Nanny Taxes and Bong Hits
In defense of Tom Daschle, and Tim Geithner, and Nancy Killefer, and Linda Chavez, and...
Katherine Mangu-WardAs the Michael Phelps mini-scandal of 2009 has demonstrated, the American people can be hypocritical jerks sometimes. They scarf down precious Matt Lauer-narrated human interest stories about how celebrities, politicians, and white sports heroes are just like us! But when Phelps hits the bong at a kegger, the nation is aghast to discover he is a totally normal person in non-chlorinated environments.
Likewise with the multitude of tax scandals now engulfing several of President Barack Obama's appointees. More Americans probably cheat on their taxes than smoke pot. And a lot of Americans smoke pot. (Look away IRS. You and your 67,024+ pages of U.S. tax code have already audited me once.) Even those who don't mean to cheat on their taxes will probably do so accidentally, unless they confine their daily activities to (a) going to a salaried job and (b) rushing home to sit perfectly still lest they earn and/or dispense freelance or self-employment income or incur any deductible expenses by, say, giving to charity or getting sick. Needless to say, this does not describe the lives of the best and brightest in government.
Yet the nation goes into paroxysms of horror when potential political appointees screw the pooch on their tax returns. The surest way to making a tax error—thus precipitating a graceful but heartbreaking withdrawal from consideration for high office—is to hire someone to take care of your children while you work extremely hard, perhaps for the U.S. government. Ideally, you will select a skilled and caring person who happens to inhabit the lowest rung of the American class system, an illegal immigrant. You will give her a chance to establish an income, credit, and possibly a path to citizenship. You will accept her into your home, make her part of your family, and pay her a fair wage for her labors. She, in turn, will probably pay taxes on her income. But you, as an employer, might forget/purposely neglect to pay an additional payroll tax on her salary.
Should you be tapped for higher office, this is a brilliant path to shame and ruin for you, your family, your party, your president, and yes, your nanny. Yet for all of your peers, it is simply normal conduct. There are about 70 million kids and 1.3 million childcare workers in the United States. While most of those people aren't full-timers, nannies can be as common as Baby Einstein DVDs among a certain set—and you'd better believe payroll taxes aren't getting paid, recorded, or otherwise properly parsed in an awful lot of houses.
The story of Obama's would-be chief performance officer Nancy Killefer is a tidy case. The woman failed to make quarterly unemployment tax payments to the District of Columbia for a year and a half. She fixed her mistake in 2005 after the D.C. government put a lien on her house for a whopping $298 dollars in taxes owed on the salaries paid to her nannies and assistant, but the city added $48.69 in interest and $600 in penalties. I only wish my tax mistakes were as low as $298. She literally and figuratively paid her debt to society years ago. But no matter, she's out of the running. (A horrible irony: Her previous job has been as the chief financial officer and chief operating officer at the Treasury Department, where she worked on a major project to modernize the IRS.)
Being in possession of two X chromosomes seems to make nanny problems worse, though the rule is far from absolute. Not one, but two Clinton nominees for attorney general of the lady persuasion were deep-sixed by the undertaxed nanny gambit. The nanny and chauffeur combo brought down judicial hottie and "very sexual woman" Kimba M. Wood. The same dragon reared its ugly head and got Zoe Baird, too. (Meanwhile, this nanny is left unmolested in her State Department appointment as a public diplomatic envoy. Is there no justice in the world?)
Linda Chavez, Bush's pick for Secretary of Labor, wound up as the star player in a too-good-to-be-true illegal employee story: Chavez was the first Hispanic nominee to a cabinet position, and she was caught employing an illegal Guatemalan immigrant off the books. Or so the headlines screamed. Later, it emerged that Chavez had never employed the Guatemalan woman in question, but had instead given her money and helped her escape domestic abuse. Never mind, she was out, too.
Who is the big winner in the tax evasion sweepstakes? Confirmed Treasury Secretary Tim Geithner. What does Geithner have that all these other guys and gals don't? After all, in addition to failing to pay $34,023 in self-employment tax from 2001 to 2004, he has had his share of household staff tax screw-ups: According to the Associated Press, he "filed the taxes late for his household employees in 1996 for years 1993 to 1995; he incorrectly calculated Medicare taxes for his household employees in 1998 and received an IRS notice; and he received notices from the Social Security Administration and the IRS after not filing 2003 and 2004 forms for his household employees." He also has an undocumented housekeeper for a few months in 2005. But he's in!
And now, as Tom Daschle and his hedge-funded untaxed chauffeur get out of Dodge, tax return tucked between his legs, it's easy to wonder if it was the ridiculous Libeskindian glasses that did him in. They're just so darned expensive-looking. If it's to be class war, fine. Go after people with nannies and chauffeurs and assistants. (Daschle started it, anyway, with his bragging about his rust bucket of a car and his numerous votes for higher taxes on the rich.) But in that case, call a spade a spade. Ask the question, "Are you now or have you ever been in charge of household help?" on the vetting questionnaire, and strike those who reply in the affirmative. Precious few talented, ambitious people will be left once that crew has been stricken from the rolls.
Anyone in search of a guiding principle, a bright line, or any other absolute won't find one. Michael Barone, king of the wonks, valiantly attempted to find a rule of thumb that divides Geithner's $34,000 from Daschle's $146,000 from Killefer's $298. Geithner, he says, is uniquely qualified to run Treasury, whereas lots of people know about Daschle's bailiwick, health care nationalization. But this explanation doesn't hold much water. Sometimes (oftentimes, in Washington) there simply is no rule. It's just that some people get screwed and some people sneak by, just like you and me when it comes to taxes. Looks like politicians really are just like us!
No New Deals
No New Deals
Let entrepreneurs and innovation stimulate the economy
Shikha DalmiaThere is one thing that's giving political momentum to the Bush-Obama multi-trillion bailout/stimulus spending spree, and it is not a superior understanding of how to fix the ailing economy. It is fear. "Nameless, unreasoning, unjustified terror," as FDR once said.
The economy is in terrible shape. Financial markets are in a deep freeze. The stock market has lost over 40 percent of its value from the Dow's peak last year and 401(k) portfolios are shrinking. Unemployment is rising to levels not seen in 25 years. Companies—big and small—are downsizing or, worse, shuttering their doors completely. And home foreclosure rates are reaching record highs.
Under such circumstances, the fear is that we might well reach the point of no return—or, as a CNN anchor recently put it, face permanent "economic catastrophe."
But it's as likely that government intervention might well delay the recovery process, just as it did in the 1930s when a combination of spending and regulations unleashed by FDR's New Deal turned a recession into a prolonged depression.
Rather than a time for panicked reactions, this is the time to fully understand a lesson of history: The rubble of every recession contains the seeds of its own regeneration. Physical and human capital of dying economic sectors don't vanish with them. These assets—equipment, property, workers—are re-released into the economy, where entrepreneurs, unless thwarted by taxes and regulations, scoop them up and inevitably find more productive uses for them. In the process, new companies are born and new jobs created—offering, over time, far better returns and wages than before.
This is not idle, theoretical speculation.
On a micro level, consider the Pony Express, which was the UPS of 1860. The company cut down delivery time for coast-to-coast mail from six weeks to 10 days by using horse riders instead of ships going around South America. It was wildly successful, but only for about a year. Then commercial telegraph came along, and the company went belly up. Hundreds of workers lost their jobs at a time when civil war was starting, a major recession was brewing after a European bubble in railroads burst, and unemployment was soaring as immigrants from Ireland and elsewhere were coming in droves. But according to Saddles and Spurs, a rare group biography that traces the fortunes of the laid-off riders, all of them found equal or better jobs, in the burgeoning telegraph industry, rodeos and other shows, and as scouts in the Union Army.
On the macro level, consider the experience of the U.S. steel industry in the 20th century and the tech sector at the start of the 21st century. Both went through brutal downsizings that eventually strengthened the American economy and led to generally higher living standards.
Until about 1945, Big Steel—consisting of companies such as U.S. Steel that produced steel from iron ore in large mills—dominated the world market, producing about half of the global steel output. This hegemony, notes University of Dayton economic historian Larry Schweikart, led the industry to precisely the same vices that are responsible for torpedoing the Detroit-based car makers today: bloated corporate bureaucracies; a pampered, unionized workforce with unsustainable legacy costs; and inefficient production methods.
By the 1960s, Big Steel was facing stiff competition from overseas producers, first from Japan and Europe and then from Third World countries such as Brazil. About a quarter of American steel producers went bankrupt between 1974 and 1987. The industry's global market share shrank to 11 percent and employment dropped from 2.5 million in 1974 to 1 million in 1997. But this fight for survival, spanning decades and several recessions, eventually restored the overall industry to profitability. Led by companies such as Nucor, domestic steel makers discovered new ways to turn scrap into steel in sleeker, smaller factories called "mini-mills," using non-unionized workers and a leaner management team.
The physical and human resources that the steel industry squeezed out in its quest for more efficiency didn't simply go up in smoke. They were utilized by other sectors of the economy. For example, employment in the plastics industry, which replaced steel for some uses, grew over 18 percent between 1980 and 2006.
If American-owned automakers were among the loudest voices demanding a bailout from the Bush administration, American steel makers are among the loudest voices demanding massive stimulus spending (on schools, roads, bridges, rapid transit, and other steel-intensive projects) from the Obama administration right now. But if the industry emerged stronger without artificial measures to boost demand for steel once, there is no reason to believe that it won't do so now.
An arguably more stunning comeback involves the dot-com industry. After the 2000 stock market crash, hundreds of Silicon Valley startups collapsed, throwing thousands of highly paid computer professionals out of work. However, within a few short years the industry began to recover, reabsorbing many of the laid-off workers.
One reason for the industry's quick recovery, according to Todd Zywicki, an economist at the George Mason University, was that it was able to rapidly redeploy its resources away from failing enterprises toward more promising ones. Unlike traditional industries, much of the dot-com sector was financed not by debt from bond holders but venture capitalists with equity stakes. This meant that when these companies started showing signs of trouble, their financiers were able to cut their losses and seed other ventures without getting bogged down in time-consuming bankruptcy proceedings.
What's more, they did so at a time when there was a glut of computer talent, not to mention cheap office space, equipment, and other physical assets—all of which positioned them for future success. "If Washington had appointed itself in charge of saving the industry, it would have declared AOL too big to fail," comments Zywicki. "The net effect would have been to retard the advance of broadband and we would all still be using slow-speed dial up to access the Internet."
These are tough economic times and it is impossible to know in advance where the next telegraphic or broadband revolution will come from to drive us out of recession. But the American economy has demonstrated awesome powers of self-correction when its entrepreneurs are left alone to blaze new trails—without a panicked Washington pushing them off course.
FDR famously proclaimed that we have nothing to fear but fear itself. That, and a government that will get in the way of an economic recovery.
From Liberation to Obligation
From Liberation to Obligation
The economic downturn will place a heavier burden on women.
LIONEL TIGER
In a serious economic recession, the environment is often suffused with danger. Unlike in a war, however, when you peer across the ridge or down the road, there is no clear-cut enemy.
But there are clear casualties in downturns, including the current one -- including that male employment is more vulnerable than female employment. According to the Bureau of Labor Statistics, an extraordinary 82% of current job losers are men. Because for various reasons these jobs were more lucrative than women's jobs to start with, the end point is not only sharp changes in income but new requirements for how families can live.
The impact of these uneven job losses will be felt along lines which have been apparent for quite some time to some of us concerned with basic biology. Ever since females gained control of reproduction, mainly with The Pill, there has been a cascade of subtle but extensive shifts in sociosexual experience. Now, in both a real and symbolic sense, women are acquiring control of production too.
But they are also being more controlled by it. Like men in the past, they no longer have a sassy choice between job or family. Bread before self-expression and "fulfilling potential."
First find a job. Maybe then, find yourself.
More and more women are having children without husbands. Within the family system, men are more likely to become outlaws than in-laws. They leave the family system, or don't join it in the first place. This is decisively more likely when they have no work.
Who wants an out-of-work man? They are unlikely to be considered plausible candidates as mates by sensible women -- which is virtually all women in this context -- who understand the essential economic envelope of romance.
That traditional diamond ring is after all a wholly useless but flagrantly symbolic promise by prehubby of care and resources to come. The rule of thumb and the third finger left hand is that the ring is supposed to cost at least two months of after-tax income. What if there's no such income now or in the foreseeable future?
But breakfast has to be made, children lulled to sleep, granny taken to her dentist. What is happening in the cold turbulence of the economy is affecting and will affect more deeply the warm intimate parts of life. In short, there will be more pressure than ever on women.
Overall, women will never neglect their families. If women have to, they will tie themselves into knots to do what's necessary. They will have to find ways to earn money while their men -- if they have them -- sally forth to job lines and soon breadlines.
Irritated slogans about equal opportunity will fade, replaced by dour acceptance of equal obligation. Or if the current data are predictive for women, unequal obligation.
Mr. Tiger teaches anthropology at Rutgers and is the author of "The Decline of Males" (St. Martin's, 2000).
Senate Reaches $780 Billion Compromise Package
Senate Reaches $780 Billion Compromise Package
Democrats and GOP Moderates Negotiate a Leaner Plan; Housing and Auto Tax Breaks Could Push the Total to $820 Billion
GREG HITT JONATHAN WEISMAN
WASHINGTON -- Senate Democratic leaders struck a deal late Friday with three moderate Republicans on a leaner economic-recovery package, clearing a path to Senate passage of one of the most ambitious fiscal stimulus plans in decades.
The deal came after five days of partisan gridlock, and followed news earlier Friday that employers had slashed nearly 600,000 jobs in January. Senators valued the compromise plan at $780 billion -- well less than the $930 billion plan the Senate debated most of the day.
No final vote on the package was expected before Monday.
Not counted in that estimate are several popular tax breaks -- including measures to encourage auto and home sales -- that were approved this week on the Senate floor and are expected to be incorporated into the legislation. Those could push the final cost of the Senate plan closer to $820 billion.
The New Senate Plan
The compromise reached by Democratic leaders with moderate Republicans involves cuts to spending and tax-credit provisions in the stimulus bill before the Senate, including:
- Funding to computerize health records
- National study on the comparative effectiveness of health treatments
- A tax break for solar and wind firms
- Medicaid payments to states
- A $500 payroll tax credit for people earning less than $75,000
- An expansion of tax credits for low-income workers with children
Left to right: Sens. Joe Lieberman (I., Conn.), Ben Nelson (D., Neb.), Susan Collins (R., Maine) and Arlen Specter (R., Pa.), who helped craft the less-costly, economic-stimulus plan as part of a bipartisan group of moderate senators at the Capitol on Friday.
Among the $110 billion in spending cuts: $98 million for school nutrition, $3.5 billion for school construction, and $100 million for the National Oceanic and Atmospheric Administration.
The deal jettisons or pares back a number of items that President Barack Obama had wanted. Funding to computerize health records is all but gone, as is a national study on the comparative effectiveness of health treatments. Mr. Obama's Make Work Pay payroll-tax holiday was clipped back, and an expansion of the child tax credit for the working poor was also trimmed. At least half the funds to subsidize state education spending were eliminated.
White House aides refused to call those cuts a defeat for the president. Indeed, Sen. Susan Collins (R., Maine) said White House chief of staff Rahm Emanuel helped negotiate the final deal. One White House aide called the compromise "a strategic retreat" to get the bill into House-Senate negotiations and off the Senate floor, where it was being picked apart.
It remained unclear Friday night when the Senate would vote on the compromise.
The plan includes some $25 billion in trims from the $275 billion tax-relief elements in the earlier Senate package. Senate Finance Chairman Max Baucus (D., Mont.) said the decision to scale back the tax cuts reflected an effort to "get this more balanced." Through the day, liberal members of the Democratic caucus pushed back against proposed cuts, insisting that all of the reductions in the package not come from spending, aides and senators said.
The reductions in tax relief would come from sharply scaling back a proposal to allow money-losing firms to get refunds for taxes paid in past years. It would also trim eligibility for the payroll tax holiday, phasing out the benefit for couples making more than $140,000 a year, down from $150,000, and for singles making $70,000, down from $75,000, congressional aides said. Also, the agreement raises the earnings threshold to $8,100 for low-income taxpayers to qualify for the refundable child tax credit.
Even a scaled-down Senate package, if passed, would likely be broadly consistent with the House-passed bill, and well within the range of what Mr. Obama originally called on Congress to approve.
The new plan would still provide an array of tax cuts for individuals and business, aid to cash-strapped states and billions of dollars in new spending, as well as more jobless benefits, food aid for the poor and road and bridge construction, among other things.
If the Senate passes a plan, it would set up private House-Senate negotiations, which were expected to begin next week. Big questions loom over the Senate's more generous tax breaks, including the auto and housing incentives. And the Senate will head into negotiations with sharply lower funding on education -- a major priority of top House Democrats, including Speaker Nancy Pelosi of California.
Democratic leaders have promised Republicans a voice in final negotiations. But the talks also will offer Mr. Obama and his aides a chance to exert even more influence on the details of the final package, amid efforts to conclude action by the end of next week.
Tax Cut Better Than Stimulus
2:25David Ranson, of H.C. Wainwright Economics, talks with Dow Jones Newswires' Simon Constable about the government efforts to jump start the economy and explains to Simon Constable why a tax cut would be better.
The stimulus debate has highlighted the political terrain that President Obama faces: a smaller but more vociferously conservative Republican Party battling a liberal Democratic leadership that is anxious to put its majorities to work passing long-deferred priorities.
Senate Majority leader Harry Reid, in his effort to round up votes, bargained for much of Friday with Republican Maine Sens. Collins and Olympia Snowe, and Sen. Arlen Specter (R., Pa.), who all played key roles in the compromise. Working with a group of moderate Democrats led by Sen. Ben Nelson of Nebraska, Sen. Collins and others proposed cutting tens of billions of dollars from the original Senate bill, hoping to better hone proposals with an immediate benefit to the economy.
Mr. Reid had to compromise to win the handful of Republicans he needs to the bill. Democrats control the chamber with a 58-41 majority, but they need Republican support to achieve the 60 votes that ensure passage of any measure.
Three Republicans -- Sens. Collins, Snowe and Specter -- endorsed the package Friday night.
Hours earlier, Mr. Obama seized on the bleak jobs report to harshly criticize the Senate's inaction. "These numbers demand action," Mr. Obama said. "It is inexcusable and irresponsible for any of us to get bogged down in distraction, delay and politics, while millions of Americans are being put out of work."
To ratchet up the political pressure on lawmakers, who must still reconcile the House and Senate versions of the bill, the president will make his first foray Monday out of the Washington area to a town-hall meeting in Elkhart, Ind., where the jobless rate in the last year has soared to 15.3% from 4.7%.
The What and How of Obama
The What and How of Obama
If he really wanted to curb lobbyists he'd shrink government.
Here's a little flavor of the questions White House Press Secretary Robert Gibbs has been fielding two weeks running:
![[Potomac Watch]](http://s.wsj.net/public/resources/images/ED-AI969_PW0206_E_20090205130808.jpg)
Getty ImagesIs this going to be bipartisan? What happened to the vetting process? Does this undercut the president's rhetoric on an era of responsibility? Will this restore the president's credibility on changing the culture in Washington? What's the point of having policies if you're going to have waivers? What kind of message does this send? Is the president embarrassed by this? Is this more Washington as usual?
The knock on Candidate Obama was that he put style ahead of substance. Who knew what he was going to do (and who cared)? It was all about how he was going to do it -- with bipartisanship and ethics and a new era of "responsibility." Now comes the reckoning. President Obama is being judged not on the what, but the how.
That's one way to make sense of these tumultuous first days -- from the furors over Tim Geithner's and Tom Daschle's taxes, to the howls over waivers for lobbyists, to the teeth gnashing over the Democrats' "stimulus" bill. Somewhere, deep in this administration, somebody is working on serious policy. Not that you'd know it from the debate over Mr. Obama's self-imposed standards for governing. It's an early glimpse of the challenges he faces going forward.
Mr. Daschle didn't get done in by his taxes. The administration stuck with Mr. Geithner, and would've stuck with Mr. Daschle (and his limo) right up through confirmation. Given the deference accorded to presidential nominees and Mr. Daschle's Senate history, Mr. Obama might rightly have expected success.
What Mr. Daschle didn't survive was his boss's own pronouncements about rich people and special interests. As the media dug into Daschle taxland, it discovered that (wow) he was a rich person, routinely paid by special interests to help them navigate the giant federal government.
Wait, wait, cried Mr. Obama, let's focus on the what -- namely, my health-care agenda, to which I believe Mr. Daschle is integral. No, no, roared the mob, we want to talk about the things you used to talk about, namely, how you could ever justify this. He couldn't. Next up: Leon Panetta and Hilda Solis.
His first full day in office, Mr. Obama imposed the "most sweeping ethics reform in history," barring officials from working on issues on which they'd lobbied in recent years. Then came the realization that a lot of really smart people hadn't just sat around for years waiting for him to give them government jobs, but had used their expertise for private profit.
What followed was a succession of waivers granting several top officials immunity from the rules. And what followed that was all the fury that could be collectively spewed by good-government types, left-wing blogs, and Senate Republicans. The administration attempted to explain that what mattered was that it was in the "public interest" to have qualified individuals running government. True. But that's not how Mr. Obama said he'd do things.
All this has put the president on defense, just as he should be nurturing something that really is related to policy -- his "stimulus." Not so long ago -- say, last month -- the measure of a president's success was whether he passed his agenda. George W. Bush would've been grateful to occasionally overcome a Senate filibuster. But this administration, riffing off its pledge to cross the aisle, set out an early standard of achieving 80 Senate votes. The White House outlined this aspiration, even as it handed over authorship to House Democrats -- partisans all.
What predictably emerged was a colossal spending embarrassment -- long on condoms, short on stimulus -- that justified every House Republican (and 11 House Democrats) in voting no. Mr. Obama didn't like the result, but since he's supposed to be changing the tone, couldn't gripe at his own party. Majority Leader Harry Reid knows this, and has ignored pleas to fix the mess in the Senate. Public support is ebbing away, giving the GOP more cover to run. Mr. Obama will get his stimulus, but what is in it will at most rank equally with headlines about how it was so many voted against it.
The president is reassuring the public that it takes time to change Washington. It also takes an understanding of the problems. Bipartisanship isn't just Super Bowl cookies; it requires Mr. Obama forcing his own party to make ideological concessions. More rules won't curb lobbyists. That requires cutting back the influence of government -- on which lobbying thrives. Will Mr. Obama go there?
Unless he does, it isn't clear how he navigates these problems -- which aren't going away. His promises to change the way Washington worked weren't throwaway lines tacked to an otherwise meaty agenda. They were his agenda. From now until 2012, he'll be flyspecked for every interaction with a special interest, lobbyist, wealthy individual, or Republican. The problem with lofty aspirations is that at some point they meet reality.
From Awful to Merely Bad
From Awful to Merely Bad: Reviewing the Bank Rescue Options
Purchasing 'toxic' assets is no easy solution.
R. GLENN HUBBARD, HAL SCOTT, LUIGI ZINGALES
When Henry Paulson, President Bush's Treasury secretary, first introduced the Troubled Asset Relief Program (TARP) in Congress last September, we cautioned against using government funds to buy mortgages and mortgage-related securities from banks. After the Emergency Economic Stabilization Act was signed into law in early October, the Treasury decided not to buy these assets. Instead, it used the first $350 billion of TARP funds to inject capital first into nine systemically important troubled banks, and later into insurer AIG (as part of a refinancing) and auto makers General Motors and Chrysler.
This approach seems to have achieved (albeit at a high cost for taxpayers) its principal objective of avoiding a massive collapse of the financial system. But it has not yet resulted in an increase in bank lending or the attraction of new private equity to the banking system, both of which are important to reviving the economy. There now appears to be active consideration of using TARP funds to buy "bad assets" from the banks. Major problems with so doing remain.
The central issue is how to price the assets. When the subprime crisis hit in the summer of 2007, the Treasury's first response was to encourage the private sector to create a fund -- the so-called Super SIV (structured investment vehicle) -- to buy mortgage-related assets. This proposal foundered due to the difficulty of setting a price for these assets, which come in complex and incomparable varieties. If Treasury pays close to par, it is paying far too much. If it pays current prices, no one will sell because of the adverse impact on their capital. If it pulls a price out of a hat, it will be acting arbitrarily.
Initial discussions focused on using a reverse auction with asset holders "bidding" to sell their mortgage-related securities to the Treasury. Such an approach raises significant problems -- most significant is the risk posed by asymmetric information regarding the value of these securities. Because the holders of complex and incomparable mortgage-related securities have more information regarding their worth than does Treasury, Treasury is at a huge disadvantage and will likely overpay. Moreover, there will have to be many auctions of very different securities. All of this will take months to execute.
Reportedly, thought is now being given to only buying "bad assets" and putting them in a fund (called a "bad bank") owned by the government. This new variation raises additional problems. First, how should "bad assets" be defined? As the recession deepens, bad assets have multiplied and will continue to multiply from mortgages and mortgage-related securities to many other assets classes, including credit-card portfolios. We see little sense in defining bad assets simply as those that have been already significantly written down. The bank may be more exposed to losses from assets that have not been significantly written down, but could well be.
Further, as the potential class of bad assets expands so does the cost of purchase. Total mortgage-related securities and mortgages held by banks alone are estimated to be $6 trillion, of which mortgage-backed securities are $1.3 trillion. Total bank assets are $16.5 trillion.
Another proposal is to guarantee the value of bad assets rather than buy them. This outcome could be accomplished by a direct guarantee of assets that remained on the balance sheet of banks (or were brought in from outside conduits or SIVs), or into one government-run bad bank.
A version of this approach was used in the second round of TARP financing for Citigroup and Bank of America. In the case of Citigroup, a $306 billion asset pool was created in which Citigroup absorbs the first $29 billion of losses, the Treasury and FDIC jointly fund 90% of the next $15 billion ($5 billion from the Treasury through TARP, and $10 billion from the FDIC), and the Fed finally funds 90% of the remaining losses. In return, the government received $7 billion in preferred stock (with an 8% yield) -- $4 billion to Treasury, $3 billion to FDIC. Under this approach, the problem of valuing the assets has been finessed into a problem of valuing the stock.
With more transparency, which Congress and its Oversight Panel would surely demand, that finesse would not work. A conservative estimate puts the value of the Citigroup option -- i.e., the potential cost to taxpayers -- at $60 billion, taking account of the stock warrants the government received. If one were to repeat this approach for all banks the cost would be as much as TARP. And, if the market for toxic assets were to fall further, the government could easily be responsible for trillions of dollars of losses. Last but not least, having the Fed become the residual risk bearer further undermines the Fed's financial stability and its ultimate independence, a concern recently voiced by the Committee on Capital Markets Regulation.
A more reasonable alternative would be to encourage banks to spin off the toxic assets into separate affiliated bad banks (as under a new reported German initiative). Ownership of these two entities would be allocated pro rata to all the financial investors as a proportion of the most updated accounting value of these assets. So a bank with $30 billion of bad assets and $70 billion of good assets will see its debt divided 30%-70% and its equity divided 30%-70%. Each $100 debt claim will become a $30 debt claim in the bad bank and a $70 debt claim in the good bank. The same would be true for equity. To limit the exposure of the FDIC to the bad bank, insured deposits and FDIC-guaranteed debt should remain in the good bank to the extent there are sufficient matching good assets. In addition, off-balance-sheet derivative contracts remain off balance sheet for the good bank to avoid the possibility that the failure of the bad bank would create systemic risk. Furthermore, convincing evidence would be needed before guaranteeing any of the liabilities of a bad bank because ordinarily a bad-bank failure should not result in systemic risk.
An alternative would be for the government to facilitate the injection of new, private-equity capital into banks by eliminating regulatory restrictions, such as bank ownership by private-equity or commercial firms, and providing protection against loss or dilution if there were to be subsequent government intervention. A subsidy for this private risk capital could even be given. As long as private capital holds most of the risk, it will certainly be allocated more efficiently than government money, minimizing the taxpayer cost of any subsidy. This idea would have to be more fully explored.
Whatever is done with respect to still solvent institutions, banks with dangerously low, or no or negative capital, should be taken over by the government through already established FDIC procedures, such as bridge loans. Just as with the Savings and Loan crisis of the 1980s, there is a significant risk that shareholders (and managers) with nothing to lose will roll the dice and lose even more. Existing shareholders with no equity should not benefit by government support. Further, a government takeover (just like a corporate bankruptcy) permits the restructuring of bank debt. As the S&L debacle shows, a decision worse than a nationalization of the banking sector is a nationalization of the losses, which still leaves the gains in private hands.
With still solvent institutions, there is no affordable and workable plan that will by itself assure that these banks will start lending and that private capital will return. We have stabilized the financial system against massive collapse, which is probably all the government can do. While we hope some more improvement may come from the bad bank or private-equity solutions outlined above, the road to further recovery of the financial system now lies principally with the economy's recovery and the success of the fiscal stimulus.
Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush. Mr. Scott is professor of international financial systems at Harvard Law School. Mr. Zingales is professor of finance at the University of Chicago Booth School of Business.
Friday, February 6, 2009
Bracing Ourselves
Bracing Ourselves
America prepares for the worst, and Republicans suddenly seem serious.
All week the word I kept thinking of was "braced." America is braced, like people who are going fast and see a crash ahead. They know huge and historic challenges are here. They're not confident they can or will be met. Our most productive citizens are our most sophisticated, and our most sophisticated have the least faith in the ability of our institutions to face the future and get us through whole. They have the least faith because they work in them.
![[Declarations]](http://s.wsj.net/public/resources/images/ED-AI977_Noonan_DV_20090206132815.jpg)
CorbisTuesday I talked to people who support a Catholic college. I said a great stress is here and coming, and people are going to be reminded of what's important, and the greatest of these will be our faith, it's what is going to hold us together as a country. As for each of us individually, I think it's like the old story told about Muhammad Ali. It was back in the 1960s and Mr. Ali, who was still Cassius Clay, was a rising star of boxing, on his way to being champ. One day he was on a plane, going to a big bout. He was feeling good, laughing with friends. The stewardess walked by before they took off, looked down and saw that his seatbelt was unfastened. She asked him to fasten it. He ignored her. She asked him again, he paid no attention. Now she leaned in and issued an order: Fasten the seatbelt, now. Mr. Clay turned, looked her up and down, and purred, "Superman don't need no seatbelt."
She said, "Superman don't need no airplane. Buckle up." And he did.
We all think we're supermen, and we're not, and you're lucky to have a faith that both grounds you and catches you.
But during the part in which I spoke in rather stark terms of how I see the future, I think I saw correctly that the physical attitude of some in the audience was alert, leaned forward: braced. Again, like people who know a crash is coming. Afterward I asked an educator in the audience if I was too grim. He looked at me and said simply: No.
A sign of the times: We had a good time at lunch. It is an era marked by deep cognitive dissonance. Your long-term thoughts are pessimistic, and yet you're cheerful in the day to day.
On Wednesday, in an interview with Politico, Dick Cheney warned of the possible deaths of "perhaps hundreds of thousands" of Americans in a terror attack using nuclear or biological weapons. "I think there is a high probability of such an attempt," he said.
When the interview broke and was read on the air, I was in a room off a television studio. For a moment everything went silent, and then a makeup woman said to a guest, "I don't see how anyone can think that's not true."
I told her I'm certain it is true. And it didn't seem to me any of the half dozen others there found the content of Cheney's message surprising. They got a grim or preoccupied look.
The question for the Obama administration: Do they think Mr. Cheney is essentially correct, that bad men are coming with evil and deadly intent, but that America can afford to, must for moral reasons, change its stance regarding interrogation and detention of terrorists? Or, deep down, do the president and those around him think Mr. Cheney is wrong, that people who make such warnings are hyping the threat for political purposes? And, therefore, that interrogation techniques, etc., can of course be relaxed? I don't know the precise answer to this question. Do they know exactly what they think? Or are they reading raw threat files each day trying to figure out what they think?
The bad thing about new political eras is that everyone within them has to learn everything for the first time. Every new president starts out fresh, in part because he doesn't know what he doesn't know. Ignorance keeps you perky.
On the economy, I continue to find no one, Democrat or Republican, who has faith that the stimulus bill passed by the House will solve anything or make anything better, though many argue that doing absolutely nothing will surely make things worse by not promising at least the possibility of improvement through action.
Meanwhile, the inquest on President Obama's great stimulus mistake continues.
His serious and consequential policy mistake is that he put his prestige behind not a new way of breaking through but an old way of staying put. This marked a dreadful misreading of the moment. And now he's digging in. His political mistake, which in retrospect we will see as huge, is that he remoralized the Republicans. He let them back in the game.
Mr. Obama has a talent for reviving his enemies. He did it with Hillary Clinton, who almost beat him after his early wins, and who was given the State Department. He has now done it with Republicans on the Hill. This is very nice of him, but not in his interests. Mr. Obama should have written the stimulus bill side by side with Republicans, picked them off, co-opted their views. Did he not understand their weakness? They had no real position from which to oppose high and wasteful spending, having backed eight years of it with nary a peep. They started the struggle over the stimulus bill at a real disadvantage. Then four things: Nancy Pelosi served up old-style pork, Mr. Obama swallowed it, Republicans shocked themselves by being serious, and then they startled themselves by being unified. But it was their seriousness that was most important: They didn't know they were! They hadn't been in years!
One senses in a new way the disaster that is Nancy Pelosi. She was all right as leader of the opposition in the Bush era, opposition being joyful and she being by nature chipper. She is tough, experienced, and of course only two years ago she was a breakthrough figure, the first female speaker. But her public comments are often quite mad—we're losing 500 million jobs a month; here's some fresh insight on Catholic doctrine—and in a crisis demanding of creativity, depth and the long view, she seems more than ever a mere ward heeler, a hack, a pol. She's not big enough for the age, is she? She's not up to it.
Whatever happens in the Senate, Republicans have to some degree already won. They should not revert to the triumphalism of the Bush era, when they often got giddy and thick-necked and spiked the ball. They should "act like they been there before." They should begin to seize back the talking mantle from the president. And—most important—they must stay serious.
The national conversation on the economy is frozen, and has been for a while. Republicans say tax cuts, tax cuts, tax cuts. Democrats say spend, new programs, more money. You can't spend enough for the Democratic base, or cut taxes enough for the Republican. But in a time when all the grown-ups of America know spending is going to bankrupt us and tax cuts without spending cuts is more of the medicine that's killing us, the same old arguments, which sound less like arguments than compulsive tics, only add to the public sense that no one is in charge.
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