Some Straight Talk For House Republicans: Time To Lead From The Rear

It's Time For Some Really Horrendous Bipartisan Legislation

The question of the day is whether House Republicans are going to support some form of bipartisan bailout deal. The Paulson plan is pretty much the only plan that is on the table with any conceivable chance of passing a Democrat-controlled House and Senate, period. There will undoubtedly be battles over what to add on to the basic bones of the Paulson plan, or whether to tinker around the edges of its structure, but while people debate the academic merits of plans laid out by Newt Gingrich, the Republican Study Committee, and others, we need to bear in mind that none of those plans has any chance of passing this Congress.

Nobody is threatening a filibuster of the Paulson plan in the Senate, and indeed I have not seen any sign of major organized opposition among Senate Republicans. As we all know from elementary school Civics, if Nancy Pelosi can get her caucus to line up behind the bill, not a single House Republican’s vote is needed to pass it. The bailout remains massively unpopular and sets many bad policy precedents, and under ordinary conditions Republican intransigence would be the right and honorable thing to do: make the majority take responsibility for doing something unpopular, present a coherent alternative, capitalize at the polls, and replace as much of the unpopular plan as possible with the alternative after the elections.

These are not normal times. House Republicans need badly to come to grips with four very unpleasant realities, and to do so ASAP – and if ever there is a time for John McCain to lead them, this is it:(1) Congress Is Run By Cowards

As I said, the votes of House Republicans are in practical terms utterly meaningless. We have seen over the years innumerable occasions of both Democratic and Republican majorities in the House blithely bulldozing the powerless minority. But given the unpopularity of the Paulson plan at large and with the Democrats’ base, to say nothing of the role of Congressional Democrats in creating this mess, Nancy Pelosi simply lacks the courage to have her caucus take ownership of the plan and vote for it. She is frozen by her fear. She cannot lead, and she will not lead. And nobody’s even asking Barack Obama to step in and provide the leadership that is absent.

In normal times, her cowardice could be highlighted and run against. But today, if Congress is to act, the minority must take the wheel and lead. It’s no answer to say the bailout is unpopular. Sometimes, the people need leadership, not followership; that’s why voters elected leaders in the first place. If McCain and the House Republicans lead, the deal will get done. If they don’t, it won’t. It’s that simple.

And the leadership squabble in the House GOP is precisely why we need McCain to lean on people. To understand John Boehner’s posture you have to remember that

(1) Boehner’s job as head of his caucus is in deep trouble anyway for reasons that predate this crisis.

(2) Pretty much everyone who is gunning for said job is against the bailout, and loudly so.

(3) They have a majority of the caucus behind them.

(4) If Boehner wants to keep his job he is not gonna get ahead of his caucus.

In other words, somebody needs to rally the GOP caucus, and it won’t be its leader. You know how sometimes in children’s books and cartoons and comic books, you have a character who has some really bizarre and sometimes irritating talent or superpower, and all of a sudden circumstances arise in which that character’s unique talents are suddenly needed to save the world? That’s where we are today. John McCain’s signature talent as a legislator is his ability to get horrendous bipartisan legislation passed. Today, the nation needs some horrendous bipartisan legislation. It’s time for McCain to get the House Republicans to follow him where their best political and policy judgment and their constituents are all telling them not to go.

(2) Psychology Trumps Policy

The point where I have reluctantly parted company with the Paulson plan’s critics throughout this debate is the difference between looking at this as an issue of policy and looking at it as an issue of psychology. The primary importance of a deal, almost any deal, is its immediate effect on investor confidence, to prevent things like massive bank failures, a run on the money market funds and a freeze of the commercial paper markets, which would collapse the stock market and lead to Very Bad Things. Even if this might be the healthiest solution in the longest run, we are at the point of a potentially massive short-term system failure with huge real-world consequences for millions of Americans. Preventing that Worst Case Scenario by propping up investor confidence won’t prevent a recession, but is nonetheless a critically important goal of national policy. Bear in mind that as the U.S. goes, so goes the world; you may recall that 1933 ushered in some developments with rather adverse consequences for our national security. In other words, the actual merits of a deal may be far less important than doing something quickly that reassures the markets. There’s an old military saying that a bad solution today is sometimes better than a good one a week from now; or, as Chesterton put it, if a thing is worth doing, it’s worth doing badly. Speed matters more than getting it right; and we can always push for additional pro-growth measures and scaling back of the worst add-ons later if the Democrats insist on larding the bill up with goodies. All the policy arguments in the world can’t stop a herd of frightened investors from stampeding off a cliff, and will do us no good at the bottom.

(3) The Market Will Arrive Too Late To Help

The RSC and other proposals are premised on the idea that pro-growth policies can bring nervous private capital out from hiding. It’s not gonna happen in time to prevent a meltdown, because people who invested in mortgage-backed securities before and ended up losing their shirts are just not going to ride in on a shiny white unicorn and start doing the same thing all over again, no matter how many tax incentives you give them, especially when so many of them are out of free cash right now. That may not be a rational answer but it’s a realistic one: fear is a powerful emotion, and it can run wild for a long time before it exhausts itself.

And that means government needs to step in. Not because the market can’t figure out the right prices for the MBS and related debt securities at issue, but because nobody who has enough money to invest to make the market liquid again is able to let go of the fear. Government does not invest wisely, and I have no illusions that it will do a great job of pricing the assets Paulson wants to buy. Yes, the Paulson plan is a blunt instrument that will undoubtedly proceed the way ham-handed government solutions always do. But the simple fact that government can mobilize a huge amount of cash quickly means it can fix the situation, for pretty much precisely the same reason why government can build armies and go to the moon. Government works best when what is needed is simply the unique economy of scale and the coercive power to move with great speed it brings to the table.

If you don’t believe me, I suggest you spend the weekend hitting up investors for $700 billion to start your own hedge fund to invest solely in underperforming mortgage-backed securities. You may find it harder than you think.

Let me give you a rudimentary explanation of why rapid government action will work – not perfectly, but well enough to unfreeze the joints of the financial system. As anyone who has ever played Monopoly understands, the economics of the price of everything on the board changes when everybody is out of cash and in hock up to their eyeballs. But parachute one new player in who is flush, or better yet has a limitless line of credit, and that player can make serious profits in a hurry and at least temporarily keep the others on the board from going under when they hit street repairs or the luxury tax.

Paulson plans to buy up MBS (which I’m using here as shorthand) at some price that is maybe around the current market price, give or take, but in highly illiquid markets. And even if this means that the sellers of MBS are realizing their losses ASAP by selling at a steep discount, cashing out those losses and taking the charge to the balance sheet up front, that still has value that no private entity has the scale to provide on such short notice.

Let’s say you are a bank. You hold $400 million face amount of MBS. Market price, to the extent there’s one at all, appears to be $25, so your portfolio is worth $100 million on paper.

But you don’t have $100 million cash; you have zero cash and what may or may not be $100 million worth of MBS. The paper price, however, is useless unless you can actually find a buyer at that price. If you try to sell, given how thin the market is (so few buyers that any significant increase in sales will imbalance supply and demand), the price could go down. If you and every other bank who is in the same hole tries to sell at once with no new buyers, it could go waaaaaaaay down. And really nobody out there has enough private free capital to buy it all.

Suddenly Uncle Hank comes in with his bottomless debit card and says, you know what? I bet if I buy you out at $25 I can make a profit. And to extend or perhaps mix the Monopoly analogy, Hank buys out some of the inventory of everybody else on the board too. He buys Boardwalk for $150. He buys the railroads for $40 a piece, all four of them. He buys the orange set with the three hotels for $600. And in the end – getting us back to the MBS world – he’ll make a profit on some of those when they pay at maturity at $100 or $70 or $45, lose his shirt on others, and maybe earn an average return of maybe $30, so he stands a good chance of making a profit simply because he was the only guy who could afford to take advantage of good buying opportunities at such an enormous scale. Uncle Hank hasn’t outsmarted the market, he was just the only guy who could afford the risk.

But even if the taxpayer doesn’t make a profit, the system will be able to function again without the uncertainty of having the balance sheet tied up in illiquid assets. Because your bank now has $100 million in cash, and can get out of the business of freaking out about your MBS portfolio and trying to figure out how much of the rest of your investments have to be called in to keep a cushion in case the bank next door holds a fire sale and the price drops to $10. Bingo – you can now go back to lending money.

The private sector can do this – but not with nearly this kind of speed. Which, when you consider why that’s not happening, brings us back to our original point about this being a fundamentally psychological crisis – a mental recession, if you will, but one that’s no less real for being mental. The government can bear larger risk and thus proceed without the fear that keeps private capital sidelined after a traumatic experience.

(4) Life Is Not Fair

If the markets go blooey over the lack of a deal, the fact that the bailout had been unpopular will not save the lack of a bailout from being even more unpopular. And Republicans will get the blame – because the media’s already blaming the House GOP, because our guy is in the White House and will get tagged as the new Hoover, because all the political contributions to Democrats in the world, and all the explanations of how bad public policy was at fault, can’t break the Republicans=rich people=free market=Wall Street link in the public mind. And with just five weeks until the elections, that will mean that economic disaster is followed by electoral disaster and quite possibly the end of the free market as we know it at the hands of the winners of that election.

Republicans can grouse about this but we know in our hearts it is true. Failure to act will be political suicide for the GOP. So in the end, it’s not only about putting the nation first, but saving the party’s political hide as well. It’s time for the minority to lead.

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