American politics

The politics of failure

The rejection of the bail-out plan represents a profound domestic defeat for George Bush

GEORGE BUSH’S speech to the country on Tuesday September 30th had a quality of exhaustion about it. It proposed no new ideas or initiatives, promising merely to make another attempt to reach a deal with the House of Representatives, which the evening before had rejected the proposed $700 billion financial-rescue package. This was the seventh consecutive day on which he had pleaded in public for the bill’s passage. The effort is not over, he explained: “I assure our citizens and citizens around the world that this is not the end of the legislative process.”

Negotiations between the White House and Congress continue. Supporters of the bill hope the market turmoil that followed its rejection might chasten legislators who voted against it. Mr Bush sought to increase pressure on the recalcitrants when he pointed out that the one-day stockmarket loss—over $1 trillion—was greater than the estimated cost of the bail-out.

A new rescue plan will not be put to a vote before October 1st. In any case it cannot disguise the damage that the congressional defeat has already done to the dying administration. This was humiliation, not only because of the size and significance of the plan but because the presidential faults and weaknesses that contributed to defeat have existed throughout Mr Bush’s two terms. Congress was testing Mr Bush’s mode of administration to destruction. This was defeat not only of a bill but of much of what his administration has stood for.

Since Franklin D. Roosevelt revealed the importance of talking directly to the public with his “fireside chats” during the Great Depression, the ability to influence public debate directly through appeals and persuasion has been one of the most powerful tools of any president. Mr Bush has used this power patchily, at best. His set-piece national addresses on the financial crisis have been short and passionless. They have shown little sense of a leader able to guide and shape national debate. According to polls by Pew Research Centre, 43% of Americans describe themselves as confused about the bail-out; half say they are scared. The power of guidance has long been beyond the president: his most recent job-approval rating (according to Gallup) was 27%, the lowest of his presidency.

Mr Bush lost credibility with the public a while ago. The vote in the House revealed how little the president has left among his own party and on Capitol Hill. Mr Bush has been reduced to a by-standing role in the financial crisis, leaving the design of the bail-out to Hank Paulson, the treasury secretary and Ben Bernanke, chairman of the Federal Reserve. Mr Bush left the task of lobbying Congress to his chief of staff, Josh Bolten, and to Mr Paulson—at least until he joined them at the last minute. Too little, too late, said Republicans.

Mr Bush faced an uphill struggle on Capitol Hill: representatives want to put as much distance as they can between themselves and him. That was a big reason why more than three-quarters of those facing close races voted against his proposals. But that was only 30 people; 228 voted against, including 133 Republicans.

Another factor was at play: this was a day of reckoning for the partisanship that has been a hallmark of the administration from the start. With Mr Bush in office, more congressional votes have run along party lines; campaigns and public debate have been more polarised. Although Democrats were persuaded to vote by roughly two to one in favour of the bail-out plan, bi-partisanship means more than just reaching out to the other side. It also means persuading your own party to compromise, which Mr Bush failed to do. Most of those who voted against the rescue came from the extreme ends of the parties, market fundamentalists on the Republican side; the black and Hispanic caucuses among Democrats (they are among the most left-wing members of Congress). This was an ideological defeat for an ideological president.

Senate May Try to Revive Financial-Rescue Legislation (Update2)

Sept. 30 (Bloomberg) — The U.S. Senate will try to salvage a $700 billion financial-rescue package after the measure was defeated in the House of Representatives. The lawmakers won’t have a lot of room to negotiate.

While the legislation will need to be tweaked enough to win over reluctant House Republicans, the lawmakers will risk losing votes from Democrats if they veer too far from the delicate compromise that congressional leaders hammered out with the U.S. Treasury.

“They’re not going to totally revamp the bill,” said Pete Davis, president of Davis Capital Investment Ideas in Washington, who spoke to House and Senate leaders yesterday. “They’ll make some minor changes and pass it. This is all about political cover.”

The House rejected the legislation yesterday in a 228 to 205 vote, sending the Dow Jones Industrial Average tumbling 778

points for its biggest point drop ever and erasing more than $1 trillion in market value. The Standard & Poor’s 500 Index fell 8.4 percent, the most since Oct. 26, 1987. The S&P 500 today rose 40.09 points, or 3.6 percent, at 11:51 a.m. in New York. The Dow Jones Industrial Average gained 291.27 or 2.81 percent to 10,656.72.

`A Different Result’

Senators say they have no choice but to revive the measure, which is designed to restore confidence in the nation’s banking system.

“We don’t intend to leave here without the job being done,” said Banking Committee Chairman Christopher Dodd, a Connecticut Democrat. He said lawmakers will “hopefully come back Wednesday and get a different result.”

Senate Minority Leader Mitch McConnell, a Kentucky Republican, vowed that the lawmakers would take action soon.

“We intend to pass this legislation this week and we will pass it on a broad bipartisan basis,” he said today on the chamber floor. Senate Majority Leader Harry Reid, a Nevada Democrat, said approving the legislation is the top priority.

Money-market rates jumped in Europe today, with lenders hoarding cash as the third quarter ends. Rates on three-month loans in dollars were as high as 10 percent as of 10:50 a.m. in London, said Ronald Tharun, a money-market trader at Landesbank Baden-Wuerttemberg in Stuttgart.

To pick up the 12 votes needed to pass the bill in the House, the bill will need cosmetic changes, lawmakers and analysts say. Ninety-five Democrats joined the 133 Republicans who voted against the bill. Both sides are looking for changes.

Expanded FDIC Role?

House Republican conservatives are likely to keep pressing for a mandatory insurance program they initially proposed for mortgage-backed securities. They may also try to force the Securities and Exchange Commission to suspend mark-to-market accounting and require bank regulators to assess the real value of the troubled assets, lawmakers say.

Either measure could drive away Democratic votes.

The Senate may also consider expanding the authority of the Federal Deposit Insurance Corp., Dodd said today.

Under one plan, pushed by House Republicans, the FDIC would issue lenders certificates they could use as capital, which the banks would have to pay back with interest. The proposal would give the FDIC more say in how the institutions are run.

Democrats say they may also seek stronger oversight on the rescue plan, tougher limits on executive compensation and more relief for homeowners facing foreclosure.

Bankruptcy Provision

Some Democrats want a provision that would allow bankruptcy judges to alter the terms of a home mortgage for individuals in bankruptcy, even reducing the principal balance. That would be a deal-killer for many Republicans, a danger that presidential nominee Barack Obama recognized: He opposed including that in the original bill, angering fellow Democrats.

The Senate won’t hold any roll-call votes today because several lawmakers will be celebrating Rosh Hashanah, the Jewish New Year. Gregg and Dodd urged investors not to view that pause as inaction.

“We can certainly work,” said Dodd.

House Majority Leader Steny Hoyer said he expects his chamber to be ready to take up the plan again after a Senate vote. “We’re not out of business until this is addressed,” Hoyer said.

Hoyer said he has spoken with Republican Whip Roy Blunt and both are committed to working together on a compromise.

Some lawmakers are proving tough to sell on the plan.

`Better Bill’

“We can craft a much better bill,” said Representative Brad Sherman, a California Democrat who voted against the bill. He objected to the “tens of billions of dollars” that could go to foreign companies and said the oversight board the plan would create would be powerless.

Sherman wants more relief for homeowners and stronger restrictions on executive compensation, among other measures.

Representative Jeb Hensarling, a Texas Republican, said most Republican conservatives oppose the idea of Treasury purchasing troubled assets, because it puts too much of the expense on taxpayers.

“That is a model that House conservatives feel is fundamentally flawed,” said Hensarling, the chairman of a group of more than 100 House Republican conservatives called the Republican Study Committee.

Still, the markets may dictate that Congress act now.

“It’s just not acceptable for Congress to essentially tell Main Street or Wall Street to drop dead,” said Chris Lehane, a Democratic consultant who was former Vice President Al Gore’s communications director. “The Dow dropping 777 points is a pretty powerful force to find another 12 votes.”

Trichet Says U.S. Must Pass Plan to Rescue `Global Finance’

Oct. 1 (Bloomberg) — European Central Bank President Jean- Claude Trichet said U.S. lawmakers must pass a $700 billion rescue package for banks to shore up confidence in the global financial system.

“It has to go, for the sake of the U.S. and for the sake of global finance,” Trichet said in an interview in Frankfurt with Bloomberg Television late yesterday. “I am confident, but of course it is the decision of the U.S. Congress.”

President George W. Bush and Senate leaders yesterday vowed to revive a plan aimed at buying distressed assets from banks that was rejected by Congress a day earlier. The vote roiled markets already struggling to cope with the collapse of Lehman Brothers Holdings Inc. European governments have helped rescue at least five banks since Sept. 28, with Trichet taking part in talks to save Belgium’s Fortis over the weekend.

Trichet said a pan-European approach to the banking crisis was unlikely, saying “we are not a fully-fledged federation with a federal budget.”

“Each country has to mobilize its own efforts,” said Trichet. “But of course there is a European spirit and that is the spirit of the single market.”

Trichet declined to answer questions about ECB monetary policy before tomorrow’s interest-rate decision. All 58 economists surveyed by Bloomberg News expect the central bank to keep its benchmark rate at 4.25 percent.

Clear Message

U.S. stocks plunged after lawmakers rejected a proposal that would give the Treasury broad power to buy mortgage-backed securities saddling investors and financial institutions with losses. Banks have recorded $588 billion in writedowns since the start of last year.

“I think the message from the markets yesterday was clear,” Senate Republican leader Mitch McConnell said on Sept. 30.

Stocks rebounded yesterday on optimism the bill will be passed later this week. The Standard & Poor’s 500 Index rose 58.35 points to 1,164.74, recouping more than half of the previous day’s 8.8 percent plunge.

European leaders are trying to better coordinate their response to the financial crisis. Luxembourg Finance Minister Jean-Claude Juncker said yesterday he expects to meet with Trichet and French President Nicolas Sarkozy on Oct. 4 to discuss “a more systematic approach.”

Trichet’s ECB has so far chosen not to follow the Federal Reserve in slashing interest rates since credit markets seized up 13 months ago, injecting cash into their markets instead, while keeping monetary policy focused on inflation.

Price Stability

“What’s needed is for us to continue to tell our fellow citizens that we will ensure price stability,” Trichet said in an interview broadcast yesterday on the France 2 television channel.

Belgium, the Netherlands and Luxembourg on Sept. 28 agreed to inject 11.2 billion euros ($16 billion) into Fortis, the largest Belgian financial-services company.

Governments and other authorities have also taken steps to protect the U.K.’s Bradford & Bingley Plc, Brussels- and Paris- based Dexia SA, Iceland’s Glitnir Bank hf and Germany’s Hypo Real Estate Holding AG. Ireland yesterday guaranteed the deposits and borrowings of six lenders.

U.S. Stocks Surge on Speculation Bank-Rescue Plan Will Pass

Sept. 30 (Bloomberg) — U.S. stocks jumped the most in six years as growing expectations that lawmakers will salvage a $700 billion bank-rescue package helped the Standard & Poor’s 500 Index recover more than half of yesterday’s 8.8 percent plunge.

JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. climbed more than 13 percent as Senate leaders vowed to resume work on the bailout plan this week after its rejection spurred the market’s steepest decline in two decades. Hess Corp. and Schlumberger Ltd. added more than 5.8 percent as optimism about the proposal helped oil rebound from a $10-a-barrel drop. All 10 industries in the S&P 500 advanced at least 1.3 percent.

“There is some renewed hope that Congress will come back and try to get the amended plan through,” Robert Doll, who oversees $1.3 trillion as chief investment officer of global equities at BlackRock Inc. in Plainsboro, New Jersey, said in a Bloomberg Television interview. “We have to restore confidence, we have to reduce fear, we have to get banks to lend money.”

The S&P 500 rose 58.35 points, or 5.3 percent, to 1,164.74, its biggest rally since July 2002. The Dow Jones Industrial Average jumped 485.21, or 4.7 percent, to 10,850.66 and earlier gained more than 500 points. The Nasdaq Composite Index added 5 percent to 2,082.33. More than five stocks climbed for each that fell on the New York Stock Exchange.

Worst Since 2002

Even with the advance, the S&P 500 had its worst month since 2002, with a decline of 9.2 percent, and tumbled 9 percent for the quarter. The cost of borrowing dollars overnight increased the most on record after the defeat of the bailout plan.

About 1.62 billion shares changed hands on the NYSE, 15 percent more than the three-month moving average. European stocks rose, while Asian shares declined. Government bonds in the U.S. and Europe fell. The dollar climbed the most against the euro since the shared currency’s 1999 introduction.

More than $1 trillion in market value was erased yesterday in the worst day for the S&P 500 since the “Black Monday” crash of 1987 after the House of Representatives rejected a plan designed to rid financial institutions of bad loans. President George W. Bush this morning urged passage of the legislation to prevent “lasting damage” to the economy.

The Dow average lost 6 percent in September, and the Nasdaq fell 12 percent. The S&P 500’s retreat since the end of June was its fourth-straight quarterly decline, the longest stretch since 2001. The Dow slipped 4.4 percent and the Nasdaq tumbled 9.2 percent.

$600 Billion

The MSCI World Index of 23 developed nations dropped 12 percent this month as almost $600 billion of credit losses and writedowns at financial institutions worldwide prompted banks to hoard cash, forced Lehman Brothers Holdings Inc. into bankruptcy and spurred government seizures of American International Group Inc. and the U.K.’s Bradford & Bingley Plc.

Financial companies in the S&P 500 this month traded at 1.1 times their book value, the lowest valuation since Bloomberg began tracking the data in 1995. Commercial banks in the gauge trade at 0.8 times book value, also a 13-year low.

“The market was way overdone, and we’re seeing a bounce back,” said John Wilson, the co-director of equity strategy at Memphis, Tennessee-based Morgan Keegan, which manages $120 billion. “The stage was set for saner minds to step in and pick some things off today. We’ve seen some nice gains in some of the financials.”

JPMorgan, Citigroup

JPMorgan, the biggest U.S. bank by deposits, climbed 14 percent to $46.70. Citigroup rose 16 percent to $20.51. Bank of America surged 16 percent to $35. Goldman Sachs Group Inc. increased 6.1 percent to $128 and Morgan Stanley gained 9.6 percent to $23.

Senate Majority Leader Harry Reid said approving the bank bailout legislation remains a top priority. Congress will take action on the plan this week, Senate Minority Leader Mitch McConnell said. Voters have flooded Capitol Hill offices with complaints about the bill’s rejection, according to a House Republican leadership aide.

Bush said the defeat of the plan “is not the end of the legislative process.” Presidential candidates Barack Obama and John McCain joined him in urging Congress to return to work on the plan.

The S&P 500 Regional Banks Index of 12 stocks climbed 16 percent after plunging 24 percent yesterday, its biggest tumble since the gauge was created in 2003.

Sovereign Surges

Sovereign Bancorp, which plummeted 72 percent yesterday, surged 70 percent to $3.95. The second-largest U.S. savings and loan said its chief executive officer will be replaced and analysts raised their stock recommendations. The bank also said it sold its holdings of collateralized debt obligations and is “well capitalized.”

National City Corp., Ohio’s largest bank, climbed 29 percent after losing 63 percent yesterday. Fifth Third Bancorp increased 31 percent to $11.90.

Hess, the fifth-biggest U.S. oil company, added 7.8 percent to $82.08. Schlumberger, the largest oilfield-services contractor, climbed 5.9 percent to $78.09. Crude for November delivery rose $4.27, or 4.4 percent, to $100.64 a barrel on speculation that new action on the rescue plan may avert an economic slowdown that would curb demand. The fuel dropped the most in seven years yesterday.

Officials from Microsoft Corp. to Office Depot Inc. and Schering-Plough Corp. said the government’s failure to bail out the U.S. banking industry put the entire economy at risk unless a deal comes soon. They called on lawmakers to put aside partisan differences and work to restore credit supplies and confidence to the financial markets.

Microsoft Gains

Microsoft, the world’s biggest software maker, added 6.7 percent to $26.69 as Merrill Lynch & Co. recommended buying the shares. Schering-Plough, the Kenilworth, New Jersey-based drugmaker, rose 5.5 percent to $18.47. Office Depot, the second- largest office-supplies company, gained 2.5 percent to $5.82.

Apple Inc. jumped 8 percent to $113.66, the biggest advance since November. The stock’s 18 percent drop yesterday was “overdone,” and the maker of the iPhone and Macintosh computer may climb to $145 in the “intermediate term,” according to Goldman Sachs.

Dr Pepper Snapple Group Inc. advanced 9.1 percent to $26.48. The drinks maker spun off by Cadbury Plc this year was picked to replace Wm. Wrigley Jr. Co. in the S&P 500. Wrigley is being acquired by closely held Mars Inc.

Hartford Financial Services Group Inc. fell the most in the S&P 500 on concerns the Connecticut-based insurer may need to raise capital after Fitch Ratings lowered its outlook. Hartford dropped 18 percent to $40.99.

VIX Retreats

The benchmark index for U.S. stock options slid 16 percent to 39.39 after closing yesterday at a record 46.72. The VIX, as the measure is known, is considered the market’s “fear gauge” because it tends to rise as stocks fall. Stocks usually advance after the VIX peaks, according to a note to clients by Harrison, New York-based research firm Bespoke Investment Group LLC.

Transportation stocks yesterday signaled U.S. shares may be poised for more losses, according to Dow Theory, which holds that the 30-stock industrial average takes cues from the Dow Jones Transportation Average. The gauge of companies such as FedEx Corp. and Ryder Systems Inc. slid to the lowest level since March 17 yesterday. That may suggest the industrials’ record 777.68- point plunge yesterday won’t mark its bottom, investors said.

Consumer confidence unexpectedly rose in September in a survey taken before the recent worsening of the credit crisis and plunge in stocks. The Conference Board’s confidence index rose to 59.8, a third consecutive increase, from 58.5 the prior month. A separate report showed home prices fell in July at the fastest pace on record from a year earlier.

Chicago PMI

A measure of U.S. business activity slowed for the first time in seven months as new orders and inventories weakened. The National Association of Purchasing Management-Chicago said its business index decreased to 56.7 this month from 57.9 in August. Fifty is the dividing line between growth and contraction.

The London interbank offered rate, or Libor, that banks charge each other for overnight loans jumped 431 basis points to an all-time high of 6.88 percent, the British Bankers’ Association said today.

Europe’s Dow Jones Stoxx 600 Index added 1.8 percent as Dexia SA, the world’s biggest lender to local governments, climbed 6.1 percent on a 6.4 billion-euro ($9.2 billion) state- backed rescue.

Anglo Irish Bank Corp. Plc rallied 67 percent after Ireland’s government said it will guarantee bank deposits and debts for two years, seeking to restore confidence in the country’s financial industry.

FDIC Seeks Authority to Raise Deposit Insurance Limit (Update3)

Sept. 30 (Bloomberg) — Federal Deposit Insurance Corp. Chairman Sheila Bair is seeking authority to temporarily raise deposit insurance limits from $100,000, giving banks liquidity amid a “crisis of confidence” in the banking industry.

“I do believe that it would be helpful for the FDIC to have the temporary ability to raise deposit insurance limits,” Bair said today in a statement in Washington. She has discussed proposals with congressional leaders revising a $700 billion bank rescue after the House defeated the plan this week.

Bair didn’t specify a size of the increase and said boosting coverage would give banks added liquidity and reassure depositors. The FDIC in 2000 considered doubling the coverage. The Federal Reserve and Treasury at the time opposed the increase, and the measure failed to pass Congress.

An increase in coverage to as much as $250,000 would be insufficient to protect small- and mid-sized companies, former FDIC Chairman William Isaac said in an interview. The Treasury’s recent step to guarantee all assets in money market mutual funds would leave banks at a competitive disadvantage, Isaac said.

“They are trying to propose increasing the deposit insurance limit to buy a few votes,” said Isaac, who runs bank consulting firm Secura Group in Sarasota, Florida. “This won’t solve the problem. They’re trying to do as little as possible to get the votes for a bad bill.”

Treasury Secretary Henry Paulson, on a conference call with bankers, said today raising coverage for the first time since 1980 is “an option that’s potentially on the table,” said Robert Davis, executive vice president of the American Bankers Association, which organized the call to brief grassroots organizers on strategies to resurrect Paulson’s bailout plan.

Paulson

“He acknowledged that it was one of the issues in Washington that’s being discussed,” said Davis, who was on the call. He said Paulson didn’t express an opinion and wouldn’t elaborate on specific proposals. “He wasn’t prepared to discuss any legislation or how it might change,” he said.

The Washington-based agency also may seek to increase the $250,000 insurance limit on Individual Retirement Accounts. “That would be up to Congress to decide how it may break down in different categories,” FDIC spokesman Andrew Gray said.

Bankers oppose a permanent increase in coverage that would be funded by industry assessments, although support for a one- year bump is gaining momentum in Congress, ABA President Edward Yingling said. The group hasn’t settled on the size of an increase or which assets should be covered, he said.

`Collateral Issues’

“There are lot’s of collateral issues to raising deposit insurance and we would not want to permanently up it in four days,” Yingling said in an interview. “This is not taxpayer money; it’s bank premiums. We would want to have with the Congress a careful analysis before anything is done permanently.”

New Hampshire Senator Judd Gregg, the chief negotiator for Republicans on the rescue bill, said he was willing to consider proposals to expand the FDIC’s role as well as raising the size of bank accounts the agency insures to $250,000. Barack Obama, the Democratic presidential nominee, and John McCain, the Republican nominee, also back raising the level to $250,000.

Senate Banking Committee Chairman Christopher Dodd said he’s spoken with Bair about expanding the FDIC’s authority “on a temporary basis.”

“We’re certainly going to look at that,” Dodd said today on Capitol Hill. “That isn’t modifying the plan we have; that would be adding to it.”

Small Businesses

Representative Carolyn Maloney, a New York Democrat, said small businesses in her district would support higher limits on deposit insurance. “Many of them are opening up numerous accounts for FDIC insurance,” Maloney said. “It is difficult to conduct business that way.”

House Republicans have proposed expanding the FDIC’s authority to handle more troubled institutions. They’re also exploring plans to revive a 1980s-era program that would let the FDIC issue certificates to banks that could be used as capital and would be repaid with interest. Isaac, who ran the FDIC from ‘81 to ‘85, said the agency can use its existing powers to protect general creditors in the event of a bank failure like he said the FDIC did for Wachovia creditors this week.

Euro Falls Most Since 2001 Against Dollar as Bailouts Spread

Sept. 30 (Bloomberg) — The euro fell the most against the dollar since 2001 after France and Belgium led a state-backed rescue of Dexia SA, as the widening financial crisis forces governments to prop up financial institutions across Europe.

The cost of borrowing in dollars and euros reached record highs today as banks’ reluctance to lend at the end of the third quarter exacerbated the freeze in global credit markets. The dollar rose against the yen on speculation the U.S. Senate will salvage a $700 billion bank-bailout plan as early as tomorrow after Congress rejected it yesterday.

“The consensus is the U.S. banking system is a little bit further along in its exposure of its toxic assets,” said Firas Askari, head currency trader at BMO Nesbitt Burns in Toronto. “It’s a case of which is relatively worse. The dollar’s going to benefit against the euro because Europe has more to expose.”

The euro tumbled 2.4 percent to $1.4092 at 5 p.m. in New York, from $1.4434 yesterday, the most since a 2.5 percent slide in January 2001. The currency dropped as much as 3 percent, the biggest intraday decline since its 1999 debut. The euro slid to 149.56 yen from 150.38. The yen weakened to 106.11 per dollar from 104.18, after reaching 103.54, the most since Sept. 16.

Implied volatility on one-month euro-dollar options rose to 16.9575 percent, or the highest in almost eight years. On Sept. 18, it reached 15.55 percent, the same level that triggered the Group of Seven nations to buy euros in 2000 to halt the 27 percent slide from its 1999 debut. The dollar had its biggest drop ever against the euro Sept. 22, falling 2.1 percent.

The euro also fell against the British pound after Belgium and France said they would lend Dexia, the world’s biggest lender to local governments, $9.2 billion to shore up capital.

Bank Borrowing

The capital infusion for Dexia comes two days after Belgium, the Netherlands and Luxembourg rescued Fortis, the largest Belgian financial-services company, Britain took control of Bradford & Bingley Plc, the country’s biggest lender to landlords, and Germany bailed out Hypo Real Estate Holding AG.

Banks are being squeezed amid a surge in borrowing costs as lenders hoard cash on concern more financial institutions will fail. The euro interbank offered rate, or Euribor, for one-month loans jumped to a record 5.05 percent, the European Banking Federation said. The London interbank offered rate, or Libor, that banks charge each other for overnight loans climbed 431 basis points to an all-time high of 6.88 percent today, the British Bankers’ Association said.

`Fundamentals Are Irrelevant’

“There’s a dollar shortage globally,” said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. “Demand for liquidity trumps the fundamentals. Fundamentally, the U.S. is awful, and Europe is awful. Fundamentals are irrelevant today.”

Foreign banks are paying the highest premiums in at least a decade to borrow in dollars in the swaps market even after the Federal Reserve more than doubled the amount of funds available to other central banks yesterday by expanding swap lines.

The Fed’s actions included increasing existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The price on one-year cross-currency basis swaps between yen and dollars reached minus 70 basis points, the biggest effective premium for dollar funding since Bloomberg began tracking the data in 1997. The highest reached in 1998, during the Asian banking crisis was minus 38.5 basis points in October 1998, according to Bloomberg data.

`Mad Scramble’

“There is a mad scramble for U.S. dollar funding demand from a global U.S. dollar-based financial system,” said Claudio Piron, Singapore-based head of Asian currency research at JPMorgan Chase & Co, the second-biggest U.S. bank by market value. “Central banks have been extending swap lines as lenders of the last resort. The banks access this liquidity, but they hoard it for themselves as they believe it too risky to lend to anyone else.”

The U.S. Senate will try to revive a $700 billion financial-rescue package after yesterday’s defeat in the House of Representatives. The bill would have allowed the government to buy troubled assets from banks. Institutions posted $590 billion of losses and writedowns since the start of last year following the collapse of the U.S. subprime-mortgage market.

“The U.S. problem has been public for a while, we’re dealing with it,” said Russell LaScala, the New York-based head of foreign exchange trading at Deutsche Bank AG, the world’s biggest foreign-exchange trader. “Traders are very confident something’s going to be passed in the next seven days. That’s definitely a sentiment that’s being priced in the market.”

Rising Yen

Higher-yielding currencies recouped losses against the Japanese yen as Europe’s benchmark Dow Jones Stoxx 600 Index gained 1 percent. The New Zealand dollar gained 1.5 percent to 71.07 yen after dropping 3.7 percent yesterday. The Australian dollar was little changed at 84.08 yen, after rising as much as 1.6 percent to 85.18 yen after falling 4.9 percent yesterday.

“I would be very cautious in betting on further near-term dollar-yen losses,” said Michael Klawitter, a currency strategist at Dresdner Kleinwort in Frankfurt. “Any positive news on the political front would have quite an impact.”

The yen typically declines when demand for high-yielding currencies rises, as traders put on so-called carry trades. In such transactions, investors get funds in countries with low borrowing costs and buy assets where returns are higher. Japan’s 0.5 percent target lending rate compares with 7 percent in Australia and 7.5 percent in New Zealand.

Quarter End

The yen rose the most of all 16 most-actively traded currencies yesterday after the Standard & Poor’s 500 Index plunged the most since the 1987 crash.

The Japanese currency rose 12 percent against the euro this quarter. The dollar fell 0.9 percent against the yen, paring a 7 percent gain in the previous three months. The euro is down 11 percent against the dollar.

“It is the last day of the quarter,” said Daragh Maher, deputy head of global currency strategy in London at Calyon, the investment-banking arm of France’s Credit Agricole SA. “You can get more unusual volatility, and I think we will get back to a more real market toward the end of the week and we can reassess what is happening then.”

The Great Bank Robbery of 2008

Henry Merritt “Hank” Paulson Jr.

A.K.A. “The Treasurer”

The Paulson bailout failed in the House. If it isn’t a death blow to the plan, it should be. This is not an economic plan: it is a heist.

It will go down as The Great Bank Robbery of 2008.

The economics behind it are nonsense, but we are naïve if we spend much time even considering the “arguments” for it. This is a money and power grab, pure and simple.

Just as magazine covers today feature scantily clad women that would have been scandalous a generation ago, in the same manner Paulson’s proposal — made in broad daylight and on national TV! — is almost naked in its audacity.

Austrian economists tend to be libertarians in their political views, and they are often chided for not keeping these systems hermetically sealed and separated in their minds. Fortunately, this alleged vice is a virtue in our present situation. Because of all the mumbo jumbo thrown around to show why the plan is necessary, some very sharp academic economists are in a tizzy trying to treat this as an extra-credit question, rather than a crime scene. That is a waste of time.

In this article, we will of course cover why the Keynesian justifications — coming from a “free-market” administration — are nonsense. But in the grand scheme, that’s not entirely relevant. People didn’t seriously consider the testimony of the tobacco company CEOs about the nonexistent dangers of smoking, because everyone knew those executives stood to lose billions from the settlement. So by the same token, no one should pay much attention to the official statements made by Henry Paulson, since he stands to personally be put in charge of doling out hundreds of billions of dollars to some of the most powerful people on the planet.

The Keynesian Fallacy: The Paulson Plan Won’t Create Wealth

In very simple terms, the Paulson Plan is a straight-up transfer of $700 billion — and counting! — from the taxpayers to a few big financial institutions. (Some smaller banks are complaining that they don’t own the exotic mortgage-backed derivatives, but rather simple mortgages. They do not believe they will see a dime of the Paulson money.) It’s easy to get all twisted around, but just remind yourself of this: the Paulson Plan has the federal government borrow $700 billion (through issuing Treasury debt) in order to buy assets from Wall Street banks. (We are neglecting the time delay in the program; the entire $700 billion wouldn’t be spent all at once.)

Some analysts think that the price paid for these “toxic” assets is important. No it isn’t. The government officials running this operation will dole out the favors on both ends, when the mortgage-backed securities are coming and when they are going. Neglecting this insight, some people want to say that if the government pays $700 billion for a portfolio of assets that is really only worth $400 billion, then the taxpayers really only lost $300 billion, not the full $700 billion.

Yet this thinking is naïve. The taxpayers are not going to be treated as equivalent to shareholders of a firm that just acquired $400 billion in assets. The taxpayers are not going to get a cut of the monthly mortgage payments (less the servicing costs on the $700 billion in new debt) tied to the government’s massive portfolio. Instead, the government will simply bump up its annual spending by a few billion dollars. Maybe it will have to spend the money on homeownership programs, or homebuilder job retraining, but the net income from those government-owned assets certainly won’t translate into a dollar-for-dollar tax cut.

“Some very sharp academic economists are in a tizzy trying to treat this as an extra-credit question, rather than a crime scene.”

And then at some point — during a future Republican administration, no doubt — there will be a push to “privatize” the secondary mortgage market, and the government’s portfolio at that time will be auctioned off at very generous prices to politically connected institutions. For example, maybe the $400 billion portfolio is auctioned off for $250 billion. (Perhaps the big banks have to set up subsidiaries owned by minorities and women who get preferential treatment in the bidding process. But whatever the ruse, they will find a way to justify the low prices.) When all is said and done, the government will have played hot potato with the MBS, and the national debt — borne by taxpayers — would be $450 (=$700-$250) billion higher. The favored financial institutions would be “up” roughly the same amount, collectively. (Throughout, we are ignoring the timings of the payoffs and the effect on present discounted value.)

It is the crudest Keynesianism to view the Paulson Plan as an injection of capital or “liquidity.” That money has to come from somewhere. If it is taxed or borrowed, then it is just a shell game; the liquidity is drained from elsewhere, to be injected into Wall Street.

Besides taxing or borrowing, the government has a trump card: it can have the Federal Reserve simply create the new money out of thin air, by engaging in some “Open Market Operations.” Yet even in this case, real wealth still hasn’t increased. Certain nominal figures, like “aggregate asset values” might go up. But that’s not very relevant, because the economy isn’t really richer. After all, there aren’t more tractors or office buildings just because Bernanke allows the monetary base to grow more rapidly. So what happens in this case is that prices rise; people find it harder to buy milk, bread, and gasoline. But the Wall Street fat cats are fine with the general price hikes, because they got their hands on the newly injected funny money early in the game.

But Won’t the Credit Markets Collapse?

Some observers would admit the legitimacy of my analysis above. “However,” they might say, “the Paulson Plan, or something like it, is necessary to avert a total meltdown of the financial system. We’re not trying to boost aggregate investment, so much as clearing out a clogged pipe.”

This talk of a breakdown in the financial system is a bogeyman. Steve Landsburg does such a great job of exploding this myth that I will simply quote him:

So what’s special about banks [that they deserve a bailout]? According to what I keep reading, it’s that without banks, nobody can borrow, and the economy grinds to a halt.

Well, let’s think about that. Banks don’t lend their own money; they lend other people’s (their depositors’ and their stockholders’). Just because the banks disappear doesn’t mean the lenders will. Borrowers will still want to borrow and lenders will still want to lend. The only question is whether they’ll be able to find each other.

… [A]s any user of match.com can tell you, the technology for finding partners has improved since [the 1930s]. When a firm wants to raise capital, why can’t it just sell bonds over the web? Or issue new stock? Or approach one of the hedge funds that seem to be swimming in cash? Or borrow abroad?

… I’m not sure these big Wall Street banks are really necessary, and I’m not sure we’d miss them much if they were gone. Maybe there’s something I’m missing, but if so, I think it should be incumbent on Messrs. Bernanke, Paulson and above all Bush to explain what it is.

Conclusion

The Paulson Plan is a heist. It is a grand scheme in which the public will end up owing hundreds of billions of dollars to holders of new debt claims issued by the US Treasury. The plan won’t “prop up” asset values and it won’t provide any real stimulus to the economy.

Despite the dire warnings — coming from the same folks who brought you the Iraq invasion to remove WMD — there is no threat of a financial meltdown. If Goldman Sachs failed, the sun would still rise the next morning.

Far from providing stability and confidence, the Fed, Treasury, and SEC’s recent moves have ensured that US capital markets will now function with the same efficiency as public education in this country. The Paulson Plan is one more step in the socialization of America, but it is also a great bank robbery.

Financial crisis

Into the land of the unknown

Global market turmoil continues after the rejection of the mortgage-rescue plan in America

HOW many votes in Congress will the latest financial upheaval change? That is the calculus underway in Washington, DC, after the House of Representatives defeated the proposed $700 billion mortgage-rescue plan by 228 to 205 on Monday September 29th. Democrats backed it by 140 votes to 95, while Republicans opposed it by 133 to 65.

Bankers had been under no illusions that the tweaked Paulson plan would cure all the financial system’s ills. But most had seen it as a step in the right direction, and had expected it to pass. Its rejection sent stockmarkets into freefall. The Dow Jones Industrial Average finished down by 7%, and suffered its biggest-ever points loss. Perhaps fittingly in an economy that is in danger of sliding into depression, the only stock among the 500 in the S&P index that finished higher was Campbell’s Soup. The S&P closed 29% below its peak. Reflecting fears that consumer demand will wilt, shares of Apple Computer, creator of the iPhone, fell by 18%. The rout continued in Asia, but shares rebounded in Europe on Tuesday morning on hopes that the bill would eventually pass.

But credit markets, already dysfunctional, were even closer to breaking point. Banks grew even less willing to lend to each other on Monday and Tuesday, and money-market funds fled anything with a whiff of risk. Some corporations are struggling to roll-over commercial paper, short-term debt issued to finance working capital, payroll payments and the like. In an effort to keep money markets from drying up, the Federal Reserve has doubled the size of a vital lending facility for banks, to $300 billion, and expanded agreements with other central banks that funnel dollars to lenders abroad.

These unprecedented injections are aimed at easing concerns that weak participants in the interbank market will fail to honour their debts. But many banks are now assumed to be not only illiquid but insolvent. Last week Washington Mutual, a thrift saddled with rotten mortgages, became the largest-ever American lender to fail. And on Monday Citigroup agreed to buy most of the assets of Wachovia, an even bigger American bank, in a deal brokered by regulators. On Tuesday Barack Obama, the Democratic candidate to be president, proposed that deposit insurance be extended to $250,000 “as a step that would boost small businesses, make our banking system more secure, and help restore public confidence in our financial system.”

The no vote was a big blow to George Bush, Hank Paulson, the treasury secretary, and Ben Bernanke, the Federal Reserve chairman. They gave dire warnings of the consequences of an unchecked crisis, in hopes of persuading Congress to approve an unusually aggressive and early fiscal intervention. (It took many more years for a systemic response to widespread failures of American savings and loan banks in the 1980s). But because the intervention is relatively early, voters have yet to see much impact from the crisis on their lives. “On Monday morning…the sun came up and a lot of people went to work, and [they] couldn’t understand what this panic was in Washington,” Paul Kanjorski, a Democrat from Pennsylvania, told Mr Paulson last week. It was far easier for voters to relate to $700 billion of their taxes being spent on a mess in Wall Street.

Party leaders largely agreed with the diagnosis, as did the presidential candidates of both parties. But polls showed that voters were split; constituent phone calls and e-mails ran heavily against the bill. Administration officials and party leaders are back at work trying to find a way to get at least 12 members to switch their vote; the betting both on Wall Street and in Washington, DC, is they will succeed. (Passage in the Senate is considered less problematic.) But it should not be taken for granted. Without amendments, anyone who changes his vote will face fierce criticism when he seeks re-election. Any amendments to appease Republicans could cost Democratic support, and vice-versa.

“You can’t let one day’s trading dictate public policymaking,” argues Scott Garrett, a New Jersey Republican and member of the Republican Study Committee, a block of conservative members who led opposition to the bill. “The market’s going to be a factor, but we’re looking at the larger picture.” Recalcitrant Republicans would rather see a programme to sell insurance to banks against mortgage defaults, rather than buying assets from them. The Treasury strongly opposes this approach. But there may be other grounds for compromise, such as relaxing mark-to-market accounting or extending the Federal Deposit Insurance Corporation’s guarantee of a bank’s liabilities to more than just the first $100,000 of each customer’s deposits. Other proposals include giving banks more time to deduct mortgage-related operating losses from future taxable profits, letting companies repatriate foreign profits tax-free and improving the tax treatment of losses sustained by banks on their holdings of Fannie Mae and Freddie Mac stock.

For their part, more Democrats might back the proposal if the administration also agreed to more fiscal stimulus, in particular public-works spending, or taking any profits on the TARP to low-income housing. A deal may be possible, but time is short: legislators are itching to return to their districts to campaign, and investors’ appetite for risk is ebbing fast. The House is not expected to reconvene before Thursday, to accommodate the Jewish new year.

The House vote also represented a stinging rejection of John McCain, the Republican nominee. Mr McCain suspended his campaign last week for two days, citing the financial crisis, and flew to Washington, DC, to help craft a solution to it. His main task was to persuade reluctant House Republicans to back their own president. In the event they voted against the deal made by their own leadership by two to one. The humiliation meted out to Mr McCain is intense.

Amid the efforts to put the deal back together, some small hope remains that not all is lost. What is unlikely to help is the atmosphere of bitterness and recrimination that is pervading Capitol Hill. With some justification, the Democrats are aggrieved to find that they supported Mr Bush’s bill while his own party did not. But the Republicans blame the Democratic speaker, Nancy Pelosi, for making a stupidly partisan speech shortly before the vote in which she poured scorn on the Republicans she is trying to court. A lot of bridges will have to be built in a short span of time.

Too Much Money Is Beyond Legal Reach

New York-based funds are abusing ’secrecy jurisdictions.’

ROBERT M. MORGENTHAU

A major factor in the current financial crisis is the lack of transparency in the activities of the principal players in the financial markets. This opaqueness is compounded by vast sums of money that lie outside the jurisdiction of U.S. regulators and other supervisory authorities.

The $700 billion in Treasury Secretary Henry Paulson’s current proposed rescue plan pales in comparison to the volume of dollars that now escape the watchful eye, not only of U.S. regulators, but from the media and the general public as well.

There is $1.9 trillion, almost all of it run out of the New York metropolitan area, that sits in the Cayman Islands, a secrecy jurisdiction. Another $1.5 trillion is lodged in four other secrecy jurisdictions.

Following the Great Depression, we bragged about a newly installed safety net that was suppose to save us from such a hard economic fall in the future. However, the Securities and Exchange Commission, the Federal Reserve System, the Comptroller of the Currency and others have ignored trillions of dollars that have migrated to offshore jurisdictions that are secretive in nature and outside the safety net — beyond the reach of U.S. regulators.

We should have learned a long time ago that totally unsupervised markets, whether trading in tulips or subprime mortgages, will sooner rather than later get into trouble. We don’t have to look back very far in history to understand this.

Long Term Capital Management, a hedge fund “based” in Greenwich, Conn., but composed of eight partnerships chartered in the Caymans, was supposed to be the wunderkind of the financial world. At its peak in the late 1990s, its gross holdings were valued at $1.8 trillion. But, regrettably, its liabilities exceeded its assets and the Federal Reserve Bank of New York had to step in and rescue it when the value of its assets plummeted.

Most recently, two Bear Stearns hedge funds, based in the Cayman Islands, but run out of New York, collapsed without any warning to its investors. Because of the location of these financial institutions — in a secrecy jurisdiction, outside the U.S. safety net of appropriate supervision — their desperate financial condition went undetected until it was too late.

Of course, BCCI Overseas, which was part of the then largest bankruptcy in history, was also “chartered” in the Caymans.

We have to learn from our mistakes. Any significant infusion to the financial system must carry assurances that it will not add to the pool of money beyond the safety net and supervisory authority of the United States. Moreover, the trillions of dollars currently offshore and invested in funds that could impact the American economy must be brought under appropriate supervision.

If Congress and Treasury fail to bring under U.S. supervisory authority the financial institutions and transactions in secrecy jurisdictions, there will be no transparency with the inevitable consequences of the lack of transparency — namely, a repeat of the unbridled greed and recklessness that we now face. Because of the monolithic character of world financial markets, a default crisis anywhere becomes a default crisis everywhere.

The Beltway Crash

Congress lives up to its 10% approval rating.

America has survived a feckless political class in the past, and it will again after this week. But Monday’s crash and burn of the Paulson plan on Capitol Hill reveals a Washington elite that has earned every bit of the disdain that Americans have for it. This crowd can’t even make sausage.

AP

House Speaker Nancy Pelosi ( D-Calif.) with Rep. Rahm Emanuel (D-Ill.) Monday, Sept. 29, 2008.

The 228-205 defeat reflects badly on all concerned, starting with the Democrats who run the House. The majority party is responsible for assembling a majority vote, and Speaker Nancy Pelosi failed in that fundamental task.

Her highly partisan speech on the floor — blaming “right-wing ideology of anything goes, no supervision, no discipline, no regulation” for the financial distress — is no excuse for Republicans to vote no. But it is indicative of the way she has governed for the past two years — like Tom DeLay without the charm. The cynics are saying Ms. Pelosi deliberately tanked the bill by giving 95 Democrats a pass, knowing failure would hurt John McCain, and given her track record we can see why people would believe it.

House Republicans share the blame, and not only because they opposed the bill by about two-to-one, 133-65. Their immediate response was to say that many of their Members turned against the bill at the last minute because Ms. Pelosi gave her nasty speech. So they are saying that Republicans chose to oppose something they think is in the national interest merely because of a partisan slight. Thank heaven these guys weren’t at Valley Forge.

Crash Course

• A Main Street Rescue 09/29/08 — Congress passed this ‘bailout’ a long time ago.
• The Washington Panic 09/27/08 — The Paulson plan is a tool to avoid a deeper downturn.
• The Paulson Sale 09/24/08 — Taxpayers are going to put up capital one way or another.
• A Mortgage Fable 09/22/08 — Beltway trilogy: the Fed, Fannie Mae, and Bear Stearns.
• Stopping the Panic 09/20/08 – Now the task is to protect taxpayers and restore markets.
• Be It Resolved 09/19/08 – Paulson and Bernanke ask Congress for a resolution agency.
• The Fed and AIG 09/18/08 – Nationalizations aren’t stopping the financial panic.
• McCain and the Markets 09/17/08 – Denouncing ‘greed’ and Wall Street isn’t a growth agenda.
• The Fed’s Epic Day 09/17/08 – It’s only fair to praise the central bank when it does the right thing.
• Surviving the Panic 09/16/08 – A resolution agency, steady monetary policy, and a big tax cut.
• Wall Street Reckoning 09/15/08 – Treasury Secretary Hank Paulson’s refusal to blink won’t get any second guessing from us.

The vote is also a rebuke for Treasury Secretary Hank Paulson, who could barely explain how his securities auctions would work even as he showed disdain for House Republicans. President Bush did his best to provide cover for the Members, but he is a spent political force. One GOP Member who supported the bill told us that before Mr. Paulson spoke to House Republicans last week, the whip count in favor was about 70; afterwards, it was closer to 20. You can’t ask Congress for $700 billion without more modesty and a better explanation for how it would be used.

Given this historic abdication, we’re surprised financial markets didn’t melt down more than they did yesterday. Equities nonetheless took the worst bath in percentage terms since the aftermath of 9/11, with the Nasdaq falling more than 9%. But that was a sideshow compared to the credit markets, which staged another flight from all risk. The three-month Treasury yield had sunk to 0.132% the last we checked, which means investors will accept essentially no return as long as they can avoid further financial losses.

Safe in their think-tanks, some of our friends have claimed that talk of a financial crash is merely a political invention. Perhaps we’ll now test their theory. A financial panic isn’t an academic seminar, and a flight from all risk isn’t something any free-marketeer should want. A recession now seems certain, as falling commodity prices are telling us, but the point is to prevent systemic financial collapse. Maybe the Members who voted “no” figure at least they’d still have jobs.

What next? One option is that Democrats will tell Mr. Paulson that they can pass his plan with more liberal votes, but that their price has gone up. This would mean more of the tax, spend and regulate provisions that House GOP leaders stripped out before their rank-and-file headed for the exits. These would only raise the price for taxpayers of the Treasury rescue and, if the equity provisions were too onerous, make the Paulson plan far less workable.

If Mr. Paulson wants to be a statesman, he could offer a Plan B that avoids giving Treasury such a big blank check. Instead, he could propose more public capital for the Federal Deposit Insurance Corp., which would do more of the creative financial plumbing it has done over the last week. (See here.) This will have to happen next year anyway, and the FDIC has long experience protecting taxpayers for public capital injections through preferred stock and warrants.

At the same time, the Secretary could salvage his own proposal by promising that while Treasury would start the purchase of toxic securities from banks, he would quickly (within weeks) turn the process over to a new and separate resolution agency. Congress could make this part of the legislation. This would remove Mr. Paulson as the political lightning rod he has become, and also give the rescue process the political insulation it needs. Such an agency could also work closely with the FDIC to protect taxpayers.

Members may not believe Hank Paulson, but they ought to pay attention to markets. The financial system has a huge capital hole due to losses on mortgage securities and other assets, and private capital won’t begin to fill it without the life preserver of public capital. Before it leaves town to campaign, Congress needs to act to defend and restabilize the financial system. After the last two weeks, and especially after yesterday, the Members also need to act to redeem their own reputations, to the extent they are still worth redeeming.