up the conservative vote, as these observers had predicted. (These people insisted on anonymity because McCain is known in Republican circles to have a long memory and a vindictive streak.)

By then I had already concluded that that there was a disturbingly erratic side of McCain's nature. There's a certain lack of seriousness in him. And he does not appear to be a reflective man, or very interested in domestic issues. [...]

McCain's recent conduct of his campaign -- his willingness to lie repeatedly (including in his acceptance speech) and to play Russian roulette with the vice-presidency, in order to fulfill his long-held ambition -- has reinforced my earlier, and growing, sense that John McCain is not a principled man.

In fact, it's not clear who he is.

McCain is certainly losing friends fast, isn't he? Drew's condemnation comes just a couple of days after Richard Cohen's. Which came a couple of days after Stephen Chapman's. Which followed Michael Kinsley, Thomas Friedman, Sebastian Mallaby, Joe Klein, E.J. Dionne, Jr., Ruth Marcus, Mark Halperin, and Bob Herbert. Even David Brooks is getting there.

All admired John McCain, all held him in the highest regard, and all of have been disgusted as McCain has descended into a Republican hack. McCain probably doesn't care -- hacks can't be bothered to earn and keep respect -- but their collective revolt tells us quite a bit about McCain's transition.

The London Economist on Why John McCain Is Not Qualified to Be President

It writes:

What Sarah Palin means | The woman from nowhere | The Economist: THE most audacious move of the race so far is also, potentially, the most self-destructive.... [McCain] has chosen as his running mate, on the basis of the most cursory vetting, a first-term governor of Alaska.... The political calculations behind Mr McCain’s choice hardly look robust. Mrs Palin is not quite the pork-busting reformer that her supporters claim. She may have become famous as the governor who finally killed the infamous “bridge to nowhere”—the $220m bridge to the sparsely inhabited island of Gravina, Alaska. But she was in favour of the bridge before she was against it (and told local residents that they weren’t “nowhere to her”).... Nor is Mrs Palin well placed to win over the moderate and independent voters who hold the keys to the White House.... [I]t is hard to see how a woman who supports the teaching of creationism rather than contraception, and who is soon to become a 44-year-old grandmother, helps him with soccer moms in the Philadelphia suburbs....

The moose in the room, of course, is her lack of experience. When Geraldine Ferraro was picked as Walter Mondale’s running-mate, she had served in the House for three terms. Even the hapless Dan Quayle, George Bush senior’s sidekick, had served in the House and Senate for 12 years. Mrs Palin, who has been the governor of a state with a population of 670,000 for less than two years, is the most inexperienced candidate for a mainstream party in modern history.

Inexperienced and Bush-level incurious.... This... raises serious questions about the way he makes decisions. Mr McCain had met Mrs Palin only once, for a 15-minute chat at the National Governors’ Association meeting, before summoning her to his ranch for her final interview. The New York Times claims that his team arrived in Alaska only on August 28th, a day before the announcement. As a result, his advisers seem to have been gobsmacked by the Palin show that is now playing on the national stage. She has links to the wacky Alaska Independence Party, which wants to secede from the Union. She is on record disagreeing with Mr McCain on global warming, among other issues. The contrast with Mr Obama’s choice of the highly experienced and much-vetted Joe Biden is striking.

Mr McCain’s appointment also raises more general worries about the Republican Party’s fitness for government. Up until the middle of last week Mr McCain was... considering... Joe Lieberman... and Tom Ridge.... Mr McCain reluctantly rejected both men because their pro-choice views are anathema to the Christian right.... One of the biggest problems with the Bush administration is that it appointed so many incompetents because they were sound on Roe v Wade. Mrs Palin’s elevation suggests that, far from breaking with Mr Bush, Mr McCain is repeating his mistakes.

Calculated Risk: Weekly Unemployment Claims Increase to 455,000

Paul Krugman sends us to Calculated Risk, which says:

Memory Monitor

Calculated Risk: Weekly Unemployment Claims Increase to 455,000: The DOL reports on weekly unemployment insurance claims:

In the week ending Sept. 13, the advance figure for seasonally adjusted initial claims was 455,000, an increase of 10,000 from the previous week's unrevised figure of 445,000. The 4-week moving average was 445,000, an increase of 5,000 from the previous week's unrevised average of 440,000.

Yes, it's a recession.

Hotline/National Journal/Atlantic Monthly Death Spiral Watch

Look at this graph:


It's a simulation of what statistical sampling error alone would do to the percentage margin between Obama and McCain in the Diageo/Hotline/National Journal/Atlantic Monthly daily tracking poll if the race were tied and if there was no motion at all in underlying voter preferences.

The point has been made before by Matt Yglesias:

The Three Day Itch: One thing a week’s vacation from blogging helps you get perspective on is the Gallup tracking poll. On August 1 when I had my last day at The Atlantic it was time for panic.... Then Obama started to regain ground, going up to a four point lead.... In short, McCain’s “Celebrity” ad and drilling attacks were working well, but when the McCain campaign went after Obama on the tire gauge thing he came up with effective countermeasures and regained his lead. Maybe. Or maybe none of that happened. As everyone knows, there’s sampling error associated with polling....

Alan Abramowitz points out if you look at the daily results... you see... incredible volatility.... [If they reported the daily samples] people could see that this is basically statistical noise in a stable race. But Gallup doesn’t report its daily results, they report a... three day rolling average, [and] you get these pleasant looking peaks and valleys in the race. The change over time here is large enough in magnitude... but also slow enough in pace (unlike on the one day chart) to be plausibly interpreted as public opinion shifting in response to events. And since the human mind is designed to recognize patterns and construct narratives, and since it suits the interests of campaign journalists to write narratives, people interpret the peaks and valleys of the three-day average as real shifts in public opinion...

And people are wrong to so interpret the peaks and valleys of the three-day average.

But does Hotline tell its readers that its three-day tracking poll is essentially a con to attract eyeballs? Does the National Journal? Does the Atlantic Monthly?

Are there reasons to trust any of their publications? To pay them any money? To buy things made by their advertisers (including Diageo, the world's leading beer, spirits and wine company)? To employ their pollsters who actually carry out the survey (Financial Dynamics, with Democrat Ed Reilly and Republican Brent McGoldrick as principles).


At least, I can't think of any reason. Maybe you can.

Why oh why can't we have a better press corps?

John McCain Is Not Only Dishonest and Dishonorable But Also the Stupidest Man Alive--Save for His Foreign Policy Advisor Randy Scheunemann

For some reason, Glenn Kessler and Ed O'Keefe won't say up front what is really going on--that John McCain found himself, for some reason, at sea and that Randy Scheunemann, for some reason, would rather insult a NATO ally than admit that John McCain found himself at sea.

Can't anybody play this game? Can't Kessler and O'Keefe tell it straigh? Can't McCain and Scheunemann do foreign policy?

McCain Slights Spanish Prime Minister: Republican presidential nominee John McCain suggested this week that he would continue President Bush's policy of having cool relations with the government of Spain, despite having made starkly contrasting statements to the Spanish press earlier this year saying he looked forward to normalized relations with the NATO ally.... McCain seemed to lump Spanish Prime Minister Jose Luis Zapatero in the same category as the anti-American leaders of Venezuela, Bolivia and Cuba....

McCain has suggested that as president he would seek to repair relations that have been badly frayed in Europe during Bush's tenure. In an early-April interview with a reporter from Spanish newspaper El Pais, McCain said, "This is the moment to leave behind discrepancies with Spain.... I would like for [President Zapatero] to visit the United States. I am very interested not only in normalizing relations with Spain but in obtaining good and productive relations with the goal of addressing many issues and challenges that we have to confront together."

The reporter for the Miami radio station seemed surprised that McCain, after discussing anti-American antagonists in Latin South America, acted so coolly to the idea of meeting with Zapatero.... "I can assure you I will establish closer relations with our friends and I will stand up to those who want to do harm to the United States of America."... "I'm talking about the president of Spain," she noted. Given this fourth opportunity to extend an olive branch, McCain stuck to his guns: "I'm willing to meet with any leader who is dedicated to the same principles and philosophy that we are for human rights, democracy and freedom and I will stand up to those who are not." That McCain would lump Zapatero in with such Latin American bad guys as Venezuela's Hugo Chavez comes as a surprise....

So, was McCain purposely trying to diss the Spanish leader? Questions about whether McCain forgot which country Zapatero leads, got confused about Spain's geographic relationship to Latin America, or confused Zapatero with the Zapatista rebels from Mexico have exploded on blogs since reports of the interview first surfaced. McCain foreign policy adviser Randy Sheunemann said McCain's answer was intentional.... Asked to explain McCain's apparent shift in tone and position since April, Scheunemann gave almost no ground.

"In this week's interview, Senator McCain did not rule in or rule out a White House meeting with President Zapatero, a NATO ally," he said in an e-mail. "If elected, he will meet with a wide range of allies in a wide variety of venues but is not going to spell out scheduling and meeting location specifics in advance. He also is not going to make reckless promises to meet America's adversaries. It's called keeping your options open, unlike Senator Obama, who has publicly committed to meeting some of the world's worst dictators unconditionally in his first year in office."...

Yoly Cuello, the reporter who interviewed McCain, said she repeatedly asked McCain about Spain because "he didn't want to answer my question." "I think he was just trying not to answer the question, I think he understood" who Zapatero is and where he's from, Cuello said. She conducted the phone interview on Tuesday when McCain was campaigning in Miami and it aired Wednesday on Union Radio's 74 Spanish-language radio affiliates nationwide and on its stations in Colombia, Mexico and Spain...

Nobody has any business voting for John McCain. Nobody has any business arguing that John McCain is qualified to be president. Nobody.

Is 2008 Our 1929?

No. It is not. The most important reason it is not is that Bernanke and Paulson are both focused like laser beams on not making the same mistakes as were made in 1929.

They are also focused, but not quite as much, on not making the mistakes made by Arthur Burns in the 1970s.

And they are also focused, but not quite as much, on not making the mistakes the Bank of Japan made in the 1990s.

They want to make their own, original, mistakes...

John McCain Is Dishonest and Dishonorable

Outsourced to Sam Stein:

McCain Pre-Palin: Mayors And Governors Can't Handle National Security: When does being a governor or mayor for a short period of time not disqualify your credentials on national security? When you are John McCain and your task is to defend your vice presidential candidate Sarah Palin.

When does being a governor or mayor for a short period of time ABSOLUTELY disqualify your credentials on national security? When you are John McCain and your task is to defeat primary opponents Mitt Romney and Rudy Giuliani.

Back in October 2007, when McCain's candidacy still appeared dead and buried, the Senator berated the two Republican front runners for lacking the necessary political experience to handle commander in chief responsibilities.

"I have had a strong and a long relationship on national security, I've been involved in every national crisis that this nation has faced since Beirut, I understand the issues, I understand and appreciate the enormity of the challenge we face from radical Islamic extremism," the Senator declared. "I am prepared. I am prepared. I need no on-the-job training. I wasn't a mayor for a short period of time. I wasn't a governor for a short period of time"...

More Lies from Marc Ambinder

The Atlantic Monthly death spiral continues.

Let's begin with a rhetoric lesson:

Synecdoche - Wikipedia: Synecdoche from Greek συνεκδοχη, "simultaneous understanding" (pronounced /sɪˈnɛkdəkɪ/) is a figure of speech in which: a term denoting a part of something is used to refer to the whole thing, or a term denoting a thing (a "whole") is used to refer to part of it, or a term denoting a specific class of thing is used to refer to a larger, more general class, or a term denoting a general class of thing is used to refer to a smaller, more specific class, or a term denoting a material is used to refer to an object composed of that material...

Douglas Holtz-Eakin said:

CBS Horserace: "He did this"... holding up his BlackBerry.... "Telecommunications of the United States is a premier innovation in the past 15 years, comes right through the Commerce committee so you're looking at the miracle John McCain helped create and that's what he did"...

Doug was engaging in this rhetorical form of συνεκδοχη, using his Blackberry device as a pointer to refer to the more general class of things that together make up the complex of telecommunications innovations of the past fifteen years. He was not claiming that John McCain invented the Blackberry.

Marc Ambinder never bothered to even try to get the story right:

Marc Ambinder: Who Needs Obama When The McCain Campaign'll Run Against Itself?: There shouldn't be a debate about it: the McCain campaign has made a hash out of the first three days of the week, and most of the forks were manufactured in Arlington.... [For example:] The adviser who bragged about McCain's inventing the Blackberry...

Why oh why can't we have a better press corps?

Marc Ambinder Says That $5,000 Might Be Greater than $12,000!

The Atlantic Monthly death spiral watch continues, as Marc Ambinder gets himself deep into "opinions on shape of earth differ" territory:

Marc Ambinder: Fact-checking Obama: First, CBS News's Wyatt Andrews reports on a charge that Barack Obama often makes about John McCain's health care plan: that it will result in tax increases for tens of millions of Americans. The truth is that it... well, it might not--although McCain would require Americans to begin to pay taxes on the health benefits their employers provide to them, some analysts think that they'd get more than that money back in the form of the refundable tax credit that McCain is proposing.... [T]he money McCain would give employees might not cover the cost of the premiums which average mroe than $12,000 per family. And one reason for changing the tax incentives is to put the kibosh on the employer-based system.  Non-partisan analysts don't think McCain's plan would expand coverage...

Question: Does Marc Ambinder so ignorant that he does not know that McCain's tax credit maxes out at $5,000, which is less than $12,000? Or is he so mendacious that he thinks it important to hide that fact from those of his readers who don't already know it?

Why oh why can't we have a better press corps?

John McCain Is Dishonest, Dishonorable, and Incompetent

From Ezra Klein:

EzraKlein Archive | The American Prospect: READY ON DAY NONE. Sarah Palin's main main job as governor was manage the state's energy portfolio, but she doesn't actually know how much energy Alaska produces. John McCain's main job as chairman of the Senate Commerce Committee was to manage the Committee's business, but John McCain doesn't know what the Committee does and does not have jurisdiction over. Is there really no way to disqualify presidential tickets on grounds of gross incompetence?

Finance Socialism

A message from Barack Obama:

And then yesterday, John McCain's big solution to the crisis we're facing is – get ready for it – a commission. That's Washington-speak for "we'll get back to you later." Folks, we don't need a commission to figure out what happened. We know what happened. Too many in Washington and on Wall Street weren't minding the store. CEOs got greedy. Lobbyists got their way. Politicians sat on their hands until it was too late. We don't need a commission to tell us how we got into this mess, we need a President who will lead us out of this mess – and that's the kind of President I intend to be.

You've heard of finance capitalism--this appears to be finance socialism.

Were I Barack Obama, I would announce now that Nancy Pelosi and Harry Reid are calling congress back into session to deal with the financial crisis the day after the election--and if George W. Bush won't sign the plan they pass, they will repass it on Inauguration Day.

What the plan should be--ah, that requires a little thought...

GLRP!! Investment Tools

Paul Krugman tells us to go read Felix Salmon:

Financial Risks in Lehman Collapse - How big is settlement risk right now? An indicator one might look at is the number of "fails to deliver" and "fails to receive" reported by primary dealers in U.S. Treasury bonds. Last week, before Lehman was expected to file for bankruptcy, fails to deliver rose by $351 billion to $410 billion; fails to receive rose by $336 billion to $389 billion. (PDF here; Excel file here.) Again, there have been bigger spikes in the past, but they haven't happened at the same time as the bankruptcy of a primary dealer. Right now is the last time that anybody wants to be worrying about failed trades, because they can't have any assurance that their counterparty will still exist by the time they're all worked out.

Lehman Brothers has more than $600 billion in assets that will need to be liquidated as part of its bankruptcy. That's an order of magnitude greater than any bankruptcy the world has ever seen: No one has a clue how to even get started on something so huge, let alone what the repercussions will be. Is there $600 billion in cash sitting on the sidelines of the global financial markets just waiting for an opportunity to snap up assets on the cheap? No. So as Lehman's assets get liquidated, asset prices in general, and bond prices in particular, are likely to be under a great deal of pressure

In turn, that's going to hurt other players in the global financial system, from hedge funds and sovereign wealth funds to small- and medium-sized regional banks. Anybody who's leveraged and who marks their assets to market is at risk of margin calls and possible bankruptcy themselves, depending on the volatility and risk profile of those assets.

The upshot is a state of radical uncertainty: as Paul Krugman says today, "nobody knows what will happen next."... There is a very, very long list of things that could go horribly wrong from here on out. The liquidation of Lehman is one; the possible collapse of American International Group is another. Beyond that are countless hedge funds and other financial institutions which, collectively, present significant systemic risk.

But the biggest and most obvious risk of all is the one associated with Lehman's own debt, which is now trading at less than 35 cents on the dollar. That's a big loss for the institutions holding it—but it also means an unknowably huge loss for anybody who wrote credit protection on Lehman Brothers at any point over the past five years. Those sellers of credit protection are staring down the barrel of billions of dollars in claims, and they're going to have to raise that money quick by selling anything they can get their hands on—and that might well include stocks.

This Is a Joke, Isn't It?

In my email inbox this morning: >**McCain Health Credit Could Give Coverage to a Third or More of Uninsured: Low-Income Workers Would Benefit Most from GOP Presidential Candidate’s Proposal:** Washington, DC- A new Tax Foundation study shows John McCain’s pitch to replace a tax subsidy that favors high-income people with a refundable credit that favors low- and middle-income people would cover a third or more of Americans that are uninsured, leading to a net tax cut for most taxpayers. >In Tax Foundation Fiscal Fact No. 144, “McCain’s Health Credit: The Intersection of Health Policy and Tax Policy,” Tax Foundation Vice President for Economic Policy Robert Carroll, Ph.D., explains that the Republican presidential nominee’s proposal to replace the current income tax exclusion for employer-based insurance with a large health tax credit – $5,000 for family coverage and $2,500 for individual coverage – would sharply reduce tax-driven biases in America’s health care system. >“Because people would receive the full credit even if the insurance cost less, the proposal simultaneously provides a powerful incentive to purchase insurance and to purchase an amount of insurance without regard to income tax considerations,” says Carroll. “Less generous proposals have already been estimated to decrease the number of uninsured by over 15 million, so the McCain health credit would probably decrease the number of uninsured from the current roughly 45 million to 30 million and probably much lower”... Everybody should stop reading the moment Tax Foundation Vice President for Economic Policy Robert Carroll, Ph.D. begins talking about how health insurance plans in America today that costs less than $200 a month. Health insurance plans cost $400 a month for individuals, and $1000 a month for families on average--and cost more if you aren't in a group, and have to go into the individual market. The Tax Foundation is *not* repeat NOT an analytical operation. I have absolutely no clue how $2500 tax credits for individuals and $5000 tax credits for families are supposed to induce 15 million people who do not currently have health insurance to pay $3000 out of pocket for individuals and $7000 out of pocket for families for policies. I simply cannot make the math work.

This Is How Things Have Been since 1979...

Ezra Klein writes:

EzraKlein Archive | The American Prospect: Noting that he instinctively shares the optimism that this won't turn into another Great Depression, Atrios writes that his confidence is "largely based on the knowledge that there are smart technocrats who know what they're doing, and not on the reality that while those these people exist they probably aren't actually steering the ship. George Bush, Chris Cox, Dick Cheney, and Henry Paulson are."

Putting aside whether Paulson knows what he's doing -- I think he's acquitted himself well thus far -- one of the odd facts about this crisis is that the elected branches of government have been completely cut out of the response. George W. Bush and Dick Cheney have not, as far as anyone can tell, been steering the ship. According to The Wall Street Journal, Bush was briefed on the rescue after it was in play. And even then, he was only "briefed." There's been no effort on the part of the White House to even advance the idea that Bush is an engaged participant who's actively signing off on these actions, possibly because suggesting his involvement in a crisis of this complexity would cause the stock market to run and hide in a corner.

Congress, too, has been cut totally out of the loop. The AIG bailout -- in fact, all of the bailouts -- have been conceived entirely without their involvement. Indeed, the Federal Reserve and the Treasury Department have been acting, over the course of this crisis, as if they are the sum total of the government. And that may be the correct approach: Neither the president nor the legislative branch possess the expertise or speed to be involved in the real-time crisis management that Bernanke and Paulson are trying to manage. They could, presumably, reverse decisions after the fact or change the contours of the law, but for now, the ship is being steered by the Chairman of the Federal Reserve, the Treasury Secretary, and an informal working group of Wall Street CEOs and banking powerhouses. And the government, as we normally think of it, has basically accepted their temporary authority. You've heard of martial law? We're currently in a state of market law.

This is how things have been since 1979--when Carter appointed Volcker to head the Fed, Volcker decided he was going to stop inflation no matter what the cost and would dare anyone else to try to block him, and congress and the president decided that challenging the Fed meant taking responsibility for inflation and thus blame if anything went wrong. Congress and the president occasionally show up to pass tax cuts--and twice, in 1990 and 1993, to take action to try to balance the budget. But otherwise the technocrats at the Fed and the Treasury run things.

This is the Age of Central Bankers.

John McCain Is Dishonest and Dishonorable:

I missed this, from McCain attack dog Joe Lieberman:

Lieberman: Obama Has Not Always "Put The Country First": In my opinion, the choice could not be more clear: between one candidate, John McCain, who's had experience, been tested in war and tried in peace, another candidate who has not. Between one candidate, John McCain, who has always put the country first, worked across party lines to get things done, and one candidate who has not. Between one candidate who's a talker, and the other candidate who's the leader America needs as our next candidate...

And, of course Newsweek's Howard Fineman said that McCain doesn't approve of Lieberman's message--it is not clear whether he believes that McCain is too befuddled to understand what his campaign is doing or is being carefully kept in the dark. Greg Sargent observed:

TPM Election Central | Talking Points Memo | Fineman: McCain Wouldn't Approve Of His Own Campaign's Message: Wow, such perfect timing! Below we noted at some length that the national media was failing to hold the McCain campaign accountable for its surrogates' pattern of questioning Obama's patriotism.... Fineman said that while Lieberman's quote was clearly questionable, McCain himself wouldn't sanction it. "I still don't think if you said to McCain flat out, 'Do you approve of that kind of message,' that he would necessarily agree with it or support it," Fineman said. But Howard, the McCain campaign itself blasted Lieberman's quote out to its press list, which constitutes an official McCain campaign endorsement of the quote. Isn't McCain responsible for his own campaign's message? And besides, if McCain doesn't agree with Lieberman, why hasn't he said so yet?...

John McCain needs to retire, immediately. Joe Lieberman needs to retire, immediately. Howard Fineman needs to retire, immediately. Honest people don't vote Republican. Friends don't let friends read Newsweek or buy goods made by its advertisers.

20080917: Economics 113: American Economic History: Mock Midterm

Economics 113: American Economic History: Mock Midterm

A: One-Sentence Identifications (25 points): Briefly state--one sentence--for each of the following people/places/things/concepts its importance for American economic history up through the Civil War. A good strategy is to tie each ID into one or more of the major factors of production: land, labor, capital, technology, and institutions.

Alexander Hamilton, Leland Stanford, Eli Whitney, smallpox, Hernan Cortez, Erie Canal, Northwest Ordinance, Louisiana Purchase, 1808, Mississippi River, American system of manufactures, Missouri-Mississippi-Ohio River system, Royal Proclamation of 1763, corn, sugar islands, cotton gin.

B: One-Paragraph Discussions (25 points): Write one paragraph (three to six sentences) answering each of the following questions:

1) Why did the United States develop differently from Latin America in the colonial period?

2) Why was the United States one of the richest countries in the world at the time of its founding?

3) Why was America a relatively equal country (for white guys) until after the Civil War?

4) British observers before the Civil War wrote back that America was a labor-scarce economy. What difference did they think this scarcity of labor made for American economic development before the Civil War?

5) What was the role of the availability of natural resources as a key factor driving American econonic growth before 1865?

C: Essay: Write an essay on one and only one of the two following topics (25 points):

1) As of the start of the twentieth century, the American economy was almost universally regarded as successful. What were the major aspects of this economic success? Why did they come to pass? Why did so much go so right for the American economy?

2) For those of us who have read a few too many alternate history novels: How would the U.S. economy have been different in 1860 if the U.S. government had followed a zero-tariff policy since 1787?

D: Problem (25 points):

Begin with our growth equation for preindustrial growth in living standards:

g(y) = (1/3)(g(N)-g(L)) + (2/3)g(E)

where g(y) is the growth rate of output per worker, g(N) is the growth rate of available natural resources, g(L) is the growth rate of the labor force, and g(E) is the growth rate of labor efficiency--which in the preindustrial age we fix at 0.9% per year.

1) In preindustrial America up until 1860, the growth rate of natural resources g(N) was 4.2% per year and the rate of growth of the labor force g(L) was 3.0% per year. What was the rate of growth of output per worker g(y)?

2) Suppose that the rate of population growth over any extended period is governed by a semi-Malthusian equation:

g(L) = 2% per year + g(y)

Is this consistent with your answer to (1) above?

3) According to the growth equation and the semi-Malthusian population equation, what would have been the growth rate of output per worker g(y) before the Civil War if the rate of growth of available natural resources g(N) had been zero--if Imperial Britain had remained in control and had, for geopolitical reasons, penned the colonists east of the Appalachians?

4) According to the growth equation and the semi-Malthusian population equation, what would have been the growth rate of the labor force g(L) before the Civil War if the rate of growth of available natural resources g(N) had been zero--if Imperial Britain had remained in control and had, for geopolitical reasons, penned the colonists east of the Appalachians?

5) Explain, in a paragraph or two, how this counterfactual alternate-history "little America" would likely have been different in 1860 than America actually was.

The Epicurean Dealmaker on the Coming Age of Universal Banking--or Not

It writes:

The Epicurean Dealmaker: The K-T Boundary: Okay, boys and girls, today we start a new class project.

Now that Lehman Brothers and Merrill Lynch have disappeared as independent investment banks over the past few days, it is time to determine whether the investment banking industry as we know it is entering a new era. The vaporization of Lehman Brothers at the point of impact of the Chicxulub subprime meteor1 and the absorption of the Thundering Herd into the gaping maw of Ken Lewis's petty cash account have left us with only two independent i-banks of any materiality, Goldman Sachs and Morgan Stanley. Those two were last seen limping around the tropical forests of southern Wyoming, so it is presumed by knowledgeable commentators that they have survived the weekend's events.

Never one to avoid a swift roll in the hay with conventional wisdom, certain elements of the chattering classes have already begun to speculate that Goldman and Morgan are not long for independence. These pundits speculate that the once-fearsome predators will be consumed by giant, lumbering herbivorous dinosaurs, some of which have been eyeing the carnivores' ecological niche covetously for, oh, about 40 million years or so. The rationale, of course, is that GS and MS will need to shelter under the protective wing of a commercial bank in order to have access to less volatile sources of funding for their huge sales and trading operations. How such unnatural inter-species combinations might be accomplished, and whether they can be done without entailing the utter destruction of one or both of the presumptive mergees—questions one might legitimately pose concerning the merger of BAC and Merrill, by the way—seem not to have attracted too much attention from these budding eugenicists.

Alternatively, there is a countervailing "Small is Beautiful" argument developing around certain other watercoolers. This crowd is yammering on about how the new order will be taken over by swarms of little furry advisory boutiques, who will survive the impending nuclear winter by sheltering in the moldering corpses of the reptilian behemoths and raise their multitudinous young on the detritus of integrated investment banks past. Certain advocates of this scenario contend that this will truly signal the end of the Age of Dinosaurs and the rise of the Age of Mammals. In contrast, others insist that, once free to run about, the little boutiquers will gradually reaggregate—like scattered globules of mercury—into great big "multi-product, multi-geography" investment banks again. Should this happen, we will likely learn that all those so-called "mammals" were really devious little reptiles in disguise, who donned fake fur and whiskers to confound hostile regulators and lawmakers while they secretly rebuilt the Age of Dinosaurs, Version 2.0.

As I am an exemplar of those few bankers who crossed the reptilian-mammalian divide into boutiqueland some years ago, I must admit that I have a predilection for the SiB-ers' position. (I know my partners and I would certainly not mind being able to pick up a passel of disgruntled former Lehmanites on the cheap.) Nevertheless, I am clear-eyed enough to know that there are many hidden forces at work in the ecological woodpile, and I could make a credible case for either of these theories, plus the as-yet unconsidered one exemplified in the status quo.

In any event, I am a realist when it comes to industry structure, not an idealist. I believe people and firms will try all sorts of ways to exploit the current market upheaval, including utilizing different (and the same old) organizational forms. As you might expect, Goldman Sachs' CFO insisted today on their earnings call that it does not want to buy a commercial bank or sell itself to one and that all is for the best in this best of all possible worlds for the Teflon Investment Bank. (Although he would have to say that, wouldn't he?) Other than plummeting stock prices, there seem to be few hints that Morgan Stanley or Goldman Sachs are not long for the planet. As far as anyone can tell, they are not insolvent or illiquid, but one could have credibly said the same about Bear Stearns or Lehman a few days before they kicked the proverbial bucket.

Only time—as I have heard it said, somewhere or other—will tell.

The Financial Accelerator in Action

Calculated Risk:

Calculated Risk: TED Spread Blowout: The TED spread has increased to 2.76% (from just over 2% yesterday). This is far above the highs reached in August 2007, late 2007 and in the spring of 2008. Note: the TED spread is the difference between the three month T-bill and the LIBOR interest rate. Usually the TED spread is less than 0.5%. The higher the spread, the greater the perceived credit risks (compared to "risk free" treasuries). Much of the increase in the TED spread is because of the flight to safety. From Bloomberg: Treasury 3-Month Bill Rates Drop to Lowest Since at Least 1954

U.S. Treasury three-month bill rates dropped to the lowest since at least 1954 ... Investors pushed the rate as low as 0.233 percent as the loss of confidence in credit markets deepened.

Even Now, Ruth Marcus Cannot Come Clean (Washington Post Death Spiral Watch)

Ruth Marcus admits that she has been lying to her readers for years and years:

True Whoppers: [M]y expressed desire to hold both campaigns accountable for their lapses from good policy and honest argument.... [I]t is a phony evenhandedness, comfortable for journalists but ultimately misleading, that equates these failures without measuring the grossness of their deviation from the standard of decency. In the 2008 race, and especially in the past few weeks, the imbalance has become unnervingly stark. Ideological differences aside, John McCain's campaign has been more dishonest, more unfair, more -- to use a word that resonates with McCain -- dishonorable than Barack Obama's.... McCain's... whoppers are bigger; there are more of them. He -- the easy out would be to say "his campaign" -- has been misleading, and at times has outright lied, about his opponent. He has misrepresented -- that's the charitable verb -- his vice presidential nominee's record. Called on these fouls, he has denied and repeated them....

[T]he McCain campaign has its story about Sarah Palin, and it's sticking with it -- facts be damned. She said "thanks but no thanks" to that "Bridge to Nowhere," except that she didn't: She backed the bridge until it was unpopular, then scooped up the money and used it for other projects. More than a year after McCain began railing against the bridge, Palin, then a gubernatorial candidate, said the state should build it "now -- while our congressional delegation is in a strong position to assist."

Palin sold the gubernatorial jet, on eBay and for a profit -- except that she didn't. She didn't take earmarks as governor -- except for the $256 million she sought last year, and the $197 million wish list for 2008....

Sitting on the couch with the women of "The View" last week, McCain offered a litany of excuses for his conduct this time around: Obama's ads are hard-hitting, too. The tone wouldn't be so negative if Obama had agreed to more debates. McCain's own lipstick comment was different because he was referring to health care.

You had to wonder: Are there any corners left for McCain? Is there any reason to trust that a man running this campaign would go on to be an honest president?

But she still cannot come clean. The imbalance has not become "unnervingly stark" in the last few weeks. The imbalance has been unnervingly stark for a long, long time--and Ruth Marcus has kept her eyes firmly closed for that long long time.

Does she seriously expect us to be stupid enough to believe that Steve Schmidt and John McCain are any bigger liars than Karl Rove and George W. Bush, or than Lee Atwater and Ronald Reagan?

Why oh why can't we have a better press corps?

W00T!! (Lend Freely at a Penalty Rate Edition)

I guess the "let Lehman fail" strategy did not work out so well:

Fed Statement on AIG:

The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under Section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.

The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance.

The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.

LIBOR + 8.5%--now thats lending freely at a penalty rate! They've given AIG a credit card!

The TED Spread Investment Tools

TED spread - Wikipedia: Initially, the TED spread was the difference between the interest rate for the three month U.S. Treasuries contract and three month Eurodollars contract as represented by the London Inter Bank Offered Rate (LIBOR). However, since the Chicago Mercantile Exchange dropped the T-bill futures, the TED spread is now calculated as the difference between the three month T-bill interest rate and three month LIBOR. The TED spread is a measure of liquidity and shows the degree to which banks are willing to lend money to one another. The TED spread can be used as an indicator of credit risk. This is because U.S. T-bills are considered risk free while the LIBOR rate reflects the credit risk of lending to commercial banks. As the TED spread increases, the risk of default (also known as counterparty risk) is considered to be increasing, and investors will have a preference for safe investments. As the spread decreases, the risk of default is considered to be decreasing.[1] The name originates from the initialism of "T-Bill" and "ED"—the ticker symbol for the Eurodollar futures contract...

Paul Kedrosky: AIG Bailout is Allegedly Over to Congress

Paul Kedrosky: AIG Bailout is Allegedly Over to Congress: Take your second deep breath of the week. We are at a cusp tonight, with a Treasury deal allegedly on the table to provide a $80b bridge loan to doombound insurance company AIG. The deal would apparently include warrants to the government, and heavy incentives to disgorge AIG's many assets quickly in a kind of low-grade firesale.

It seems clear that were that not to happen tonight then AIG would file for bankruptcy tomorrow, and that would have immense and unknowable consequences. While that does not make a bailout required, it is also true that we are in an immense financial event with unknowable spiraling effects in worldwide markets.

The main risks tonight are political, not economic, however. Congress is frustrated at feeling like it is playing from behind in this debacle, and in an election year with massive financial commitments being made -- Bear Stearns plus Fannie/Freddie plus A.I.G. plus, plus -- and with an angry electorate having had this ill-explained to them, we are at an incredibly risky moment.

Jeff Frankel Discovers McCain "Advisor" Donald Luskin

He is puzzled:

Jeff Frankels Weblog | Views on the Economy and the World: I am still not sure whether [Luskin's] column was meant as a joke.  At the risk of finding out that I have been taken in by a prank, I will assume that the author is serious...

But Jeff is always worth reading:

Jeff Frankels Weblog | Views on the Economy and the World: [F]or the last 40 years, rhetoric notwithstanding, Republican presidents have pursued policies... farther removed from the ideal of good... economics than have Democratic presidents. This is especially true... [of] the textbook version.... But... it applies even to the “conservative economics” version that puts priority simply on small government. The criteria underlying this generalization about Republican presidents are:

  1. Growth in the size of the government, as measured by employment and spending.
  2. Lack of fiscal discipline, as measured by budget deficits.
  3. Lack of commitment to price stability, as measured by pressure on the Fed for easier monetary policy when politically advantageous.
  4. Departures from free trade.
  5. Use of government powers to protect and subsidize favored special interests (such as agriculture and the oil and gas sector, among others)....   

Republican presidents have since 1971 indulged in these five departures from “conservatism” to a greater extent than Democratic presidents. The name I would give to this set of departures... is neither “liberal” nor “conservative” but, rather, “illiberal”...

Real conservatives take note: you will never have a party until you kill the Republican Party, and replace it with something new. You should start now, for all of our sakes.

Yes, It Is a Recession Not Just in Construction and Finance, But in Goods Production too...

The Federal Reserve:

Industrial Production and Capacity Utilization: Industrial production decreased 1.1 percent in August and was revised down in June and July to show smaller gains of 0.2 percent and 0.1 percent respectively. After little movement over the previous three months, factory output was down 1.0 percent in August, in part because of a drop of 11.9 percent in the production of motor vehicles and parts. Excluding motor vehicles and parts, the index for manufacturing decreased 0.3 percent...

For about a year we have been blessing the disconnect between financial chaos and construction depression on the one side and real-side economic "weakness" elsewhere in the economy. Let's hope the disconnect continues. But it looks as though it isn't: the recession has spread out from construction into goods production broadly:

Now This Is a Surprise...

Breaking news:

Fed to Offer Bridge Loan to A.I.G. and Take Control of Firm: Updated: The Federal Reserve plans to offer an $85 billion bridge loan to the American International Group in return for control of the ailing insurance giant, people briefed on the matter said Tuesday night.

In an intense discussion at the Federal Reserve Bank of New York on Tuesday afternoon, the Fed and a group of executives from JPMorgan Chase, Goldman Sachs and other firms agreed that a banking syndicate to provide the $75 billion in emergency financing could not be arranged by Tuesday night.

If the Fed intervenes, it would be an eleventh-hour bailout of A.I.G., whose debt downgrades by major credit ratings agencies could have sparked a debilitating need for additional capital.

Concerns about A.I.G.’s health have gripped the financial markets, as many investors feared the insurance giant would follow Lehman Brothers into bankruptcy. An A.I.G. collapse could be an even bigger systemic threat to major financial firms than Lehman’s downfall, because of the company’s dominant position in insuring mortgage-linked securities...

Note to Self: Dittmar on Zipf's Law

Berkeley International-Macro-History Seminar: Jeremiah Dittmar (2008), "Cities, Institutions, and Growth: The Emergence of Zipf's Law in Urban Europe"

This paper is really one of five papers, each of which has a different one-sentence takeaway:

  • Modern, sophisticated tools of economic growth confirm what historians already knew about the specificity and separate development path of Eastern Europe.
  • Zipf's law as applied to city growth is not a law of nature, but instead merely a law of market economies--as the development of Eastern Europe shows
  • There have long been arguments about why Eastern Europe was relatively poor; here is evidence that Eastern Europe was because of the successful sixteenth-century noble reaction Zipf not a mathematical curiosity--leads you to ask fruitful questions about the world
  • There have long been arguments about why Western Europe became relatively rich; here is evidence on the side of the "because of markets" explanation.

Every Time I Try to Get Out They Drag Me Back in...

I wanted to spend the day writing about health care exclusively. But no. The Republicans won't let me. Instead, I am compelled to note that John McCain has demonstrated that he is completely unqualified to be president by choosing a vice-presidential candidate who really, badly needs to be under the care of a mental health professional.

Jake Tapper:

Political Punch: At a fundraiser in Canton, Ohio, this evening, Alaska Gov. Sarah Palin had an interesting description of her speech to the Republican convention. “There Ohio was right out in front, right in front of me," Palin said. "The teleprompter got messed up, I couldn’t follow it, and I just decided I’d just talk to the people in front of me. It was Ohio.”

This struck many of us -- who, as she spoke, followed along with her prepared remarks, and noted how closely she stuck to the script -- as an unusual claim. (Especially those of my colleagues on the convention floor at the time, reading along on the prompter with her, noticing her excellent and disciplined delivery, how she punched words that were underlined and paused where it said "pause," noting that "nuclear" was spelled out for her phonetically)....

I should note that, after Palin's speech, some conservative bloggers reported that sources close to McCain had told them that the teleprompter had broken and Palin "winged it." "The teleprompter did not break," wrote Politico's Jonathan Martin.  "Sarah Palin delivered a powerful speech last night, but she did not 'wing it'..." Says Martin, "Perhaps there were moments where it scrolled slightly past her exact point in the speech. But I was sitting in the press section next to the stage, within easy eyeshot of the teleprompter. I frequently looked up at the machine, and there was no serious malfunction. A top convention planner confirms this morning that there were no major problems."

Do not, please, do not make John McCain president.

Every Time I Try to Get Out They Drag Me Back in...


Steve Benen:

The Washington Monthly: At this point, I suspect Carly Fiorina, a McCain advisor/surrogate and the former CEO of Hewlett Packard, wishes she hadn't spent the last two weeks criticizing those who dared to question Sarah Palin's qualifications. Appearing on KTRS in St. Louis, Fiorina was asked whether Palin has the experience to run a major company, such as Hewlett Packard. "No, I don't," Fiorina said. "But you know what? That's not what she's running for. Running a corporation is a different set of things."

Perhaps, but I'd love to hear Fiorina, or anyone else at the McCain campaign, explain precisely what those qualities are.... [W]hat are the skills and credentials that Palin brings to the table that make her a superior choice to be one heartbeat from the presidency... but make her a poor choice to head a major corporation. A background in finance?... The ability to manage a large bureaucracy?... Leadership skills? Gravitas? An ability to think quickly on one's feet?... [F]or Carly Fiorina, a leading McCain surrogate, Palin is the perfect choice to be one heartbeat from the presidency, but she's not to be trusted with a Fortune 500 company.

Go ahead.... Explain to us why Palin is prepared to lead the nation and the free world, but clearly doesn't have the background to lead a company....

Update: Fiorina wouldn't trust McCain with HP, either.

John McCain: Dishonorable and Dishonest

Why do I have to wait for a genre book editor at a medium-sized press to point this out to me (while he takes a break from worrying about his ill wife) when he have thousands upon thousands of well-paid "journalists" in Washington? Some of the answer is that it makes me physically ill to read the WSJ editorial page, so I don't see Thomas Frank's columns there But this should have been a major part of the zeitgeist:

Making Light: Mmm, "good people": Posted by Patrick [Nielsen Hayden] at 10:00 AM * 57 comments: Sarah Palin, accepting the nomination of the Republican Party for Vice President of the United States:

A writer observed: “We grow good people in our small towns, with honesty, sincerity, and dignity.” I know just the kind of people that writer had in mind when he praised Harry Truman...

Who was this anonymous “writer”? Funny you should ask. Evidently, as Thomas Frank points out, it was the avowed anti-Semite Westbrook Pegler, a newspaper columnist popular from the 1930s to the 1960s, whose many distinguished accomplishments included publicly regretting that would-be FDR assassin Giuseppe Zangara “hit the wrong man,” writing in 1963 that it is “clearly the bounden duty of all intelligent Americans to proclaim and practice bigotry,” and, when Robert F. Kennedy first began considering a run for President, expressing his hope that “some white patriot of the Southern tier will spatter his spoonful of brains in public premises before the snow flies.”

Honesty! Sincerity! Dignity! Good people! (Thanks to Stephen Leigh for pointing out this story, which I missed entirely while falling behind on the news.) (Oh, and for what it’s worth, Harry Truman regarded Pegler as a “guttersnipe.”)

Toward Universal Banking

Barry Eichengreen pointe this out to me yesterday, and I could have blogged it first if I had been smart.

Justin Fox:

Aren't you sort of glad Congress repealed Glass-Steagall?: Was deregulation a factor in bringing us to our financial system to its current teetering state? Yeah, sure. But the deregulatory decision most often cited by lefty (and not so lefty) observers--the 1999 repeal of the Depression-era Glass Steagall Act that had separated depositary banking from investment banking--is actually looking pretty good this Monday morning. Without Glass-Steagall repeal, Bank of America wouldn't be able to buy Merrill Lynch, the only bit of arguably positive news to come out of this crazy weekend. And more generally, it is looking like investment banks that don't have big consumer banking franchises aren't up to the challenge of surviving modern-day financial crises. Of the five big independent investment banks that existed six months ago, only two survive.

Now it is true is that we failed to replace the archaic Glass-Steagall rules with a sensible, modernized regulatory structure. But don't worry, we'll be getting to that soon enough!

Yet More Health Care Reform Blogging

The WSJ's Washington Wire:

Washington Wire: McCain-Obama Health Care Debate (Quietly) Rolls On: Because McCain would create a new tax break and not completely get rid of the existing tax breaks, his plan would cost $1.3 trillion over 10 years, according to the nonpartisan Tax Policy Center. The center predicts it would only cover about 5 million new people with insurance at its peak. By contrast, the center predicts Obama’s plan would cost $1.6 trillion over 10 years but eventually get insurance to an additional 34 million people...

McCain would also produce higher administrative costs, and a smaller proportion of health spending would actually go for health care.


There is no law of nature that says that when the VXO hits 40 all stock market investors are so panicked already that every piece of news is going to be perceived as better than expected. Still... The Big Picture | S&P 500 vs. Volatility Index: Complacency or Capitulation? >Via Barry Ritholtz

Be Afraid. Be Very Afraid

Barry Ritholtz looks at McCain's economic advisors, and sweats:

The Big Picture | Bad Commentary, Poor Advice, Weak Analysis: Some really bad, misguided commentary:

Short-Selling More Damaging than Weak Retail Sales; a Catch-22 for Equity Capital by David Malpass

When the guy who told you not to worry about the credit crunch in August 2007 ('Don't Panic About the Credit Market) begins to blame short sellers, all you can do is shake your head in disgust. Then there is this amusing-in-a-gallows-way headline from Gawker:

Good Morning, Your Money Is On Fire

And what has to be the single dumbest discussion on recent events in the published press:

Don Luskin: Fannie, Freddie Bailout Should Be Good for the Market (Smart Money, 9/12/08)  "I love the government rescue of Fannie Mae (FNM) and Freddie Mac (FRE). We'll look back on it in a little while and realize it was the turning point in the credit crisis and the housing downturn . . . "

I had an email exchange with someone over the weekend who asked me about Luskin -- I said, rather than me giving you my opinion, they should just read any of his old columns or watch his old appearances on on a 6 month delay. Unconditionally awful . . . 

Don't let any of your friends ever vote Republican, ever. For your money's sake, if nothing else will move you.

Felix Salmon FEELS the Fear, Sweats Openly, Swallows Hard, and Stammers...

He writes, apropos of the likely forthcoming bankruptcy of AIG:

AIG Is Toast: AIG, which is a huge player in the P&C business, will have a substantial amount of exposure to the damage caused by hurricane Ike -- damage estimated at between $6 billion and $18 billion. AIG stock is now trading on option value only, which means that we can no longer look to its share price as an indication of what the market thinks is going to happen. But we can certainly look to the bond market, and if you thought the share price was ugly, just wait until you see this:

AIG's $2.5 billion of 5.85 percent notes due in 2018 plunged 19.5 cents to 33 cents on the dollar as of 9:55 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

33 cents on the dollar? The message is loud and clear: AIG is toast. This is the massive counterparty failure everybody's been scared of, and frankly I'm astonished that the broader stock market isn't plunging as a result. No one is prepared for the repercussions here: the failure of AIG is likely to be an order of magnitude more harmful than the failure of LTCM would have been. And it's not even happening on a Friday, where we could have yet another Emergency Weekend to try to work things out. Here's my favorite comment on my stock-market round-up yesterday:

That's right, Felix. FEEL the fear, sweat openly, swallow hard, stammer, piss your pants. You pathetic weasel. Go back inside until you get a grip.

I'm not ashamed to admit it: I'm having a really hard time being sanguine right now. Of course I hope that the global financial system will be able to get through this somehow. But Hank Paulson's new hard-line no-bailouts policy isn't helping: it was justifiable with Lehman, but the unintended consequence is that no one now expects a bailout for AIG, and that's just making things worse. My one hope is that someone will essentially find a way for AIG's bondholders to suffer all the losses, while AIG's counterparties suffer very little if at all. (That also seems to be the idea behind Barclays buying Lehman's brokerage operations.) So long as counterparty risk is minimized, we should be able to get through this. But will that happen? I have no idea.

Inflation is, among other things, a way of writing down the real values of all nominal debts in a relatively equitable manner.

And in a world of scarcity, it is better to disappoint the rentier than to cause mass unemployment, if you have to do one or the other.

Just saying.

Shame on Marty Feldstein. Shame on John Taylor

May I say that this is embarrassing? Really embarrassing:

John McCain Has a Tax Plan To Create Jobs - [B]y maintaining strong control over the growth of government spending, Mr. McCain will bring the budget into balance. His long record of fighting against excessive government spending, his plans to veto earmarks and reverse the spending binge of the past few years, and his strong commitment to balancing the budget...

Their willingness to roll over and tell spinmaster-generated lies is the principal reason why their successors as Republican economic policymakers will be scorned and ignored whenever the Republicans hold power--just as their predecessors' willigness to roll over and tell lies is the principal reason why they were scorned and ignored when they served in government.

McCain vs. Obama on Financial Regulation

Jackie Calmes calls John McCain a liar:

In Candidates, 2 Approaches to Wall Street: On the campaign trail on Monday, Mr. McCain, the Republican presidential nominee, struck a populist tone. Speaking in Florida, he said that the economy’s underlying fundamentals remained strong but were being threatened “because of the greed by some based in Wall Street and we have got to fix it.” But his record on the issue, and the views of those he has always cited as his most influential advisers, suggest that he has never departed in any major way from his party’s embrace of deregulation and relying more on market forces.... He has often taken his lead on financial issues from two outspoken advocates of free market approaches, former Senator Phil Gramm and Alan Greenspan.... Individuals associated with Merrill Lynch, which sold itself to Bank of America in the market upheaval of the past weekend, have given his presidential campaign nearly $300,000, making them Mr. McCain’s largest contributor, collectively.

By contrast, Barack Obama:

Mr. Obama sought Monday to attribute the financial upheaval to lax regulation during the Bush years, and in turn to link Mr. McCain to that approach. “I certainly don’t fault Senator McCain for these problems, but I do fault the economic philosophy he subscribes to,” Mr. Obama told several hundred people who gathered for an outdoor rally in Grand Junction, Colo. Mr. Obama set out his general approach to financial regulation in March, calling for regulating investment banks, mortgage brokers and hedge funds much as commercial banks are. And he would streamline the overlapping regulatory agencies and create a commission to monitor threats to the financial system and report to the White House and Congress.

There is more:

Mr. McCain was quick on Monday to issue a statement calling for “major reform” to “replace the outdated and ineffective patchwork quilt of regulatory oversight in Washington and bring transparency and accountability to Wall Street.” Later his campaign unveiled a television advertisement called “Crisis,” that began: “Our economy in crisis. Only proven reformers John McCain and Sarah Palin can fix it. Tougher rules on Wall Street to protect your life savings.” Mr. McCain’s reaction suggests how the pendulum has swung.... Mr. McCain has always been in his party’s mainstream on the issue. In early 1995, after Republicans had taken control of Congress, Mr. McCain promoted a moratorium on federal regulations of all kinds. He was quoted as saying that excessive regulations were “destroying the American family, the American dream” and voters “want these regulations stopped.” The moratorium measure was unsuccessful. “I’m always for less regulation,” he told The Wall Street Journal last March.... "I am fundamentally a deregulator.” Later that month, he gave a speech on the housing crisis in which he called for less regulation....

Mr. Obama also does not have much of a record on financial regulation.... In March 2007, however, he warned of the coming housing crisis, and a year later in a speech in Manhattan he outlined six principles for overhauling financial regulation. On Monday, he said the nation was facing “the most serious financial crisis since the Great Depression,” and attributed it on the hands-off policies of the Republican White House.... Later, citing Mr. McCain’s remarks about the economy’s strong fundamentals, he told a Colorado crowd that Mr. McCain “doesn’t get what’s happening between the mountain in Sedona where he lives and the corridors of power where he works.”

One reason for both men’s sketchy records on financial issues is that neither has been a member of the Senate Banking Committee, which has oversight of the industry and its regulators. Under both parties’ leadership, the committee often has been a graveyard for proposals opposed by lobbyists for financial institutions, including Fannie Mae and Freddie Mac, which last week were forced into government conservatorships. Industry lobbyists’ success in killing such regulations meant senators outside the banking panel did not have to take a stand on them.

Yet Another Reason to Vote Against John McCain

Ezra Klein:

Ezra Klein Archive: Today, John McCain said, "Wall Street has betrayed us. They've broken the social contract between capitalism and the average citizen and the worker. And workers are paying a very heavy price while a lot of them are not only emerging unscathed but some of them are left with packages of a hundred million dollars or so. This is a result of excess and greed and corruption.... And we got to fix it.... We have to have a 9/11 commission to find out what went wrong.... And as president, I guarantee you, it will never happen again"...

John McCain's contention is that Wall Street has, for years, been rotting in a toxic mixture of greed and overreach and corruption. Simultaneously, a 70-year-old regulatory structure has proven inadequate at checking the institution's excesses. This is, in other words, a crisis composed of trends, rather than a singular, unpredictable, catastrophe.

Three years ago, John McCain signed on to George W. Bush's efforts to privatize Social Security. He surveyed Wall Street and decided that it was a stable enough institution to entrust with the nation's pension funds. Three years ago. And this wasn't just an attempt to cozy up to Bush: McCain was arguing for privatization in 1999. So McCain's argument is that Wall Street is built atop an unstable regulatory foundation and is shot through with most of the seven deadly sins. That the situation has been allowed to fester so long is evidence that "people were asleep at the switch." Even so, McCain has consistently argued that much of Social Security should be turned over to... Wall Street. Either he wanted to tank the nation's pensions funds or he was one of the people asleep at the switch. But those are really the only two options here.