Read more about Wall Street's ongoing crisis.
Slate columnist Daniel Gross and Big Money staff writer Chadwick Matlin were online at Washingtonpost.com to chat with readers about the governments financial bailout plan: paying for it, avoiding its pitfalls, and figuring out who's holding it up. An unedited transcript of the chat follows.
Chadwick Matlin: Hi everybody, Daniel Gross of Slate and Chadwick Matlin of The Big Money here. We've got $700,000,000,000 worth of stuff to talk about. Let's get to it.
Denver: Why aren't Paulson and Bernanke (might as well throw Cox in there too) going before Congress to tender their resignations instead of asking for more money to fix a problem that only exists because of their lack of oversight? After all, they have at the least watched all of this happen and done nothing, and it appears to me they actively have participated in the process that has brought us to the brink.
Daniel Gross: No question they did watch some of this happen, and oversight could have been better. Don't think it's fair to blame Bernanke and Paulson. This fire was set a long time ago, and I actually think that the issue of regulation here has been overemphasized. This is something Wall Street did to itself in large measure, with the encouragement of consumers and investors.
Raleigh, N.C.: I just want an apology from the banks for being greedy, and I want some kind of concession. The one thing that resonated with Bush's speech last night was his remark about ordinary Americans who are making their mortgage payments on time. That's me. I just feel like we're headed toward another "trust us, we know what's best" scenario, just like Iraq.
Daniel Gross: I agree with you that the performance by executives has been shameful—total cowardice in not coming public, admitting their errors, and asking how they can personally contribute to solving the problem.
Egg Harbor Township, N.J.: I know that selected investment institutions have gone under and that there are stories of how credit has become more expensive. However, are there objective data that describe how this is a generalized condition that threatens our economy? For example, what percent of bank reserves are represented by shaky mortgages?
Daniel Gross: There's lots of data out there, mostly available on a bank by bank basis. Each quarter, they say what percentage of their loans are delinquent, or aren't performing. And of course that can change dramatically from quarter to quarter. A $300 million construction loan that was in fine shape last quarter can suddenly go bad. That's why the aggregate data on those can be misleading. They're backward looking, and what makes this so scary is that things seem to be deteriorating in real time.
Princeton, N.J.: Is the promise of the bailout a signal to banks to freeze/reduce credit until they receive funds for low-value mortgages?
Daniel Gross: No. I think it's primarily a signal to investors in these banks, and to depositors in them—and to all sorts of people who do business with them—that they shouldn't withdraw their funds, that they should stick around, because the cavalry is coming.
Los Angeles: Is it possible the economy can right itself without the bailout? How can we be certain that there won't be another economic calamity around the corner, even with the proposed bailout?
Chadwick Matlin: An important point that sometimes gets glossed over: The bailout is for the banking industry, not necessarily the entire economy. Unemployment still sinks, housing starts are buried under months worth of depression, and the fundamentals of the economy almost certainly are not sound. Passing a bailout should-and I want to emphasize should-do something to change that by allowing banks to feel comfortable about lending out new credit. But the reality is that nobody actually knows for sure that the bailout will help, not even Paulson.
Most people are certain, though, that not passing the bailout would be suffocating. Without any credit, it's hard for folks to buy/build new homes, corporations to fund new money-making projects, and the economy to grow. Credit is the grease that helps the engines run. Without it, we're probably stuck in a very low gear.
Ellicott City, Md.: I have a small amount of money in Bank of America stock. In the past few weeks, the volatility has been amazing. It's been up 10 percent one day, then down 10 percent the next—over and over again. Who are these people who are rushing in to buy and then rushing to sell so much? I assume it must be institutional investors that can move the stock so much. Why not sit back and see what happens?
Daniel Gross: Ellicott City—yes, it is institutional investors. More than ever before, the markets today are dominated by professional institutions, as opposed to individuals like you and me. And there are so many professional traders with different motivations (some short, some long, some quantitative, some fundamental) that it's not surprising stocks ping around in a time of uncertainty. In addition, a lot of these investors have their own issues—they may be concerned their investors will want to get their money back, so they sell positions suddenly to raise cash.
Arlington, Va.: The argument the Bush administration gave about not including a cap on executive compensation seems completely phony. The stockholders and board of directors would rather go bankrupt than accept help from the government with strings attached to their CEOs' salaries? Isn't this just the old boys network looking out for one another?
Daniel Gross: Yes.
This has been another in the long-running series of simple answers to smart questions.
New York: It's been suggested that, once the government took ownership of these worthless mortgage-backed securities, it could renegotiate mortgage payments with borrowers to avoid foreclosures. That would help borrowers stay in their homes, and eventually drive up the securities' values so they could be sold and some money recouped by the taxpayers. Is this actually part of the proposal? If so, could it realistically happen? Thanks.
Daniel Gross: That has been part of the proposal. I'm not sure if it's actually in there now. Remember, the original was just a very brief sketch by Paulson, basically the length of a good blog post. And I think part of the theory here is that the federal government can be more patient than other types of investors, and as a result would have more leeway in terms of renegotiating or freezing mortgages.
Mountain View, Calif.: Paulson and Bernanke claimed that without a bailout plan, the outcome would be worse. A typical phrase used is "the U.S. financial system would melt down." Everybody seems to agree with this assertion, with no questions asked. Can you clarify what it means, and can you describe the worst-case scenario with no bailout? And most importantly, how certain are you in that prediction? I can't help but remembering the "mushroom cloud" sales pitch for the necessity of the Iraq war.
Daniel Gross: That's a tough question. I had generally taken the view that this week things had settled down. And the risk of a meltdown seems more remote. After all, there aren't that many big institutions left that can fail. But I know from speaking with them that the policymakers feel otherwise. They're intently focused on some pretty obscure data points—the interest rates banks charge one another, etc. And most of those still show a high level of distrust and fear.
The ultimate fear is that banks and companies simply will stop extending credit to one another, and credit is the grease that makes the global economic machinery work
Laurel, Md.: We know that in some ways the '90s tech bubble distorted the economy, like laying too much optic cable. How much did the housing bubble distort the economy by encouraging too much housing? I live in a townhouse well-suited to a single person—about 1,200 square feet, convenient to the highway and my town's parks and shopping. It would sell for $250,000. A mile down the road, a former horse pasture has been replaced by $800,000 mansions with a ten-foot strips of grass between them.
Chadwick Matlin: Trying to assign blame in this mess is difficult because it was such a chain-reaction affair. But, yes, the housing boom certainly seems to have gotten in on the action in the early going, and has provided plenty of villains. Because housing prices were rising steadily, mortgage-lenders and mortgage-takers assumed that the price of a house on the market would also go up. That led lenders to give mortgages to folks that couldn't pay for them, and when the housing bubble burst, it made the folks who couldn't pay for them not pay for them. I can only presume that the $800,000 mansion down the road isn't worth quite that much right now.
Fallbrook, Calif.: How does this help homeowners? And why is the moral hazard justified with the banks, and not for the people hurt by unscrupulous lenders?
Daniel Gross: Directly, it doesn't really help homeowners. The way they seem to justify it is this. If I default on my mortgage, it hurts me and hurts the bank a little bit. If a gigantic mortgage lender fails, it hurts its shareholders and bondholders—but also has the capacity to disrupt the entire global financial system. That seems to be their operating theory. In order to get a bailout you have to be big, reckless, highly interconnected with other firms, and international in scope.
Athens, Ga.: Are these "instruments of mass destruction" still being written? Are the banks wanting to get rid of the old junk so they can write new, or is all that passing the loan around over for good?
Daniel Gross: Some credit default swaps are still being written. And mortgage-backed securities are still being issued. But the volumes are way, way, way down—like 80 percent or so.
Riverside, Calif.: What are the short- and long-term effects on the taxpayers and the economy if the proposed bail out takes place? What would the be if they were made to fail or other wise close businesses, as "Joe Average" would be forced to do? Thanks from an irate citizen.
Chadwick Matlin: Short term: The deficit and debt go up, as Dan mentions in his latest piece on Slate. But let's be clear: we'll only lose the whole 700 billion thing enchilada if we get our shirts stolen. We're buying assets from these banks (although we don't yet know how), and eventually we want to sell them. When we do, the goal is to break even or turn a profit. Even if we don't make a profit, we'll probably lose $200 billion at most. And really, what's $200 billion, when you're ready to lose $700 billion.
Long term effects: Nobody knows, obviously. We'll know more after Congress gets done crafting legislation, but we'll probably be with our new toxic debt children for several years. Taxes may have to go up to cover the deficit, domestic agendas of the next president will be altered, and the Fed and Treasury's regulatory abilities will be questioned. Fun!
Washington: Why $700 billion? Why not more? Why not less? Earlier this week I heard that there was a proposal to use $200 billion to start and then force the Treasury to come back. That seemed like a very sane option. What happened to that?
Daniel Gross: It does seem an arbitrary number. I think the idea was to come up with something really big, to set up the notion that the Feds will have the biggest stack of poker chips on the table, and that if anybody wants to bet against them (i.e. use their cash to make bets that banks will fail, etc.) that the government will be able to out last them. It's all about psychology to a degree. Carry a really, really big stick.
Los Angeles: Doesn't the proposed bailout run contrary to the basic notions that a large, centralized federal government is bad, and that a free, open and unregulated market is good? In other words, isn't this the very type of idea for which the Republicans have villainized FDR for so many years?
Chadwick Matlin: Yes, but the idea is that the free market was no longer performing as is, so now regulation was necessary. The goal is to alleviate the pressure on the banks and then return to a quintessentially American free-market system. That may not happen if the Democrats pack in a lot of long-term regulations in the Congressional bill. But we'll have to wait and see.
Republicans have been running away from small government for a long time. Their hesitant acceptance of this isn't that surprising.
Behind Enemy Lines: Great articles on the bailout—my gut instinct on the bailout is to reject it, but your article convinced me otherwise with just one statement: "And what's another few hundred billion dollars of debt on top of a national debt that already reaches $9.7 trillion?" The economy, in spite of math, is whatever we want it to be. Keep the Aspidistra flying! And release the funds.
Daniel Gross: Thanks. Unless you were referring to one of Chad's articles, in which case Chad thanks you.
The danger, of course, is that we print so much money that it debases the dollar and inspires inflation. (of course, we're a little late on both those fronts)
Laurel, Md.: Your answer to my question about distorting the economy suggests I wasn't clear on my point: Did building housing (not just the financial side of lending) become an out-sized portion of the economy? By extension, did that motivate the unfortunate decision to plough under grass and trees to build houses that our society didn't really need?
Daniel Gross: Yes, it did. Housing and housing-related credit swelled to an outsized portion of GDP. Between November 2001 and the middle of 2005, something like 40 percent of all jobs created in the U.S. had something to do with housing. There's no question an excess of supply was created.
Washington: From my perspective, the root of our financial problem is the fact that, as a country, we've been overextending ourselves and living beyond our means. We spend money that we don't have, whether it's homeowners taking out loans bigger then they can afford, or financial institutions using too much leverage to pile capital into risky assets. How is borrowing another $700 billion dollars from our children to pay for our current excesses going to help us live within our means as a society? It seems that the administration thinks getting drunk again as the cure for our financial hangover. Thoughts?
Chadwick Matlin: Your options, according to the Bush admin:
1.) Borrow money, bail the banks out, continue living outside our means.
2.) Don't borrow more money, still have a huge debt, and watch our "means" shrink further and further.
Throughout history, the American thing to do is #1. #2 just feels better.
Phony crisis: There's such a liquidity crisis that I got five more blind solicitations for mortgages this week. You know what we need? To put Putin in charge for six months, let him put a few of these guys in jail and nationalize their assets, and then go away. The last part is the hard part. Okay, a joke, but how gullible do you think we are after eight years of lies and spin?
Chadwick Matlin: Putin would like to be woken up when September ends, too:
Bowie, Md.: While the housing boom was running up, I developed the feeling that keeping housing prices high had become a political value in this country, in the same way keeping the price of gasoline and food low is a priority. When someone buys a home in a community, they simultaneously become a voter in it—and one of the things they do as a voter is limit the supply of housing that can be built. Even though I own a home (that didn't bubble much, despite my location) I'm glad prices have come down and hope they continue to do so, because housing has become an artificially large part of Americans' budgets. Is housing actually becoming more affordable for people who sat out the first part of this decade?
Daniel Gross: You're right. There's a huge link between politics and housing. The political system, in ways large and small, encourages homeownership—mortgage interest deductions, constant advocacy from the president on down about how home ownership is good. And we put policies in place that were supposed to make housing affordable—instead what they did is help people get into homes (interest-only mortgages are a classic example, sold as a way to get the maximum tax benefit even if you can't really afford to build up ownership)
Housing is starting to come down in price, and so is becoming affordable. But credit is less available. You probably have to make a bigger down payment and pay a higher interest rate than you did five years ago. So the price of the house is only one factor.
West Yellowstone, Mont.: I am not an expert on Wall Street, but as a retired worker who has had three houses (at different times) with mortgages, I understood that the types of mortgages with balloon payments after a few years would cause an impossible load on my finances. How could Wall Street executives, Congress or anyone else not know that this catastrophe was imminent? Will there be any accountability, or would that mean prosecuting most of the Eastern Seaboard?
Daniel Gross: This is a topic for a great book. But in short, we—Wall Street, borrowers, government officials—convinced ourselves that interest rates would always remain low, that housing prices would always rise, and that anybody could always refinance or sell their way out of trouble if they wanted to. Mortgage brokers would tell people not to worry about the balloon payments in the distance because they could just take their profits or refinance as needed.
For more on the foreclosure issue, check out Mark Gimein's article on our sister site—The Big Money.
Los Angeles: Why isn't Congress insisting on an equity position in the financial institutions as a condition to the bailout? If Paulson (or Bernanke, for that matter) were unable to recognize the dangers inherent in the current, unregulated mortgage equity market, how can they claim to be qualified to clean up the mess that the mortgage-backed "securities" have caused?
Chadwick Matlin: They still might do this, similar to the warrants they hold on AIG. (For an explanation of the inexplicably complicated warrant system, see this article.)
This probably won't happen en mass, though, because Republicans would call the Democrats Socialists. And a red 'S' may as well be a scarlet letter in this country.
Richmond, Va.: What I find most frustrating about this whole plan is the way that Paulson and Bernanke have presented it as the only option available. I suppose this makes strategic sense from their standpoint, but it basically ha sfrozen discussion of any viable alternatives. Because Congress only seems interested in posturing about executive pay, I'll ask a question that nobody there seems interested in: Are there other ways to restore some liquidity to the financial markets and prevent the credit freeze that threatens the system? A corollary: Just how did they come up with the figure of $700 billion? Is this just their best guess for the value of all those faulty mortgages floating around the securities markets? Thanks.
Chadwick Matlin: Sounds like you invite Chuck Schumer to dinner. Earlier in the week, he was making noise about releasing $150 billion at first, and seeing how that goes. Sounds like a reasonable plan to us. Paulson said it had grave consequences, but couldn't articulate them.
Wall Street Origins: I read that Wall Street originally got its name from a wall that was built to keep pigs in their sty. How did they ever get over that wall and create the modern financial system we (don't) have today ?
Daniel Gross: practice, practice.
No, that's how they got to Carnegie Hall
Mount Vernon, N.Y.: According to Jonathan Alter's book, before the inauguration in 1932, Hoover tried bamboozle FDR into supporting Hoover's recovery program and swear off any further government intervention, which FDR skillfully dodged. This is an attempt by Wall Street—and their stooges inside the Bush administration—to steal the government's liquidity and direct it to their own enrichment, and rob Obama of any ability to fund his own programs. To hell with them.
Daniel Gross: Thanks for that, and for plugging the book of my Newsweek colleague Jonathan Alter. It's called The Defining Moment and is available in paperback.
Derry, N.H.: Do either of you see a connection to our current fiscal mess and the response (or lack thereof) to the Enron/Worldcomm crisis? Did the repeal of any legislation or the timidity of the response to those failures allow greater speculation or lessen oversight to the same end?
Daniel Gross: Not so much. Yes, there were regulatory failures galore in this instance, but many dealing with mortgages were at the state level. The Wall Street investment banks that are seeking help so desperately have been very successful in warding off regulation this decade.
Los Angeles: I'm being forced to retire ... why can't I use my pension to bail myself out and not have to pay penalties?
Daniel Gross: good question. If only you were an investment bank.
Oviedo, Fla., single mom : This "liberal Democrat" is embarrassed by the grandstanding I see on the Hill. Dopes with no economic background are jostling to get in front of microphones and witlessly scream "no taxpayer bailouts for billionaires!" Makes me worried, if this represents our best and brightest. It is as if we are debating if a car with no oil should just be sent out on the road. Being mad at the person who didn't check the oil won't help the drivers, especially if the engine seizes. I like the idea of a government plan that gets banks back in business and holds the mortgages—most of which are sound—while the economy comes around. If CEO pay needs to be trimmed (a red herring in my view) to get it done, do it. Hank Paulson is sexy, by the way. Tall, intelligent, successful and forceful.
Chadwick Matlin: Please send all Paulson fan club registration forms to Oviedo, Florida. Complimentary pin-up included in reply.
Princeton, N.J.: Now we hear from the head of the Congressional Budget Office that the bailout may make things worse. Why should we believe the Bush administration when so many experts disagree, and when we know they are congenital liars?
Daniel Gross: A rhetorical question. And the answer is—at some level, we have to take them at their word and hope for the best. (Gulp!)
Gaitherburg, Md.: What I do not understand is why are we trying to go back to the way the things (easy credit) were. If we are attempting to go back, then this $700 billion only will postpone the inevitable. If we're not, then whether this $700 billion is injected or not, get ready for some serious belt-tightening. Do you think the banks will offer easy credit ever again?
Daniel Gross: You're right there. We're not going back to the easy money era of 2005, even if the $700 b goes into the system straight away. Credit is simply going to be less available to a wide range of people and companies.
Princeton, N.J.: If I sign a contract to provide mathematical consultation (I am a mathematician) to X, I can't sell my end of the contract to a graduate student without X's permission. Why can my bank sell my mortgage? Why can the people insuring my bank's end of my mortgage sell their end of the insurance policy? Why can investors buy insurance on whether bonds neither of them own will default? Have we gone nuts?
Chadwick Matlin: Answering your questions in reverse order:
3.) Because we live in a free-market system, and if there's money to be made, people will figure out a way to make it.
2.) See above.
1.) See above.
For more, read Liar's Poker by Michael Lewis. He explains how some of first mortgage packages were constructed. It's a good primer.
Washington: A while back when the first of the home crisis hit, TV and print news were trumpeting that this was the end, of how huge the problem would be. Yes, people lost their homes and times got a bit harder, but it wasn't anywere near bringing the U.S. to its knees. Now, in the past couple of weeks, we again are hearing this doom-and-gloom mantra, and all the things that could go wrong with this bailout.
What I havn't heard is what economists think would happen if we didn't bail out these companies. I understand that things may get rough for a while, but are we only saving these failing firms because "they're too big to fail"? Do the high-level government people deciding on this have the same mentality about their own jobs? Too big to fail?
Daniel Gross: The warnings we get are mostly vague—credit markets would freeze up, the system would melt down. Beyond that, efforts to quantify the damage are really guesswork. We have no idea what would really happen. Several writers have looked back to the depression and talked about how much the economy shrank between 1929 and 1932. But I don't know why that should be the yardstick. The truth is, any efforts to offer concrete numbers on the unknown should be greeted with some suspicion.
Denver: Why are we bailing out these for-profit companies? Did they not take the calculated risk/investment before everything tanked? How exactly will it affect our economy if we do not bail these banks out?
Chadwick Matlin: They did make a risk/reward analysis before everything tanked, but only for themselves. We've gotten in such a tangle that the rest of the economy is affected, and the bankers never did a risk/reward for the U.S. economy. That's the government's job, and that's why you're seeing the bailout now.
Los Angeles: Isn't the bailout plan akin to welfare for the very rich?
Daniel Gross: To a degree, yes. But the shareholders of these companies, and many of the insiders, aren't getting much help. Rather, it's people who are invested in the stocks and bonds of other companies—ones that might have suffered somewhat but haven't keeled over yet and are likely to get psychological support from this—that are getting helped the most right now.
Baltimore: I read this week (either in the New York Times or the Washington Post, can't remember which) that Paulson started warning the president in 2006 that the subprime/securitized mortgages were heading us toward disaster. Do you know if that is true? And does this not make the current crisis a fiscal Katrina, if you will? Thanks.
Daniel Gross: i don't know first hand if paulson warned bush about subprime back in 2006. I interviewed Paulson last week for Newsweek, and he said that when he took the job, he knew something bad was likely to happen before the end of the bush term. As in the past, they primary concerns had been about overseas. They knew a storm was coming, they just didn't see it originating in the U.S.
Anonymous: President George W. Bush and finance specialists Bernanke and Paulson see the entire economy in danger from a widespread loss of confidence; what they fail to see is who caused these circumstances—namely the financial bosses on Wall Street with their investment banking instruments. Why must the taxpayer intervene with $700 billion for the bailout?
Shouldn't the people in this industry who have created the problem, be called on to collect for themselves the $700 billion bailout? This not only would correct further developments in the finance industry but also re-establish the confidence they lost. As an investor, I would not gain any confidence if I as a taxpayer had to repair the damages, while the finance bosses walked off with billions!
Daniel Gross: Yes. I made this case in an online column on Slate filed earlier this week. Anybody who is for the bailout should first be required to submit a plan on how to pay for it.
Woodinville, Wash.: What is the real number? It seems to me that aside from infrastructure, this is shoring up the economic backbone of our society. If the insurance and housing finance fail, our economy would go into a tailspin. However, what we are writing is a new level of interest burden to our federal budget. When does our deficit become so large that we no longer can afford the interest? How big a percentage of the our budget is pure interest payments on the national debt? This is our society magnified. Do you think the people are ready to hear about a new economic solution to our system?
Daniel Gross: Good and big questions all. And there's no rule of thumb to determine how much federal debt is too much.
Chadwick Matlin: Alright, folks, we have to head back to our day jobs. Looks like Congress have reached a "fundamental agreement" on the bailout. Expect details to leak out as the day goes on. Thanks for the questions, and keep keeping a watchful eye on those tax dollars.