The Real Problem: Not Enough Political Legitimacy in DC

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.

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Reader Comments

Jim Archibald

September 26, 2008 10:58 AM

Part of the problem is that there are few people in the negotiation that even understand or believe in a free market economy. Obama, Pelosi, Dodd, Barney Frank and Reid are politicians with a socialist bent. Bernanke is an academic. McCain has no economic experience and is incoherent is his statements on the economy.
Only Bush and Paulson have real experience in the economy. But they are lame ducks so, as MikeM noted, they don't have the clout to change the rules of the game.

MLC

September 26, 2008 11:46 AM

I do not believe in the free market and we do not have one. We need regulation and accountability. History proves that time and again. You can make people do things for the common good so regulation is needed.

Ravikanti

September 26, 2008 12:56 PM

Why not the govt try to solve this at the root cause.
Allow people to pay the low premiums they were paying and increase the amortisation period. In japan they used to give 100 year mortgages.
Banks may make less profit, but at least they all survice and the insteading of bailing out wall street it will be a bil out of main street.

Roy Posner

September 26, 2008 01:08 PM

Though I welcome all efforts to resolve the problem quickly in the US, ultimately this will be an international issue, and it needs to be settled there as well. Put simply we need a Federal Reserve for the world. The global speculation on home loans was behind much of the failure. If there was any oversight at this level (as well as at the US level) much of the acceleration for the problem could be avoided. Or to put it in positive terms, we can great a global Fed or something similar to prevent these sorts of problems in the future (and they will occur in new, unthought of ways and dimensions), and to enable even greater prosperity for the next generations.

Dave

September 26, 2008 01:14 PM

>> Bush and Paulson have real experience in the economy

That's funny...Bush a free-marketeer?

His only 'successful' business was the Texas Rangers baseball team, which was only profitable because the taxpayers of the state of Texas subsidized his stadium (and the land was confiscated using eminent domain from its rightful owners at below-market prices).

So whatever his lip-service to free market principles, he made his money by fleecing the taxpayer.

Andrew

September 26, 2008 01:30 PM

Bush has the REAL experience in the economy? How? By throwing money at EVERY problem? Katrina? Iraq?

I think we must take a close look at ourselves and be ready to take the most bitter pill of letting the market take its own due course.

MLC, this crisis IS the accountability and regulation needed by the market when it is driven by forces way beyond its boundaries.

We cannot have our cake and eat it too.

taxee

September 26, 2008 01:38 PM

In a fit of conscience the ceo's(who made billions taking our industries to countries with no labor or environmental laws) will sign over their personal billions to the treasury to pay the national dept and then leap off tall buildings.

Tom

September 26, 2008 01:41 PM

The people responsible for the problem should pay. i.e the investment banks. WaMu and Merril Lynch got fixed with out a bail out.

KAR

September 26, 2008 03:05 PM

You've hit the nail on the head. The problem underlying the economic problem is a leadership vacuum. Paulson tried to fill it, but as an unelected official he can't. Members of Congress are jockeying for position, but no one is leading the way. This should be the president's job, but he abdicated that to Paulson. McCain tried to grab the reins but missed and fell. Obama is keeping his distance so that he doesn't come to own it. The vacuity of the executive and legislative branches of our government has been laid bare before the world.

David Mullings

September 26, 2008 05:35 PM

Yes leadership to make tough decisions and tell taxpayers the truth is required.

Funny thing is that when Obama told the country that a gas tax holiday was dumb, some people, especially Republicans, ridiculed him for telling the truth.

It seems that politicians have something against truth.

The USA does not have the money to bail out these people so you are going to print more, causing more inflation and devaluing my money - which is a tax.

How about the following:

- cut spending and apportion those savings to a bailout fund
- reinstate usury laws and force these crooks to charge nothing more than 20% interest on any loan
- force banks to change loans to 50-year and higher mortgages so that monthly payments become more affordable and buys a few years
- force CEOs to pay a higher tax on any earnings over 100 times their lowest employee
- stop raiding social security and balance the budget
- provide tax breaks to investments in manufacturing and alternative energy (job creation and export brings money back to the USA, reducing the trade deficit)
- require mortgage companies to keep the risk of default even if they use bonds to finance them (like in Europe)

And the biggest one....STOP depending on foreign governments for money to run your national affairs.

mr

September 26, 2008 05:57 PM

this item should have been written by Howie Mandel...deal or no deal! he knows better.

Michael

September 26, 2008 06:06 PM

I believe the PROPER role of any government, federal or state, in a FREE market is to advocate and not regulate participation. It is not the role of the government to actively engage in the machinations of the market. The government should be the referee or umpire and not be one of the players or teams.
If a player or a team plays "out of bounds", it is the function of the government, as the referee, to impose appropriate sanctions against the player or the team (or both).
With the current crisis, the only course of action for the government is to exercise its legitimate powers and apply the full extent letter of the law.

Dr Jayanth G Paraki

September 27, 2008 01:43 AM

The route to transformation is Profound Knowledge. "Out of the Crisis" was authored by Dr W.Edwards Deming in 1986 and his 14 Points for Management follow naturally as application of the System of Profound Knowledge (www.deming.org)

Why not have an Emergency Round Table Debate in the White House and apply methodically the Deming 14 Points for Management.

From the global perspective and unbiased outside view 700 billion $ is not an unmanageable number given that an unknown quantity of money (possibly in trillions of dollars x infinity) is traded daily in world treasury.

One can also extrapolate Einstein's Theory of Relativity to Economics. Enterprise management = critical Mass of intellect x Capital infusion squared.

James MacInnis

October 9, 2008 12:13 PM

The Fed is merely putting good money (Tax payers money)after bad.The efficacy of financial transactions such as, over the counter derivatives,have always been suspect. The law of supply and demand cannot be conned!We have sewed to the wind and we will surely reep the whirlwind.

Thank you for your interest. This blog is no longer active.

 

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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.

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