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Posted by: Michael Mandel on September 26
The failure of Thursday’s bailout talks points out a big problem: Solving this crisis is going to require a leader in Washington with the political clout to enforce unpopular measures—to divvy up the looming trillion-dollar losses. Unfortunately, George Bush no longer has the ability to keep his own party in line. Hank Paulson and Ben Bernanke are not elected, so they don’t have political legitimacy either. And the presidential election is still more than a month away, so neither Obama or McCain has legitimacy yet either.
Why is political clout needed? Let me tell a little story. You go to a friend’s house to play a nice relaxing poker game. But in the middle of the game, you are informed there is a catch. On the bottom of one of the poker chips is a little red dot. If you are the one holding the marked poker chip when the game comes to an end at midnight, you lose all your money and you have to pay for the refreshments.
So what do you do? You take a look at your chips, and if you are not the one holding the marked chip, you push your chair away from the table and say: “That’s it for me, folks! I’ve got to wake up early tomorrow morning.” Everyone else does the same thing, and the poker game comes to an end prematurely.
Of course, the game could go on if the rules were changed. Everyone can be forced to turn over their chips, so you immediately know who the big loser is. Once that person is identified, then the rest of the game can go on. Or everyone can agree to chip in for refreshments, so the losses to the marked chip holder is not as big.
In any case, the big question is: who gets to make the decision changing the rules? It could be the person whose house it is, or the organizer of the poker game, or a vote of the players. But what you need is someone who has the political will and backing to make tough decisions—to change the rules and allocated the losses, even if someone is hurt.
In short, that’s where the financial markets find themselves today. There are securities out there with deep losses, and no one knows which ones they are. What’s more, if you are doing business with a bank that has a lot of hidden deep losses, you may be the one who loses out. The result, nobody wants to lend.
What’s needed is for the government and regulators to forcibly allocate the losses. There’s lots of different ways to do it. The Paulson plan allocated a lot of the losses to the taxpayers, and bailed out the financial firms. A plan suggested by James Galbraith calls for using the $700 billion for the bank deposit insurance fund. Then the depositors get protected, and the losses fall on financial institutions, their shareholders, and their creditors. I could go on and on, but every plan has the same feature: Someone is forced to bear the loss right now.
Now, it’s possible the bailout plan will pass today, or next week. But the issue still remains—is it possible for Washington to agree on a bi-partisan bailout plan ahead of an election? I’m skeptical.
Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.