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Four Questions

Newt Gingrich says not so fast to Paulson's bailout plan. I particularly agree with this:

Four reform steps will have capital flowing with no government bureaucracy and no taxpayer burden.

First, suspend the mark-to-market rule which is insanely driving companies to unnecessary bankruptcy. If short selling can be suspended on 799 stocks (an arbitrary number and a warning of the rule by bureaucrats which is coming under the Paulson plan), the mark-to-market rule can be suspended for six months and then replaced with a more accurate three year rolling average mark-to-market.

Second, repeal Sarbanes-Oxley. It failed with Freddy Mac. It failed with Fannie Mae. It failed with Bear Stearns. It failed with Lehman Brothers. It failed with AIG. It is crippling our entrepreneurial economy. I spent three days this week in Silicon Valley. Everyone agreed Sarbanes-Oxley was crippling the economy. One firm told me they would bring more than 20 companies public in the next year if the law was repealed. Its Sarbanes-Oxley's $3 million per startup annual accounting fee that is keeping these companies private.

Third, match our competitors in China and Singapore by going to a zero capital gains tax. Private capital will flood into Wall Street with zero capital gains and it will come at no cost to the taxpayer. Even if you believe in a static analytical model in which lower capital gains taxes mean lower revenues for the Treasury, a zero capital gains tax costs much less than the Paulson plan. And if you believe in a historic model (as I do), a zero capital gains tax would lead to a dramatic increase in federal revenue through a larger, more competitive and more prosperous economy.

Fourth, immediately pass an "all of the above" energy plan designed to bring home $500 billion of the $700 billion a year we are sending overseas. With that much energy income the American economy would boom and government revenues would grow.

Also, SOX was the disastrous result of the last time Congress decided that it had to "do something."


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Carl Pham wrote:

An apt essay. You can see why Mr. Gingrich was one more of those He Who Must Be Destroyed among the fascist left.

One thing he overlooks, or perhaps does not have time for here, is demographics. I don't think you can ignore the effect on financial markets of the fact that the giant boomer generation is on the cusp of retirement. That is, I don't doubt, one of the reasons for this massive bailout. Twenty years ago, we would have just let the financial markets crump, sort themselves out, and all would be fine by and by. In fact, we did just that, in 1987. But we didn't have a huge bump of 55-year-olds who would positively freak if their 401k's plummeted 20% in one year. Even though the accounts will be back up in 5 years, they don't feel they have that kind of time.

What else does that demographic bulge have in store? Well, obviously, don't look for SS/Medicare reform any time in the next 10 years, except insofar as taxes on the working young will go through the roof to pay for it.

Two other interesting possibilities are a massive shift from growth stocks to conservative stocks and bonds, T-notes, that kind of thing. Expect it to become incredibly easy for the Treasury to borrow money, and much harder for small companies and first-time home- or auto buyers. This Paulson thing could be only the first move of a shift of national control of investment capital to the Federal government, whom the boomers trust more than umpty private boards of director.

One final result would be zooming wages in service jobs, nurses, lawn care, car mechanics, contractors. The boomers need people to take care of them, and, with shrinking young populations, those who can do those jobs will be able to demand higher wages. Again, you can kind of already see this: car mechanics these days earn more than professors. No wonder fewer men are going to college.

Dick Eagleson wrote:

Newt's last three suggestions are all good, but their goodness is largely unrelated to any uniquely tonic effect they would have on fixing the current credit market mess.

Said mess is basically a crisis of confidence in asset values. There's a ton of questionable paper floating around out there and the biggest question about it is, "What is it worth?" The markets are behaving as though the default valuation for all possibly dodgy paper is zero. This is, in a sense, prudent, but it is not, statistically, very close to being true. The repackaged, "securitized" sub-prime housing loans that are the most intensely radioactive fraction of the problem are still 80+% just fine. The problem is that no one seems able to reliably unwind all the indirection introduced by exotic derivatives to figure out how much of the troubled 15-20% of such loans happens to be mixed into any particular financial instrument.

Unfortunately, Newt's first suggestion - the only one that even tangentially addresses this issue - is to advocate the legislation of a blanket rule of thumb. Instead of following mark-to-market, which would result in fabulous quantities of sound or only slightly damaged debt securities being held instantly valueless, Newt suggests a different across-the-board fiction, mark-to-rolling-average-market; to wit, that we take all of this stuff as being worth 1/3 times what it would have fetched two years ago, plus 1/3 what it would have fetched last year, plus 1/3 of what it would fetch now - i.e., roughly zip - and come up with a new "market value" for said assets.

The proposed bailout is not, in my view, a good idea, but it does at least directly address the question of questionable valuations. The new, effective accross-the-board valuation of questionable debt securities covered by said bailout would be the $700 billion Bernanke and company propose to offer as guarantees divided by whatever the total book value of the covered paper is. Expressed as a decimal, this is equivalent to setting an X-cents-on-the-dollar working value for said debt securities.

I don't know what the denominator in this fraction is, but it seems likely that it has at least 12 digits in it. If it was, e.g. $1.4 trillion, say, then X would be 50 cents on the dollar. Given that 80+% of the underlying subprime loans are said not to be in arrears or default, it would probably be a good deal for we taxpayers if this bailout were structured as an instant, comprehensive purchase of all such primary and derivative paper by the U.S. Treasury. Uncle Sugar would be, in essence, paying 50 cnts to get assets worth, in aggregate, somewhere north of 80 cents. The big financial institutions could take their one-time haircut, swallow hard and get on with things in a, presumably, more reality-based risk assessment environment.

The problem is that the bailout, as I understand it - and I may be incorreclty grokking the fullness here - is structured as a pool of guarantees that is to be dipped into by the suddenly strapped underwriters of the aforesaid dodgy paper on an as-needed basis as they unwind all the questionable derivatives and get back to sorting the underlying sheep from goats, subprime mortgage-wise. This would appear designed to allow the institutions to keep all the good stuff and stick you and me with just the dogs - and dead dogs at that.

I'd like to be wrong about that last part. If someone has a more optimistic interpretation of the proposed Treasury bailout mechanism, I'd be delighted to be shown to be wrong.

But I very much fear I'm not.

Andy Freeman wrote:

The absurd thing about the "mark to market" ending up at 0 is that there were lots of folks willing to buy for significantly more than 0. However, regulations and the old boys club kept them out of the market.

Think about it. How many of you would have been willing to pay $0.1-20 on the dollar for these securitized loans? We're not going to see 50% defaults and even if we do, housing isn't going to fall 70%.

Adam Greenwood wrote:

Very coherent, Eagleson. I think option 3 especially would help more than you think, because it gives the marginal investor (or the marginal investment dollar) a reason to take a flier on uncertainty, now that the potential rewards of doing so would be greater.

I'm no expert but like you and Jim Manzi my understanding is that our current adhoc approach is likely to stick the taxpayer with the bill while letting some of the investors and executives skim the gravy.

Anonymous wrote:

Damn good analysis Eagleson. This is sticking it to the average guy, no doubt about it.

Anonymous wrote:

There may be room here for all sides of the blog divide to agree:

Andy Freeman wrote:

> Instead of following mark-to-market, which would result in fabulous quantities of sound or only slightly damaged debt securities being held instantly valueless

The problem with mark-to-market is that the market was restricted. That breaks when the only folks who are allowed to buy decide that they don't want to buy.

Meanwhile, I'd have happily bought any of this stuff for $0.2-30 on the dollar and I'm sure that other folks would have paid more.

I'm going to be stuck paying for stuff that I wasn't allowed to buy. Gee thanks.

Carl Pham wrote:

So Kos agrees? Well, you know what they say about stopped clocks.

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This page contains a single entry by Rand Simberg published on September 21, 2008 1:28 PM.

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