A solution for those absurd banker bonuses

Paul Krugman is pissed about the bankers who have lost hundreds of billions of dollars, and have yet paid themselves large bonuses. Maureen Dowd is also pissed. She wants disgorgement - she wants to get the money back. Of course, many, many, many people are pissed. I would say the "pissed off" group includes pretty much every American who does not live in Greenwich, Connecticut or various neighborhoods in Manhattan.

I would like the money back as well, but I don't want it back by demanding back their bonuses. I'm going to take the logic that justifies these bonuses just a bit further.

There are a couple of justifications for paying people in the financial industries lots of money. First, there's the idea that they earned it. If I negotiate a deal worth $100 million, and I negotiate a 1% fee, that means that I get $1 million. And I get it because I negotiated it, and all parties agreed to it. I am selling my services for what they are worth. That's the free market at work. I have no problem with that. I've benefited indirectly from that system; I used to work at an investment bank as a secretary, and I got good bonuses because the people that I worked for negotiated good fees for our company.

The second justification for paying large bonuses is that if you don't pay your best people well, they will leave and go elsewhere. There are a couple of problems with this argument at this point in time. First, where are they going to go? Pretty much all banks are in the same boat. Second, if your bank just lost tens of billions of dollars, then the people who work for your bank are not very good at their jobs. Seriously, would you want "Lehman Bros. mortgage bond trader" on your resume right now?

But let's take this justification at face value. The idea is that people who provide essential services should be compensated well for providing those services. Lawyers who negotiate extremely complex contracts should get paid more than ambulance chasers. Investment bankers who negotiate multibillion dollar LBOs should be paid more than people who arrange standard mortgages. As I wrote above, that's the free market at work.

But let's think about this a little differently. Right now these banks and other companies are in dire straits. The federal government is providing an essential service by bailing them out. Some people think we should be demanding partial or total ownership of these banks in exchange for our money. We're handing over large checks, we should get equity (this is Krugman's argument). But that way, some would argue, lies socialism, and banks should not be nationalized. I tend to agree. I'm not in favor of the government running my bank, even if it's in serious trouble.

When lawyers negotiate deals, they don't ask for equity in the deal, unless there are unusual circumstances; they get paid straight fees. Bankers might get equity, and venture capitalists by definition do get equity. So some equity in exchange for the taxpayer's money is a good idea, but it will not work for the whole deal.

So let's get back to this idea of high fees for essential services. The government is definitely providing an essential service to these bankers and insurance companies, and all their assorted associates. How can we charge them high fees for these essential services?

Simple. Raise their taxes. The Bush administration lowered taxes for the wealthy, arguing that would stimulate greater economic growth, because individuals are better stewards of their own money than the government. That argument is not working all that well right now.

I would love to see Republicans try to argue against raising taxes right now. I understand that raising taxes in a recession is supposed to be a recipe for disaster, so maybe we can wait six months or a year. But we are definitely providing essential services to rich people right now.

Rich people argue that they are wealthy because of their own initiative. This is true to an extent, but not the whole picture. They are capable of acting on their own initiative in ways that make them wealthy because they live in the United States of America. If they lived in Zimbabwe, no matter how resourceful and ambitious they are, they would not be wealthy (unless they were part of the corrupt ruling regime). The government is not only providing essential services right now by bailing out the financial system, it has been providing essential services for decades. Centuries, even. A reasonably effective, if often flawed, judicial system. An excellent, if often flawed, educational system. Roads, airports, etc.

One large problem with this bailout is that if the banks et al. lose huge amounts of money, even if they don't pay bonuses, they don't pay negative bonuses. Even if we get every dime of the bonuses back, all $18 billion, that's still a tiny fraction of the money required for the bailout. We can't make these bankers pay us directly for providing the essential service of bailing them out. And even if we could get money from them, it still wouldn't be enough.

One of the essential services that the government is providing is a form of insurance. The FDIC works because it is an insurance company, of sorts. Banks pay insurance premiums on their deposits; the FDIC uses that money from the premiums when it has to bail out of savings and loan or a bank. That's what the (former) $100,000 limit was for; deposits were insured to $100,000. Now it's $250,000.

There is no official insurance fund for the bailout, besides the Troubled Asset Relief Program, but that is an ad hoc insurance program, developed on the fly. The insurance fund that the banks are relying on is the pool of money that is the United States government's ability to borrow money, which is, in turn, backed by the financial stability of the United States as a whole. So, in a sense, the taxes that we all pay are payments into this insurance fund that we call the United States government that is bailing out our financial system. This is, in a sense, another version of the "essential services" that we, as a country, are providing to bankrupt bankers. We are providing them with ad hoc, made-up-on-the-fly insurance coverage for their mistakes. The problem is that they haven't paid into the insurance fund as fully as they should have; that's why the federal government has a huge debt.

So, to make sure that the insurance fund that we call the US government is fully funded, we need to charge the people who rely on that insurance fund the proper premiums. Which, in this case, is called "raising taxes." I think we should start with the capital gains tax.

Oops.

Time for a redo; the House did not pass the bailout.

I admit to some relief. Paul Krugman was in favor of it, but just barely (like pretty much everyone who was in favor of it, I think). He was tolerant of the policy, and recognized the politcal reality; this was the best the Democrats could do and expect any kind of Republican support at all.

Kos didn't like it, although he recognizes the need to do SOMETHING.

I'm torn between Krugman and Kos; I don't always agree with either, but I trust Krugman on economics, and I respect Kos on the politics.

All of that, of course, is irrelevant right now. The thing is dead. It won't come back up for at least a couple of days. I don't expect opinions to soften in the interim. The people back home are not going to discover a new love for Wall Street.

It's becoming clear that, for all his ability to manage the crisis day-to-day, Henry Paulson didn't play the politics of this well. That's not really his fault; he's not a politician. But his initial power grab didn't go over well, and springing the "$700 billion" figure out of the blue, immediately after the Merrill Lynch-Lehman-AIG few days of terror, didn't help. That's a huge chunk of change to start talking about all of a sudden.

I'm sure Paulson didn't calculate the politics of how the House and Senate would react; first, he didn't really have time, second, it's not his background. SOMEONE in the Bush White House should have realized that this was not going to play in Peoria. Of course, that would be assuming that someone in the White House would have a clue how this is going to play in Peoria. Which, obviously, no one, least of all Bush, does.

I've said it before, I'll say it again: George Bush's biggest problem isn't that he isn't very bright or isn't intellectually curious or even that he's a stubborn SOB. George W. Bush's problem - and now, our problem - is that he simply isn't a very good politician. He just doesn't know how to read other people very well, particularly when they potentially disagree with him. Which means that he does not anticipate problems like the House Republicans not going all with him. Which means that he has no idea how to GET them to go along with him. He just does not have the empathetic imagination: he cannot imagine another person's perspective very well.

Bill Clinton, of course, was an absolute genius at that. And I mean genius in the literal sense: he was not brilliant at it, he was a genius at it. He could imagine how all the other parties in a particular situation would react, not merely to a policy proposal, but to each other. Bush has no idea that that is even an important thing to try to do.

So now we're stuck with a broken deal and a financial system in crisis. We know what the minuses are: an incompetent, powerless president; a furious electorate; raging uncertainty in the financial markets; a fractured GOP, with open revolt among members.

Are there any pluses? The Democratic leadership seems to be united. Henry Paulson presumably now has a better sense of how to play the politics; he seems to learn fast. The rank and file Republicans in the House have now had their chance to make themselves heard; maybe that was enough for some of them.

Maybe Congress will come up with a better bill. It will come up with a different one, that's for sure. Maybe it will be dramatically different; maybe it will just be tweaked.

One variable I can't predict is how John Boehner and the rest of the House leadership will react. They may very well be furious at Bush for not playing this well; at the very least, they can't be happy with Bush. But if this goes down again, Wall Street is going to hold them accountable.

There's one wild variable: the VP debate is on Thursday. Ain't no way in hell this is going to be postponed. If Sarah Palin holds her own, maybe Republicans will be more confident of victory for McCain in November. But if, as seems more likely, she tanks, they may be ever-closer to panic mode. How that will play is anyone's guess.

The housing bill

A friend of mine texted me the other day to let me know that he was disappointed in the housing bill, because he doesn't want to see his taxes going to bail out people who got greedy and are now being burned. Or something like that. Anyway, he was unhappy.

I don't think anyone is happy about bailing out people who bought houses and signed mortgages for the wrong reasons. But this is a crisis, and it has to be addressed. If we don't help these people out, there will be a lot more economic damage. And I'm not a big fan of increasing our population of the homeless.

Daily Kos has a rundown of the legislative history of the bill, which is fascinating if you're part of that subgenre of political junkies who are seriously into the minutiae of getting bills actually passed. For a policy take, Paul Krugman approves, with some serious caveats. He writes, for about the zillionth time, about how unrestrained greed in unregulated or lightly regulated financial markets allows people to make really stupid decisions.

My take on it is this: it's probably the best of a bad situation. But if we want the greatest possible range of freedom, we must accept the greatest possible range of error. If we want the freedom to be able to make mistakes, we have to allow others the same freedom. And if, when we make mistakes, we occasionally depend on others to help us out of the jam we have gotten ourselves into, we must be prepared to offer the same in return to others. If we want forgiveness with a minimum of judgment, we must be prepared to, again, offer the same in return.

Well, at least we're talking about new financial regulations now

The Treasury announced a slew of new regulations for financial institutions. I'm not enough of an economist or policy wonk to really judge how well they would work, but I am skeptical, for at least a couple of reasons. First, obviously, I don't have a lot of faith in any kind of proposal on regulations of the financial industry from this administration. Second, this came up very quickly after the Bear Stearns debacle. It's clearly been in the works for a while, but it also seems to me that at this point it's probably more of a PR thing than a serious proposal. Bush & Paulson & Co. know they have to at least LOOK like they are doing something. Sounds like the key players aren't buying:

As Treasury Secretary Henry M. Paulson Jr. on Monday formally laid out an ambitious plan to overhaul the regulatory apparatus that oversees the country’s financial system, senior lawmakers and lobbyists from industries opposed to the plan predicted that most of it would be dead on arrival.

Paul Krugman is not impressed. No surprise there.

"it’s all about creating the appearance of responding to the current crisis, without actually doing anything substantive."

The key issue is actually fairly straightforward. Banks, like Citibank, Wells Fargo, etc., the kind where people put money into a normal checking account, are regulated by the federal government. In return, the government guarantees deposits, up to certain limits. This is a result of all the bank failures during the Great Depression. The federal government is kind of like a parent: you live in my house, I pay for the roof over your head, you play by my rules.
Investment banks, on the other hand, don't have the same kind of regulatory oversight. So they can make deals and buy and sell stocks and bonds and commodities and derivatives and all kinds of exotic financial instruments without the constraints that regular banks have. But they're not guaranteed by the feds like the banks. More freedom, but more risk.
Bear Stearns changed that, because Bear Stearns's survival, such as it was, was backstopped by the government. So now the investment banks, or at least one, are moving back in with the parents. They very well need the money that only the federal government can provide. And they clearly need the kind of supervision that only the government can provide. Will that happen under the current regime? Krugman, of course, is not optimistic, given the track record:

"The Bush administration, however, has spent the last seven years trying to do away with government oversight of the financial industry."

I'm going to be following this. There are a couple of political implications up front: Chris Dodd is the key player in the Senate, and Barney Frank in the House. I'm very glad both of them are on the case, I have a great deal of respect for both. Dodd is an interesting player, because, as the Senator from Connecticut, Wall Street is in his backyard, and there are a lot of Wall Street types among his constituents. So he might come across as a Wall Street guy. But he won a lot of street cred taking on Bush over wireless wiretapping, so liberals will probably have faith in him. And you just have to listen to Barney Frank talk policy to realize he's brilliant.