I would like to respond to the President’s Washington Post op-ed, “Rebuilding Something Better.”  All quotes in this post are from the President.

Nearly six months ago, my administration took office amid the most severe economic downturn since the Great Depression.

The President and his team use this language to lower the bar against which they are measured.  The U.S. economy was quite unhealthy on January 20th, and it still is.  Still, Donald Marron shows that, while the President’s statement is almost technically true, there is a big difference between “most severe … since the Great Depression” and “comparable to the Great Depression.”  Here is Donald’s graph:

You can see that the recession of the past 19 months is not comparable to the Great Depression.

Nearly six months ago, my administration took office … and many feared that our financial system was on the verge of collapse.

Incorrect.  In September-December of 2008, many feared that our financial system was on the verge of collapse.  Large financial institutions were failing roughly every other week.  By January 20^th, we were pretty much out of the woods in avoiding a financial crash.  Things were still bad and needed serious long-term repair, but that’s not the same as on the verge of collapse.  Had our financial system been on the verge of collapse in January, we (the Bush team) would not have waited to draw down the last $350 B of TARP funding.

The swift and aggressive action we took in those first few months has helped pull our financial system and our economy back from the brink.

The President uses the past tense:  “has helped.”  Which actions, exactly, have had positive effects so far?

The Administration and the Fed deserve credit for the stress tests, which have encouraged banks to raise private capital.  And they have continued the Bush Administration’s efforts to prevent particular too-big-to-fail financial institutions (AIG, Citi, Fannie & Freddie) from imploding.

They successfully followed the path (which President Bush laid in late December) to allow GM and Chrysler to enter and exit bankruptcy, although they did it in a much more heavy-handed way than we had hoped.  President Bush’s and President Obama’s actions allowed these firms to avoid immediate liquidation, but it is too soon to call this effort a success.

That’s pretty much it so far:

• The stimulus has not yet had any measurable macroeconomic benefit, although it will, starting a few months from now.
• The much-hyped TARP “Financial Stability” program to buy risky assets (aka “the Public-Private Investment Partnership,” or PPIP) has been dialed back to a fraction of its originally proposed extent.  The specifics were announced only last week.
• As of June 17th, CBO could find no evidence that any of the $50 billion allocated for foreclosure mitigation had been spent.  (See footnote (d) on page 2.)
• The President’s announced small business loan program does not yet exist.
• The President’s budget would make our fiscal position much worse than current law, necessitating both higher taxes and more debt over the next decade.  And, other than the stimulus and a huge appropriations bill, none of it has yet been enacted into law.
• Creeping Congressional and Administration protectionist actions are filling the gap left by Presidential inaction on the free trade agreements with Colombia, South Korea, and Panama.

Aside from the important and apparently successful stress tests for which the Administration and the Fed rightly deserve credit, the most successful and effective actions taken by the Obama Administration in its first six months were the continuation of the TARP capital purchase program and the extension of the auto loans.  Both were initiated by President Bush.

I cannot see what else counts as as “swift and aggressive action” that “we [the Obama Administration] took in those first few months” that “has helped pull our financial system and our economy back from the brink.”

The American Recovery and Reinvestment Act was not expected to restore the economy to full health on its own but to provide the boost necessary to stop the free fall.  So far, it has done that.

2.6 million fewer Americans are employed now than when the President took office, and the unemployment rate is 9.5% and climbing.  Job loss in June was greater than in May.  The good scenario is one in which we continue to lose jobs for “only” another six months.  Please prove that the stimulus is working.  To use the Administration’s misleading metric, how many jobs have been “saved or created” so far?

It was, from the start, a two-year program, and it will steadily save and create jobs as it ramps up over this summer and fall.

Uh-oh.  Why are the verbs now in the future tense?   And what happened to the specific and oft-repeated prediction of 3.5 million jobs by the end of next year?  Those are important language changes, along with the implicit admission that the stimulus has not yet “ramped up.”

This did not have to be a two-year program.  Congress could have front-loaded the stimulus had they instead given the cash directly to the American people, as they did on a bipartisan basis in early 2008.  We would have saved much of it, paying off our mortgages, student loans, and credit cards (which would not be a bad thing).  We would have spent the rest much more quickly than the federal and state government bureaucracies now stumbling through their usual corrupt, slow and inefficient processes.  Instead the President handed the money and program design over to a Congress of his own party, who saw it as a big honey pot rather than as an exercise in macroeconomic fiscal policy.  The President’s primary macroeconomic policy mistake was allowing Congress to pervert a rapid Keynesian stimulus into a slow-spending interest-based binge.

The President is correct that the stimulus will increase economic growth, mostly next year.  That is too late, and later than it could have been had they done it right.

We must let [the stimulus] work the way it’s supposed to, with the understanding that in any recession, unemployment tends to recover more slowly than other measures of economic activity.  …  There are some who say we must wait to meet our greatest challenges.  They favor an incremental approach or believe that doing nothing is somehow an answer.

So the President says we must wait for the stimulus to work, then attacks others who say we must wait “to meet our greatest challenges.”

Who says we must wait?  Who favors an incremental approach to our greatest challenges, or believes that doing nothing is somehow an answer?  These are straw men.  I, for one, want to address these problems, but in a different way.  In some cases the solutions being developed by Congress would do more harm than good.  This does not need to be a choice between doing something and doing nothing, or between action and inaction.  If the majority party would allow the minority to have votes on their policy proposals, this would instead be a debate among different models for reform.

Speaker Pelosi told the President’s team privately that we must not address Social Security reform.  Our greatest immediate fiscal challenge is actually the rapid aging of the population, not health costs.  This is notably absent from the President’s problem definition.  We need to bend the health cost curve down and we need to address more immediate demographic pressures in Social Security, Medicare, and Medicaid.  The Speaker says we must wait to address the Social Security challenge.  She favors inaction.

To build that [stronger] foundation, we must lower the health-care costs that are driving us into debt, create the jobs of the future within our borders, give our workers the skills and training they need to compete for those jobs, and make the tough choices necessary to bring down our deficit in the long run.

Amen.  But …

• The health reform bills being developed by a Democratic Congress would raise private and public health care costs and drive us even deeper into debt.
• Raising energy prices will hurt the economy, not help it.  One could argue that the environmental benefit from reducing U.S. carbon emissions is worth it (I would not), but it is invalid to claim that higher energy prices will help our economy.
• CBO says the President’s budget would result in deficits averaging 5.2% over the next decade, and would increase debt held by the public from 52% of GDP this year to 80% by 2019.  In the long run, we need to address immediate demographic pressures (which the Administration ignores) and change incentives to bend the long-term health cost curve down (which neither the President nor his Congressional allies have proposed).
• If we do not, then “make the tough choices necessary to bring down our deficit in the long run” just means “raise taxes.”

Already we’re making progress on health-care reform that controls costs while ensuring choice and quality, …

Maybe the President knows about a bill that has not yet been released.  Every bill that is public so far would reduce incentives for individuals to consider the costs of the insurance they buy and the medical care they use, and would therefore increase health care costs.  These bills bend the private and public sector health cost curves up, not down.

On “ensuring choice,” CBO estimates about 10 million people who under current law would be covered through an employer’s plan would under the Kennedy-Dodd bill not have access to that coverage because some employers would choose not to offer it.  This breaks the President’s promise that “If you like your health plan, you will be able to keep your health care plan, period.  No one will take it away, no matter what.”

Already we’re making progress on … energy legislation that will make clean energy the profitable kind of energy, leading to whole new industries and jobs that cannot be outsourced.

Yes, but at a cost to the economy as a whole.  The House-passed bill would make clean energy profitable by raising the cost of carbon-based energy sources, which hurts economic growth.  In addition, American manufacturers will have to pay higher energy prices that it appears their Chinese and Indian competitors will not.  This hurts American firms and American workers.

I remain confused as to why the President believes he can claim that jobs in low-carbon energy technologies “cannot be outsourced.”  Of course they can.  The maintenance jobs cannot be outsourced, but design and manufacturing of clean energy technologies can be done anywhere in the world.

We must continue to clean up the wreckage of this recession, …

Lucky for us we have an economy that self-repairs over time.  Economic growth will at some point return, with or without good policy.  In the case of the financial sector, the capital purchase program and stress tests are accelerating the pace of recovery.  In most all other cases, the President’s policies cannot be demonstrated to be helping.  GDP continues to decline, and the anticipated good scenario is one in which job growth does not return until early next year.  When you combine these uncomfortable facts with statements like “we misread the economy” and “we had incomplete information,” it is hard to see how the clean-up claim is justified.

After a rough ten days economically and politically, the President is trying to regain his footing and frame the week ahead.

The new jobs data has caused him to back off his specific commitment — there is no longer any mention of 3.5 million jobs by the end of next year.  But the primary point of this op-ed is to signal a new message, captured most succinctly here:

[The stimulus] was expected to provide the boost necessary to stop the free fall.  So far, it has done that.  It was, from the start, a two-year program, and it will steadily save and create jobs as it ramps up over the summer and fall.  We must let it work the way it’s supposed to, with the understanding that in any recession, unemployment tends to recover more slowly than other measures of economic activity.

The President’s new message is:  No second stimulus.  This one will work.  Ride it out and be patient.

He’s right that it will help, eventually.  If the July employment report due on August 7th returns us to the prior slow but steady recovery path, the President might only have to worry about 6-9 months of economic and political pain.  But if the July report shows that the June report is a new downward trend, then policymakers will have a more serious problem to address.

The President’s op-ed is titled “Rebuilding Something Better.”  Unfortunately I think there is a roadside construction sign reading “Expect lengthy delays.”  Let us hope it doesn’t take too long for the rebuilding to work.

(photo credit: Sewer Construction at Commercial and Broadway I by roland)

Responding to the President’s op-ed

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Six month economic policy status update
2. Cliff Notes: The President’s Carnegie Mellon economic speech
3. Responding to the President’s Carnegie Mellon economic speech

We’re less than two weeks away from the six month mark of the Obama Administration.  Here is a summary I would give to someone who had missed the past six months.  I think the groupings are particularly important.

Good

• The bank stress tests worked – regulators now have a common framework to evaluate the health of the 20 largest banks, and these banks are in the process of raising private capital.
• Reports are that the Fed’s Term Asset-Backed Securities Loan Facility (TALF) is working, providing liquidity to certain markets that lacked it.
• There has not been a sudden failure of a major financial institution since the President took office, in part due to significant new government efforts with AIG and Citigroup, and an ongoing flow of hundreds of billions of dollars to Fannie Mae and Freddie Mac.
• As a result, the severe instability that plagued inter-bank lending markets and certain credit markets last fall and winter has largely receded.

Bad

• As the Vice President said on Sunday, the Administration underestimated the severity of short-term macroeconomic decline.
• The U.S. economy has lost 2.64 million jobs since the beginning of the Administration, and the unemployment rate is now 9.5%.  Most private sector forecasters project economic growth will turn positive in the fourth quarter of this year, with job growth to resume sometime in 2010.  The June job report was really bad.  Watch the July report closely.
• The stimulus was poorly designed by Congress, such that it is not now having any measurable economic effect, and the bulk of the GDP boost won’t come until 2010.  When you combine this with the missed economic forecast, it means the next six months will be worse than they needed to be.
• The President’s budget would result in massive increases in both deficits and taxes, driving by significant proposed spending increases, especially in health care.  CBO projects deficits over the next decade equal to 5.2% of GDP, more than double the cumulative deficit projected under current law.  Debt held by the public would rise from 57% of GDP in 2009 to 82% of GDP by 2019, while taxes would grow from 15.5% of GDP in 2009 to almost 20% by 2019.

Too soon to tell

• Chrysler and General Motors are still operating.  Chrysler has emerged from Chapter 11 bankruptcy, and GM is working through the bankruptcy process.  It is good they have not failed, but it is unclear if they will survive in the long run.  If either firm falters, will the Obama Administration give them even more cash?  In addition, the Administration’s heavy-handed path to bankruptcy upended the traditional capital structure, increasing long-term political risk in the United States.
• There is little apparent progress on the President’s foreclosure prevention plan.  According to the Congressional Budget Office, as of [date], no funds had been spent on the program.  (See footnote d on page 7 of this CBO report.)  It takes time for mortgages to be restructured, so this may just be slow.

Non-existent

• The much-hyped plan to buy troubled/bad/legacy/toxic assets from financial institutions, aka the Public-Private Investment Partnerships (PPIP), is reportedly being dramatically dialed back, almost to non-existence.  This means that the Obama Administration’s much-hyped “new way” of doing TARP is basically the old way + the stress tests.  After all the bashing of Secretary Paulson and the Bush Administration, TARP’s application to banks looks quite similar to how it looked in December and January.
• The same CBO table shows no spending so far for the President’s small business lending program.  I can’t tell if it’s in operation or not.
• There has been almost complete radio silence on trade and open investment.  The Free Trade Agreements with Colombia and South Korea are on life support due to Presidential and Congressional inaction.  The Buy America provisions in the stimulus law are protectionist.
• The President’s budget and Congressional proposals would significantly increase federal health care spending by creating a new entitlement to health insurance.  The President and his advisors emphasize that their long-run budget plan is to “bend the health cost curve downward” by making systemic policy changes that would slow the growth of private and public health care spending.  While the Administration has proposed policy changes that would increase the information available to consumers of health care, they remain silent on how to change the incentives to use more and more expensive health care.  As a result, the President has no proposals that will slow the long-run unsustainable growth of private health care spending, and the Administration’s promises of long-run budget discipline are unsubstantiated.
• Similarly, the Administration emphasizes the long-run budgetary effects of health care cost growth, but the Administration has no policies to address the more immediate budget pressures driven by an aging population.

Uncertain and unlikely

• Climate change legislation passed the House June 26, but is unlikely to pass the Senate this year or next.

Uncertain

• Health care reform legislation will pass the House, probably in July.  Prospects in the Senate are highly uncertain.  If legislation moves in the Senate, it will not be until fall.
• The fate of the President’s financial regulatory reform package is unclear.  House Financial Services Committee Chairman Barney Frank is talking positively about moving at least part of the package this Fall.  Senate Banking Committee Chairman Chris Dodd is busy with health care reform and his re-election campaign.  I think it is unlikely legislation will be enacted this year.  If something is enacted, it will only be a piece of the whole.

Observations

Each of the good items is a joint Treasury-Fed operation.

In my judgment, four initiatives that the Administration hyped heavily appear dead or nearly dead:  PPIP, foreclosure prevention, small business lending, and climate change.  I respect that others may disagree with this judgment.

There is almost complete radio silence from the Administration on international economic policy, while incremental protectionist measures quietly move into place.

I think that over the next 3-6 months, the President’s economic stewardship will be judged almost entirely on (1) how he deals with the worsening macro picture, and (2) whether he signs into law a health care reform bill that meets his goals.  Both are fraught with peril.

Six month economic policy status update

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Cliff Notes: The President’s Carnegie Mellon economic speech
2. Responding to the President’s op-ed
3. The President’s new economic proposal

The Congressional Budget Office (CBO) has released their assessment of the Office of Management and Budget’s semiannual TARP report.  That assessment estimates how much cash has gone out the door for each part of TARP, and how much CBO expects will ultimately be returned to the Treasury.  I have converted CBO’s table (Table 1 on page 2) to a set of graphs.  Looking at the Capital Purchase Program (CPP) in the bottom bar, $199 B has gone out the door in outlays, and CBO expects $174 B of that will be paid back.  CBO calculates a subsidy rate for each program, which for CPP is 25 ÷ (174 + 25) = 13%.  Taxpayers should expect to recoup 87% of the funds that were invested on their behalf in the Capital Purchase Program and lose the other 13%.

You can see from the graph that most of the funds went to capital purchase: CPP + specific firm deals (AIG, Bank of America, and Citigroup).  CBO thinks we taxpayers will get most of our money back from Bank of America and Citigroup.  We’ll get about half back from AIG, and a little more than a quarter back from the autos and auto finance companies.  The Administration’s foreclosure mitigation program is a spending program, not an investment, and thus we expect to get none of those funds back.  Footnote (d) on CBO’s table contains a surprise:  “The Treasury has not yet disbursed any of the $15 billion allocated as of June 17, 2009, for foreclosure mitigation.”  We heard a lot about the President’s efforts on foreclosure mitigation, and yet no cash has flowed.

To answer the question, “How much bailout money will taxpayers get back?” CBO estimates that:

• $439 B of the original $700 B has been spent;
• $280 B of that will be repaid; and
• $159 B will not be repaid and will be a cost to the taxpayer.

CBO provides further detail on the Capital Purchase program by subdividing it into two parts:  CPP for the 32 banks that have already paid back the Treasury, and CPP for all the other banks.  Here’s the same graph, but with CPP split into those two parts.  You can see that the net cost to the taxpayers from the 32 banks that have already paid back Treasury was (only) $1 B.  CBO is guessing a much higher loss on the remaining outstanding CPP investments.

We do not have similar estimates for all of the Fed actions, but we do for the FDIC’s actions, and for the bailout of Fannie Mae and Freddie Mac.  The picture changes dramatically when we add these non-TARP financial rescue funds.  Courtesy of Sen. Judd Gregg’s excellent Senate Budget Committee Republican staff, I’m going to add in orange the estimated taxpayer costs of FDIC’s component of the Citigroup rescue, and CBO’s estimate of the taxpayer cost of bailing out Fannie Mae and Freddie Mac.

CBO estimates that the cost to the taxpayers of the failure of the GSE’s, Fannie Mae and Freddie Mac, will be $384 B.  That is 2.4 times larger than all the other TARP and non-TARP costs (shown here, and excluding the Fed) combined.  Here’s the Budget Committee Republican staff’s Budget Bulletin:

CBO estimated that the federal government immediately absorbed a loss of $248 billion for the book of business the GSEs had in September 2008.  To maintain an active mortgage market, the federal government is continuing to operate the GSEs, whose new commitments entered into after September 2008 would lose an estimated $136 billion over the 2009-2019 period according to CBO.

Thus when we rank the expected cost to the taxpayers of the different TARP and non-TARP programs, we get:

1. Fannie Mae & Freddie Mac ($384 B)
2. Foreclosure mitigation ($50 B)
3. Autos & auto finance ($40 B)
4. AIG ($35 B)
5. Outstanding equity investments in banks through the Capital Purchase Program ($24 B)
6. Citigroup ($15 B)
7. Bank of America ($2 B)
8. The direct Treasury cost of the Fed’s liquidity facility ($2 B)
9. Repaid equity investments in banks through the Capital Purchase Program ($1 B)

That $384 B number is huge.

And updating to include TARP + FDIC + GSEs (but not the Fed facilities), it appears CBO estimates the net cost to the taxpayer of all these non-Fed facilities will be about $553 B.

Thanks to Jim Hearn of Sen. Gregg’s Budget Committee staff for his incredible table and assistance.

Sources:

• CBO’s The Troubled Asset Relief Program: Report on Transactions through June 17, 2009
• Senate Budget Committee Republican Staff’s Budget Bulletin (June 25, 2009)

If you’re really into budget policy, you should keep your eye on the Budget Bulletin.  You can subscribe by emailing their webmaster, whom you can find here.

How much bailout money will taxpayers get back?

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Intro to TARP — TARP III: The Geithner Plan
2. Six month economic policy status update
3. Is $700 billion enough? Part 3: Secretary Geithner says we have more room

Host Chris Wallace moderated a discussion this morning with:

• Dr. Austan Goolsbee, Member of President Obama’s Council of Economic Advisers and chief economist on the President’s Economic Recovery Advisory Board;
• Senator Richard Shelby (R-AL), ranking Republican on the Senate Banking Committee;
• Thayer Capital Chairman Fred Malek; and
• Google CEO Eric Schmidt.

I offer kudos to Mr. Schmitt for his thoughtful responses throughout.  And the hero of the discussion was Mr. Wallace, who in his questions demonstrated a deep understanding of the actual options faced by policymakers, the choices they made, and the serious consequences of those choices.  I thank him for trying to elevate the policy discussion this morning.

Here’s Chris Wallace asking Fred Malek whether the Bush Administration have provided loans before a Chapter 11 filing:

WALLACE:  Let me bring in Fred Malek, though.  The President says that he has no interest in running businesses, he’s just trying to save them from collapse and get out.  [plays clip of President Obama's press conference]  Fred Malek, in the middle of a financial crisis, in the middle of a terrible recession, could the President really let General Motors and Chrysler, AIG and Citibank go under?

MALEK:  … I think what you have here, is you have two different situations.  I would label the injection of capital into the financial institutions, stabilizing the financial systems, that’s a war of necessity.  You had to do that.  But, getting into General Motors, saving General Motors and then taking them into bankruptcy, that’s a war of choice, it’s the wrong choice.

Senator Shelby later commented on this same question, as did Mr. Malek again:

SHELBY:  First of all, I advocated last fall that General Motors and Chrysler’s best bet would have go to Chapter 11 then, it would have saved a lot of money, not a political restructuring like what’s happened, where the bondholders have been sacrificed, the unions have carried the day.  …

MALEK:  … I agree with Senator Shelby.  Look, we’ve had for decades we’ve had a bankruptcy system in this country that has worked well, and has fueled the free enterprise system in a positive way.  It is impervious to politics because it’s run by federal courts.  Now, what have you done?  You have taken it out of the judicial and you’ve turned it over to the executive, and I think you’ve injected politics into it.  Senator Shelby is right, there was no sense in putting billions of dollars in and then declaring Chapter 11 afterwards.  They should have let them go into bankruptcy and let the courts work it through.  …

Mr. Wallace then asks the critical follow-up question:

WALLACE:  Let me just ask.  Mr. Goolsbee, if at some point, either the Bush Administration back in the fall, or you guys when you took over, had just said, go into Chapter 11, we’re not going to take an ownership stake, we’re not going to give you 50 billion dollars, what would have happened?

The answer is that GM and Chrysler would have liquidated.  Neither GM nor Chrysler was ready for a complex Chapter 11 filing.  Had the entered the Chapter 11 process in December or January, the firms and every outside expert told us that the restructuring would have failed and the firms would have liquidated.  We estimated this would have resulted in about 1.1 million lost jobs.

Mr. Malek was right, the loans to GM and Chrysler were a choice, but they were not the choice that he and Senator Shelby thought we faced.  The choice was loan or liquidate.  There was no feasible Chapter 11 option available at the time.  (GM may fail even now, after they have had five months to prepare for Chapter 11.)  Mr. Schmitt frames it correctly:

SCHMITT:  It seems to me that what choice did we have except try to save General Motors, given the roughly million jobs that were related at a time of incredible pain and job loss.  So if you think about it , the choice was bankruptcy, the supply chain goes away, the loss of the American automobile industry, or a band-aid.  It needs to be a band-aid, and it needs to be something we get out of.  …

Government Motors discussion on Fox News Sunday (continued)

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Dr. Goolsbee gets it wrong on the auto loans
2. Understanding the GM bankruptcy
3. Auto loans, part 3: the Bush approach

I did my first TV interview at the beginning of 2008 shortly after being promoted.  At first it was stressful, and it took me a while to get used to it.  Now that I’m on the outside, I do an occasional interview on CNBC, Fox, or CNN.  Today I’d like to describe the mechanics of doing a TV news interview from the North Lawn of the White House.  Even though I had worked in the White House for more than five years before my first on-camera interview, I did not know any of this until I actually had to do it.

Today is Jobs Day:  the first Friday of the month, when the Labor Department releases the monthly employment report.  The employment report is generally the most important economic data point of the month, and the business news channels (CNBC, Bloomberg, and Fox Business) always cover it.  They always ask for someone from the Administration to comment on the data and what it means for the economy and the policy agenda.  I see the Vice President’s economic advisor, Jared Bernstein, is doing CNBC now.  In 2008, CEA Chairman Dr. Ed Lazear and I typically did this duty.

The jobs report is released at 8:30 AM on Friday.  As with all economic data releases, Administration officials are embargoed from talking about it publicly for one hour after the release.  This gives the markets time to process the data without the Administration’s viewpoint.

For each show broadcasting at 9:30 AM, a network producer negotiates with a staffer in the White House press shop.  For us it was Eryn Witcher, a top-notch professional with prior experience in TV news who now works as the communications director at Stanford’s Hoover Institute.  Eryn would negotiate with the producers and set Ed and/or me up with interviews.

Ed and I would talk the night before about the upcoming data and what we might say about it on the air.  We were among a handful of officials who got the data reports before they were released, so that we could advise the President.  Ed and his staff also used that data to prepare the daily “economic data memos” that the President received each morning.

We would generally watch the CNBC commentary immediately after the data release (at 8:30 AM sharp) to see if we had missed anything, and to take a temperature check on the initial market reaction and expert analysis.  We would generally be prepped by Ed’s chief of staff, Pierce Scranton, who had an uncanny ability to predict what questions we would be asked, and coached us on how to give a short effective answer.  If he wasn’t fighting other fires, Deputy Press Secretary Tony Fratto would also sit in the prep session.

A little after 9 AM someone would do my makeup in my office.  Around 9:15 Eryn and I (or Eryn and Ed) would walk out to the North Lawn.  You need a good TV tie (no busy patterns), straight collar (I was often scolded for button down collars), and American flag pin.  After a while I got my own earpiece that I would bring out with me, so I wouldn’t have to use the common one that everyone else uses.  It’s also nice to know you won’t lose the earpiece during the interview.

Each network has a TV camera set up in an area on the North Lawn next to the driveway from Pennsylvania Avenue to the West Wing entrance.  The networks semi-permanently set up shop there in 1998 during the Monica Lewinsky scandal, and the gravel-filled area became known as Pebble Beach.  It was refurbished during the Bush Administration with slate and the cameras and tripods are covered with heavy green canvas when they’re not being used.  It is now referred to as Stonehenge, to which it bears a vague resemblance.

The cameras are in a long line next to each other.  Each is set up so that the person on air has the north entrance to the White House residence in the background.  Because of the different camera positions, each has a slightly different angle on the White House.  On the night of a big Presidential speech from the White House, try quickly switching channels and you can see the different angles.

Here’s a diagram for CNBC (roughly).  As always, you can click on the picture for a larger view.

The West Wing is the square building in the lower-left (southwest) corner.  The residence is in the lower-right corner, and that’s Pennsylvania Avenue up top.

The blue box surrounds Stonehenge with all the TV cameras.  When you’re on CNBC you stand at the red dot, facing the camera at the orange dot.  The yellow line shows the camera angle, extended to capture the north entrance to the Residence in the background.

If you look closely, to the right (east) of the blue box you can see the driveway that heads south from the Northwest Appointment Gate to the West Wing entrance.  Visitors with appointments in the West Wing walk up this driveway, and you can occasionally see them passing behind someone being interviewed on TV (especially on the evening news broadcasts).  If they’re walking from left to right on your screen, they’re arriving at the West Wing.  Right to left, they’re leaving.

About 9:15 AM Eryn and I would walk out to Stonehenge.  We would greet the cameraman and a producer, and I’d get miked up.  All the producers I met were friendly and professional, and the cameraman are universally great.  I would stand at the red dot facing the camera.  My earpiece cord would clip to the back of my jacket collar.  The cameraman would connect an audio cable to that cord, and there’s a small box at about waist high with a volume dial.  He attaches a tiny microphone to my lapel and I’m all set.

The cameraman then adjusts the camera for the shot.  I’m generally looking at myself on a monitor below the camera:  tie is straight, flag pin is upright.  (Left and right are reversed from what you’re used to in a mirror.  That takes getting used to.)  Around 9:25, I’ll hear audio of the show in my earpiece, and then a voice:

Voice 1:  Mr. Hennessey, this is [Bob] at CNBC headquarters.  Can you hear me?

Me:  Yes I can, Bob.

Voice 1:  And you can hear the program?

Me:  Yes.

Voice 1:  Great.  Can you count to ten for me, please, so we can do an audio check?

Me:  1,2,3,4,5,6,7,…

Voice 1:  That’s perfect.  Thank you.

After another minute, another voice, the producer for my segment of the show.

Voice 2:  Mr. Hennessey, this is [Tom].  We’re going to a commercial break, and will be going to you in about 2 minutes.  You’ll be interviewed by [Erin / Mark / Erin & Mark].

Me:  Sounds great.  Thank you.

During my first few interviews, the substance wasn’t that difficult for me.  I had been prepping principals for interviews and writing talking points for more than 13
years, now I just had to do the talking.  The hard parts were the nerves and the physical mechanics:

• Look at the camera lens.  Don’t let your eyes wander.
• Smile.
• Try not to “um” and “you know” too much.
• Slow down.
• Relax.

Also, TV moves very quickly.  Long answers don’t work, so I had to train myself to make my point in one or two sentences, rather than four or five.  (That’s difficult for me.)  If you go on too long, you’ll start hearing the anchor trying to jump in and move things along.  And before you know it, you’re done.

After the interview, you unmike, thank the cameraman and producer, and you’re done.  If you have another interview, you move down the line and repeat.  If not, head inside, take off the makeup, and get feedback from your colleagues and friends who email that they saw you on TV.

I only did a few in-studio interviews, and guest hosted CNBC’s Squawk Box once.  I was blown away by the ability of the anchors to multitask, and how quickly they think and react.  While one of them is talking on camera, another is checking market news or data on their screen, or scanning email.  Their producers are talking to them in their earpieces, and they are talking on camera with each other and the guests.  The coordination, reaction times, ability to adapt and improvise, and teamwork among the anchors and their producers are amazing.  Beginning that day, and ever since I have developed tremendous respect for those business news anchors hosting live fast-moving discussions.  I have enough trouble doing a single five minute segment, and they do it for 2-3 hours five days a week.

Working in the West Wing: Doing a TV news interview on the North Lawn

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Working in the West Wing: Senior Staff
2. The Real West Wing Tour Guide
3. CNN interview today

This important letter attempts to shape the pending legislation.  It makes new proposals, and it tries to set boundaries to constrain the work of the Chairmen.  I am going to walk through the letter and explain what I think it means.  I will walk through it in sequence, but will cut out the fluff, and occasionally add emphasis in bold.  Each of these quotes could merit a post by itself.  I will instead provide a survey of the whole letter.  The first notable text is the second paragraph:

Soaring health care costs make our current course unsustainable. It is unsustainable for our families, whose spiraling premiums and out-of-pocket expenses are pushing them into bankruptcy and forcing them to go without the checkups and prescriptions they need. It is unsustainable for businesses, forcing more and more of them to choose between keeping their doors open or covering their workers. And the ever-increasing cost of Medicare and Medicaid are among the main drivers of enormous budget deficits that are threatening our economic future.

This is fantastic, especially as ¶2.  He is focusing on health cost growth as the underlying problem, rather than just focusing on the uninsured, which is only one symptom of the problem.  I wrote about this in mid-April:  By focusing only on covering the uninsured, are we solving the wrong problem? Here’s the key picture from that post.  We need to focus on the red box, and not just the blue box.

The President’s letter continues:

We simply cannot afford to postpone health care reform any longer. This recognition has led an unprecedented coalition to emerge on behalf of reform — hospitals, physicians, and health insurers, labor and business, Democrats and Republicans. These groups, adversaries in past efforts, are now standing as partners on the same side of this debate.

There is a less noble explanation for the existence of this coalition.  I wrote in mid-May, “[The provider groups] want to share in the spoils of increased government spending on health care, they want to avoid being the political and policy targets of legislation, and they see no political downside to supporting a popular and powerful President with Democratic supermajorities in both the House and Senate.”

At this historic juncture, we share the goal of quality, affordable health care for all Americans. But I want to stress that reform cannot mean focusing on expanded coverage alone. Indeed, without a serious, sustained effort to reduce the growth rate of health care costs, affordable health care coverage will remain out of reach. So we must attack the root causes of the inflation in health care.

This is an astonishing paragraph from a Democratic President.  As he has done in the past, he says his goal is health care for all Americans, rather than health insurance for all Americans.  This language will allow him to declare victory with a bill that does not provide universal pre-paid health insurance.

He then reiterates that expanded coverage is insufficient.  A bill “must attack the root causes of the inflation in health care.”  This is fantastic and unexpected from a Democrat.

The President’s letter then veers wildly off course.  That paragraph continues:

… So we must attack the root causes of the inflation in health care.  That means promoting the best practices, not simply the most expensive. We should ask why places like the Mayo Clinic in Minnesota, the Cleveland Clinic in Ohio, and other institutions can offer the highest quality care at costs well below the national norm. We need to learn from their successes and replicate those best practices across our country. That’s how we can achieve reform that preserves and strengthens what’s best about our health care system, while fixing what is broken.

Geographic disparities in health spending are enormous, and if we could somehow magically reduce spending in high-cost areas to match that in low cost areas, without sacrificing too much quality, then we would make major progress in reducing the level of national health spending.  Budget Director Peter Orszag is the primary proponent of this argument, since before he entered the Administration.

But the Administration has no plan and no proposals that would actually reduce geographic disparities in health care.  They have proposals which would provide people with more information about the health care they use, but they have not proposed to change the incentives people have to use that care.  If you don’t change the incentives, you will make no significant progress in reducing geographic spending disparities or slowing health cost growth.  I wrote about this in late April:  Slowing health cost growth requires information AND incentives, and then found that CBO had already made this point.

More importantly, it is absurd to say that geographic disparities are “the root causes of the inflation in health care.”  We know what drives health cost growth:  (1) technology, (2) income growth, (3) increases in third party payment, and (4) aging of the population.  Some argue that administrative costs also contribute to growth, but I’m skeptical.  We also know that the first three reasons account for two-thirds to nearly all of cost growth, depending on which study you prefer.

The President’s letter correctly identifies the problem to be solved as health cost growth, and then completely misdiagnoses the sources of that growth.  The Administration continues to grossly foul up the problem definition, not propose a solution, and get a free ride from a lazy and compliant press corps.  You cannot slow health spending growth merely by stating a vague intent to do so.

The letter continues:

The plans you are discussing embody my core belief that Americans should have better choices for health insurance, building on the principle that if they like the coverage they have now, they can keep it, while seeing their costs lowered as our reforms take hold.

Two things jump out from this sentence.  The first i

s a clear and oft-repeated signal that “if [you] like the coverage [you] have now, [you] can keep it.”  The President says this is a core belief.  It also protects the Administration from one of the most effective attacks on expansions of government health care:  that it will squeeze our your private care.  This is tactically smart.

The second is the return to “seeing their costs lowered as our reforms take hold.”  This addresses the first box on the right side in my diagram above, and I compliment the President and his team for identifying that growing health spending hurts the more than 100 million Americans who now have health insurance, and not just those who lack it.

But for those who don’t have such options, I agree that we should create a health insurance exchange – a market where Americans can one-stop shop for a health care plan, compare benefits and prices, and choose the plan that’s best for them, in the same way that Members of Congress and their families can.

• “A” (singular) exchange, or 50 State exchanges?  There’s a big difference.
• I have never been enamored of the “one-stop shopping” argument.  I’m not opposed to it, it just doesn’t excite me.  Mostly I fear that exchanges become vehicles for Washington-directed redistribution.
• It is fascinating that he takes the traditional liberal argument that “you deserve health care that is good as Members of Congress get,” and turns it into “Americans can … choose the plan that’s best for them, in the same way that Members of Congress and their families can.”  This is creative.

None of these plans should deny coverage on the basis of a preexisting condition, …

The hardest problem in health care reform is how to deal with the small percentage of Americans with predictably high health costs.  To quote Harvard’s Dr. Kate Baicker:

Uninsured Americans who are sick pose a very different set of problems. They need health care more than health insurance. Insurance is about reducing uncertainty in spending. It is impossible to “insure” against an adverse event that has already happened, for there is no longer any uncertainty. If you were to try to purchase auto insurance that covered replacement of a car that had already been totaled in an accident, the premium would equal the cost of a new car. You would not be buying car insurance – you would be buying a car. Similarly, uninsured people with known high health costs do not need health insurance – they need health care. Private health insurers can no more charge uninsured sick people a premium lower than their expected costs. The policy problem posed by this group is how to ensure that low income uninsured sick people have the resources they need to obtain what society deems an acceptable level of care and ideally, as discussed below, to minimize the number of people in this situation.

We need to distinguish between the uninsured and the uninsurable.  The uninsured lack health insurance for a wide variety of reasons.  Some uninsured are healthy, some are sick.

The uninsurable are those who are already sick or injured, and who have predictably high future health costs.  If you have an incurable disease, you are uninsurable, because there is little uncertainty about your future spending.  (I’m oversimplifying – there is little uncertainty that you will have high health costs.)  As Kate points out, “Uninsured people with known high health costs do not need health insurance – they need health care.  … The policy problem posed by this group is how to ensure that low income uninsured sick people have the resources they need to obtain what society deems an acceptable level of care.”

So when the President says that “None of these plans should deny coverage on the basis of a preexisting condition,” the practical effect is that health insurance plans will be required to provide health care to the uninsurable, label it as “insurance,” and then charge healthy people higher premiums than are merited by their own health status.  It’s a way of hiding the cross-subsidization.

… and all of these plans should include an affordable basic benefit package that includes prevention, and protection against catastrophic costs.

The word “basic” is unusual from a Democrat.  The traditional Washington health debate has Republicans (generally) arguing that we should want more people to be able to afford access to “basic” health insurance, while Democrats (especially those farther Left) saying everyone has a right to “good” health insurance.  Setting aside the access vs. right debate for the moment, the word “basic” is a more centrist choice than I would have expected from this President.

He then runs into one of the classic problems of government-designed health care reform:  who defines the benefit package?  By saying that all of these plans should include X, he is punting the question of who gets to define X, and how specific will they be?  Governments have a terrible track record of political micromanagement of medical benefits.

I strongly believe that Americans should have the choice of a public health insurance option operating alongside private plans.

Note that he chose “I strongly believe that Americans should have” rather than the stronger “Americans must have.”  Despite the urgings of the Left, the President is leaving himself room to jettison the “public option” if that is the price of getting the Republican votes he may need.  Also, he says “alongside private plans,” again emphasizing that the public option will not, in his view, squeeze out private coverage.  I think he’s wrong and it will squeeze out private coverage, and would point to what his Administration is trying to do to Medicare private plans as proof.

I understand the Committees are moving towards a principle of shared responsibility — making every American responsible for having health insurance coverage, and asking that employers share in the cost. I share the goal of ending lapses and gaps in coverage that make us less healthy and drive up everyone’s costs, and I am open to your ideas on shared responsibility. But I believe if we are going to make people responsible for owning health insurance, we must make health care affordable. If we do end up with a system where people are responsible for their own insurance, we need to provide a hardship waiver to exempt Americans who cannot afford it. In addition, while I believe that employers have a responsibility to support health insurance for their employees, small businesses face a number of special challenges in affording health benefits and should be exempted.

This is a fairly hard slap at a mandate (individual or employer).  “I understand [you] are moving toward … I share the goal … and I am open to your ideas on shared responsibility” is not a ringing endorsement of a mandate.  He then guts the universal nature by saying that it should exempt “Americans who cannot afford it” as well as small businesses.  These exemptions would create tremendous distortions and inequities.  The resulting patchwork mandate would be a mess.  With this paragraph, I think the President weakens the prospect of a mandate becoming law.

Health care reform must not add to our deficits over the next 10 years — it must be at least deficit neutral and put America on a path to reducing its deficit over time. To fulfill this promise, I have set aside $635 billion in a health reserve fund as a down payment on reform. This reserve fund includes a numb

er of proposals to cut spending by $309 billion over 10 years –reducing overpayments to Medicare Advantage private insurers; strengthening Medicare and Medicaid payment accuracy by cutting waste, fraud and abuse; improving care for Medicare patients after hospitalizations; and encouraging physicians to form “accountable care organizations” to improve the quality of care for Medicare patients. The reserve fund also includes a proposal to limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent, which, together with other steps to close loopholes, would raise $326 billion over 10 years.

I am committed to working with the Congress to fully offset the cost of health care reform by reducing Medicare and Medicaid spending by another $200 to $300 billion over the next 10 years, and by enacting appropriate proposals to generate additional revenues. These savings will come not only by adopting new technologies and addressing the vastly different costs of care, but from going after the key drivers of skyrocketing health care costs, including unmanaged chronic diseases, duplicated tests, and unnecessary hospital readmissions.

• “It must be at least deficit neutral” – Good.
• “and [must] put America on a path to reducing its deficit over time” – Even better, if he were to actually propose a policy that might do this.  Without such a proposal, this is empty and weak.
• “I have set aside $635 billion in a health reserve fund as a down payment on reform” – Horrible.  He wants to create the entire new obligation, but fund only about half of it.
• “… cut spending by $309 billion over 10 years” – True, but his budget hides $330 B in additional spending on doctors and $17 B to expand Medicaid, so the net is a Medicare/Medicaid spending increase of $38 billion over 10 years.  (See table S-5 on page 121 of the President’s budget.)  The President’s budget increases spending on these entitlements, and uses a baseline game to claim budgetary savings to offset a new health entitlement.
• “… cutting waste, fraud and abuse” – This is the old chestnut to suggest that the cuts are good policy and won’t hurt.  There is waste, fraud, and abuse, but the cuts will also involve real reductions in payments to health providers, and they will hurt (which doesn’t make them wrong to do).
• “… a proposal to limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent” – Democrats in Congress rejected this months ago.
• “… by reducing Medicare and Medicaid spending by another $200 to $300 billion over the next 10 years” – Excellent.  Will he provide specifics?  I would be happy to suggest some.
• “… and by enacting appropriate proposals to generate additional revenues.”  aka “raise more taxes” – Horrible from my perspective.
• “…  going after the key drivers of skyrocketing health care costs, including unmanaged chronic diseases, duplicated tests, and unnecessary hospital readmissions.” – As I said earlier, these are not the key drivers of skyrocketing health care costs, and it is misleading and irresponsible to claim they are.

To identify and achieve additional savings, I am also open to your ideas about giving special consideration to the recommendations of the Medicare Payment Advisory Commission (MedPAC), a commission created by a Republican Congress. Under this approach, MedPAC’s recommendations on cost reductions would be adopted unless opposed by a joint resolution of the Congress. This is similar to a process that has been used effectively by a commission charged with closing military bases, and could be a valuable tool to help achieve health care reform in a fiscally responsible way.

This is new and interesting to me.  “A commission created by a Republican Congress” is odd, since MedPac is not known as a nonpartisan advisory group.  It is also odd to imagine giving MedPac real decision-making authority, given that it is comprised of representatives of provider groups (doctors, hospitals, nurses, etc.)

I know that you have reached out to Republican colleagues, as I have, and that you have worked hard to reach a bipartisan consensus about many of these issues. I remain hopeful that many Republicans will join us in enacting this historic legislation that will lower health care costs for families, businesses, and governments, and improve the lives of millions of Americans. So, I appreciate your efforts, and look forward to working with you so that the Congress can complete health care reform by October.

I can read this either way.  My gut says this means, “Get me a bill by October.  I would prefer it be broadly bipartisan, but don’t let the lack of Republican support prevent you from getting me a bill.”

Summary & Conclusions

The news in this letter is:

• The President continues his rhetorical focus on reducing long run health costs in addition to expanding coverage.
• While appearing to push for a public option and universality, he is leaving himself room to compromise on both if needed to get a bill to his desk.
• He has made a mandate harder to legislate by insisting on large exemptions, and he has not signaled any support for a mandate.  Goodbye mandate, I think.
• He is insisting on deficit neutrality over 10 years and reducing the deficit in the long run, while not proposing policies that achieve either goal.  He is opening the door to more Medicare and Medicaid savings to reach these goals and has floated a $200-$300 B number without specifics.
• He has opened the door to a binding commission to cut Medicare and Medicaid spending, modeled after the Base Realignment and Closure (BRAC) process.

I have mixed conclusions:

• At the 30,000-foot level, he has broken new ground for Democrats in defining the problem correctly as unsustainable health cost growth, rather than the subsidiary problem of the uninsured.  I compliment him for this.
• At the 5,000-foot level, he botches the problem definition by focusing on geographic disparities while ignoring the commonly acknowledged major drivers of health spending increases:  technology, income growth, and third party payment.  This is a fatal flaw.
• He continues to assert that we must slow cost growth, without proposing any policy changes that would do so in a measurable way.  This is an abdication of leadership and irresponsible.
• To genuinely slow health cost growth, you need to change incentives.  Doing so involves political pain.  Congress will not want to do that pain, and will not do so if the President doesn’t propose specifics.
• In addition, the short-term budget numbers still don’t add up.  He has problems with the “down payment” meaning they’re not paying for the full new obligation, ignoring the doctors and Medicaid spending hidden in the baseline, and Congress rejecting his biggest tax increase proposal.
• I am glad that he is leaning against, or at least undermining, the case for a mandate.
• The MedPAC idea is interesting.  It probably won’t work, but I don’t want to dismiss it out of hand.

The President’s letter makes it harder, not easier, to get a bill.  While I like some elements of the letter, it is inconsistent with the President’s actual proposals.  You cannot magically slow health spending growth without proposing policy changes that affect incentives and behavior.  If the President is not willing to bite the bullet and lead on slowing long-term health cost growth, h

e will instead get a bill which is just a straight entitlement expansion, partly offset by Medicare Advantage cuts and tax increases, and obscured by budget gimmicks.  His advisors will then have to construct a bogus argument that they have addressed long-term spending growth.

That would be a terrible outcome.

Parsing the President’s health care reform letter

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. How to measure health care cost control
2. Health spending fallacy
3. Apparently $634 B is only the down payment for health care reform

1. Auto loans: a deadline looms
2. Auto loans: options for the President
3. Auto loans: the Bush approach
4. Auto loans: Chrysler gets an ultimatum, GM gets a do-over
5. Auto loans: the press forgot to ask about the cost to the taxpayer
6. Should taxpayers subsidize Chrysler retiree pensions or health care?
7. The Chrysler bankruptcy sale
8. Mixed results on the Chrysler announcement

This morning I posted some basic facts on the General Motors announcement.  Now it’s time for some analysis.  Like my post Understanding the President’s CAFE announcement, this is a monster post.  I hope you find it valuable despite its length.

I want to try to tease apart the various questions that get conflated in the public forum.  My primary goal is to give you a structure for thinking about the issue.  My secondary goal is to persuade you to agree with my views on each question.  I will be satisfied if you give me credit for achieving only the primary goal.

Here is how I tease apart the questions:

1. What are the arguments for further government intervention?
2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?
3. Is the pre-packaged bankruptcy likely to succeed?
4. Is it fair?
5. Did the government structure the taxpayer financing correctly?
6. Will the Administration run GM?

Let’s take them one-by-one.

1.  What are the arguments for further government intervention?

Today the President explained why he chose to put another $30.1 B of taxpayer funds at risk to prevent GM from liquidating now.  Speaking about his decision on March 30th, he said today:

But I also recognized the importance of a viable auto industry to the well-being of families and communities across our industrial Midwest and across the United States.  In the midst of a deep recession and financial crisis, the collapse of these companies would have been devastating for countless Americans, and done enormous damage to our economy — beyond the auto industry.  It was also clear that if GM and Chrysler remade and retooled themselves for the 21st century, it would be good for American workers, good for American manufacturing, and good for America’s economy.

This is more expansive than what President Bush argued last December:

In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action. The question is how we can best give it a chance to succeed. Some argue the wisest path is to allow the auto companies to reorganize through Chapter 11 provisions of our bankruptcy laws — and provide federal loans to keep them operating while they try to restructure under the supervision of a bankruptcy court. But given the current state of the auto industry and the economy, Chapter 11 is unlikely to work for American automakers at this time.

The distinction is important.  President Bush’s arguments were time-dependent: (a) we should try to prevent our weak economy from taking another big hit right now, and (b) let’s buy GM and Chrysler time to get ready to restructure.  He also argued (c) that it was unfair to dump a liquidating auto industry on his successor (even if his successor might do something different than he would).  It was a “too big to fail now” argument.

Today President Obama made it clear that he made the decision to commit additional funds, if his conditions were met, at the end of March.  He then added new reasons to those expressed by President Bush:  that America needs “a viable auto industry,” and that it would be good for America if GM and Chrysler survived.  While he emphasizes what he would not do, “I refused to let these companies become permanent wards of the state,” President Obama defines a national interest in having auto manufacturers headquartered in the U.S.  He reinforced that with his closing line, which was surreal:

And when that happens, we can truly say that what is good for General Motors and all who work there is good for the United States of America.

This is a big expansion of the justification for government intervention in the market.  Ford is not failing, and Chrysler is emerging from bankruptcy.  President Obama is arguing that American taxpayers need to fund the survival of a third (the biggest) U.S.-based auto manufacturer, because it is important “to the well-being of families and communities across our industrial Midwest and across the United States” and because “it would be good for American workers, good for American manufacturing, and good for America’s economy.”  This argument could be extended to almost any large U.S. firm, at almost any time.

My view:  I am extremely uncomfortable with the President’s expanded argument for further government intervention.  Had the President instead argued, “The economy is beginning to recover, and we cannot jeopardize that with another major shock,” I would have been less uncomfortable with today’s commitment of additional taxpayer funds.

2.  Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?

The public debate has evolved in the past two months.  Earlier this year the question posed was, “Should the Administration bail out GM?”  The basic options were “yes,” “no,” and “only if they enter bankruptcy, and if they do they should try to pre-package it.”  The President chose the last of these options.  The President decided to put $30.1 B of additional taxpayer funding at risk to help prevent GM from liquidating in the near future, and to help them through a restructuring process.

The benefits and costs are similar to what I described in late March.  Here’s the updated version:

Benefits

• If the firm survives the bankruptcy process intact, it has a higher probability of being viable in the long run (than in a restructuring outside of bankruptcy).
• If the firm survives restructuring, the taxpayer has a higher probability of being repaid.
• Old equity holders faced the full costs of the firm’s failure (by being wiped out).  No additional moral hazard is created.

Costs

• There are still significant risks to GM’s survival:
  • Will GM and the Administration defeat the objecting unsecured creditors in court?  (however unfair that might be)
  • Will the bankruptcy process conclude quickly (within 90 days)?
  • Will GM continue to lose market share?  Can GM make cars and trucks that people want to buy?
  • Will the new fuel economy and emissions rules restrict GM’s ability to make attractive vehicles?
• This is a big new cash outlay from the taxpayer.  This costs the taxpayer, and further constrains available TARP funds.

The President made clear his answer to this question on March 30th.  At that time he laid out the conditions under which he would provide additional funding, and those conditions were met.  No one should be surprised that he is now putting more taxpayer funding at risk.  I am surprised that they only need $30 B.

My view:  We crossed this bridge back in late March.  It is not a new decision today to put more taxpayer funding at risk.  I don’t like it, but I am at least glad that some incentives have been restored:  the firm has to go through a bankruptcy process, shareholders are wiped out, and management was fired.  I remember arguments from last fall and earlier this year that GM should get more taxpayer dollars outside of a bankruptcy process.  That would have been far worse, and today’s actions mitigate some moral hazard.

Given the relative strength of the U.S. economy now compared to last December, I would have preferred an outcome of a pre-packaged bankruptcy + private DIP financing, and not exposing taxpayers to any additional risk.  If GM is really as viable as GM and the President claim it now is, then they should have no problem convincing capital markets to provide them with short-term financing.  (Judge Richard Posner argues this.)  I will guess that this was not actually a viable option, because the pre-packaging could only come together with the direct involvement of the government.  I think the real options would have been expose taxpayers to $30B more risk, or allow GM to liquidate.  I would go with the latter:  if GM can’t find private financing, they’re on their own.  I assume this means they would liquidate.  This would have been harsh and painful for those affected.  I believe the consequences of further intervention now are worse for a larger number of people in the long run.

3.  Is the pre-packaged bankruptcy likely to succeed?

There are two components to this question:

• Is the bankruptcy process likely to be quick and successful?
• Will the resulting company succeed without additional taxpayer aid?

I do not feel well-qualified to comment on the first question.  The talking heads all repeat that “GM’s bankruptcy is more complicated than Chrysler’s,” with little detail about why.  I would point out that the Administration is one for one in this process.  Their use of this part of the bankruptcy code (section 363), and the process where the old GM sells the good stuff to a new GM, and then the remaining parts are liquidated, appears to have worked for Chrysler.  From my perspective, the burden of proof now shifts to those who argue this bankruptcy will take more than 90 days.  I didn’t like it because of the precedent it set, but I wouldn’t bet against the Administration succeeding again.

Other than the “good for GM is good for America” quote, the biggest surprise in the President’s remarks was how heavily he was betting that a restructured GM will succeed.  He could easily have taken the posture, “GM has made some hard decisions, and they have a tough road ahead if they want to survive and succeed.”  Instead, he attached his own credibility to GM’s future success and said:

So I’m confident that the steps I’m announcing today will mark the end of an old GM, and the beginning of a new GM; a new GM that can produce the high-quality, safe, and fuel-efficient cars of tomorrow; that can lead America towards an energy independent future; and that is once more a symbol of America’s success.

Even with a cleaned up balance sheet and more taxpayer funding, it is by no means certain that GM will survive for the long run.  If GM fails in the next few years, the taxpayers will have lost an additional $30.1 B that the President committed today.  In addition, the above quote will come back to haunt the President.  I understand wanting to set a positive and optimistic tone.  I am confused why he did so at such great political risk to himself.

I found it useful to return to my first post on the autos and review what this new pre-packaged bankruptcy + DIP financing does to the wide range of challenges faced by GM:

Revenues

• The economic slowdown means fewer vehicles are being purchased from all auto manufacturers, foreign and domestic.
• Even apart from the economic slowdown, U.S. auto manufacturers have been losing market share over time.
• This is in part because they made a bet on light trucks versus smaller cars.  This product mix doesn’t work when gas prices are high.  Think of the proliferation of SUV’s in the past 10 years.  (Note that this was in part the fault of U.S. government policies.  SUV’s are technically light trucks, and so they qualify for lower fuel economy requirements.)

Costs & productivity

• The Detroit 3’s ongoing labor costs are higher than those of foreign-based firms.  This is still true when you compare an American worker in a GM plant in Michigan, for instance, with an American worker in a Nissan plant in Mississippi.
• Productivity is lower in U.S. plants of U.S. firms than it is in U.S. plants of foreign-based firms.  Some of this is because of the UAW contract that mandates certain inefficiencies.  Some of it is poor management.
• The Detroit 3 have huge dealer networks that are costly to the manufacturers.  These dealer franchises are often protected by state laws that make it hard for the manufacturers to make these networks smaller and more efficient.
• Auto manufacturers face a burdensome and unpredictable legislative and regulatory environment.

Balance sheets

• The Detroit 3 have enormous legacy costs from their retirees.  Past UAW contracts provided generous benefits that continue to burden these firms.  This drains profits (when they earn them) away from productivity-enhancing investments.

So can GM survive, and for how long?  Can they profit and flourish, as the President suggests they will?

• The Administration and GM argue that a restructured GM can break even in a national market of only 10m vehicles sold in America each year.  (We’re now around 9.5m/year.  “Normal” is around 16m/year.)  If accurate, this is astonishing.  This would appear to address all three of the bullets under revenues.  Addressed?  I’m skeptical.  I need to review the assumptions in GM’s new plan, especially about market share.
• I have seen no evidence that GM and UAW have reduced significantly GM’s ongoing labor costs to be competitive with the transplants.  Maybe I have missed it.  Unaddressed.
• Productivity is still lower in U.S. plants of U.S. firms that it is in U.S. plants of foreign-based firms.  As a result of high compensation costs per worker and low productivity, it appears that labor cost per vehicle produced will still be uncompetitive with the transplants.  Unaddressed.
• GM’s dealer network is being dramatically reduced.  Addressed.
• The CAFE and emissions requirements are even more burdensome than predicted, but now have at least some degree of stability, given the national standards.  On net, worse than before.
• The balance sheets will be relieved of enormous debt and legacy health and pension obligations.  Addressed.

My view:  I need to look more at what GM is assuming for market share.  The removal of the legacy obligations, combined with a big chunk of taxpayer change, will buy then many months of survival.

The Administration is stressing the balance sheet improvements, and they deserve credit for that.  Conservative critics focus on the additional burdens of the fuel economy and emissions rules, and they’re right, too.

I would focus even more on the questions asked by several commenters: “Will people want to buy GM cars and trucks?”  Additionally, can GM make a profit with still high labor costs, still low productivity, still burdensome work rules, and still slow product development cycles?

I want to GM to survive and be profitable in the long run.  Their chances are now drastically improved, assuming they survive bankruptcy.  But I don’t know if that’s an improvement from a 1% chance to a 20% chance, or from a 1% chance to an 80% chance.  A lot more needs to change beyond just cleaning up the balance sheet, and many of those needed changes are deep-seated in the culture, structures, and processes of America’s third-largest company.

4.  Is the pre-packaged bankruptcy fair?

Absolutely not.  But I want to be precise in my criticism.

The easiest thing to do in Washington is to criticize the negotiator.  “I could have gotten a better deal,” we say.  I should begin my expressing my sympathy and offering my congratulations to Steven Rattner and the Obama team for closing what was undoubtedly a complex and difficult set of negotiations.  I’m sure this one was not easy, and theirs was a thankless task.

At the same time, I share the concerns of many that the deal was not even-handed, and that the precedent will damage future business lending.  I have grave concerns about how far they were willing to stretch bankruptcy processes and the traditional capital structure to get a deal.

First I need to correct the Administration, as well as some bad reporting today by the Washington Post.  In last night’s background briefing for the press, an unnamed Senior Administration Official claimed (emphasis added):

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW — concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement.

In the term sheet for the December loan we (the Bush Administration) made to General Motors, we set out “targets,” which we took directly from the Corker amendment offered the week prior on the Senate floor:

1. Reduce outstanding unsecured debt by not less than 2/3 through conversion into equity or other debt;
2. “Reduce the total amount of compensation, including wages and benefits, paid to their U.S. employees so that, by no later than December 31, 2009, the average of such total amount, per hour and per person, is an amount that is competitive with the average total amount of such compensation, as certified by the Secretary of Labor, paid per hour and per person to employees of Nissan Motor Company, Toyota Motor Corporation, or American Honda Motor Company whose site of employment is in the United States.”
3. Eliminate the jobs bank.
4. Apply work rules no later than 12/31/09 “in a manner that is competitive with Nissan … Toyota or Honda in the U.S.”
5. Not less than half of their VEBA payment should be in the form of stock.

As best I can tell:

• They more than accomplished target #1.
• They did little to nothing on #2.  I have seen no evidence that compensation of current workers has been changed.  UAW Chief Ron Gettelfinger claimed in a message to his members, “For our active members these tentative changes mean no loss in your base hourly pay, no reduction in your health care, and no reduction in pensions.”  Maybe there’s a distinction between this statement and “total compensation.”  If so, it would be great if someone could help me understand this.  But it appears GM and UAW did nothing to address target #2.
• UAW agreed to #3 in late March.
• They made no apparent progress on target #4.  I have neither seen nor heard evidence that the work rules have been relaxed.  I am happy to be corrected.
• They accomplished #5.

It was incorrect for the Senior Administration Official to call these “demands” of the Bush Administration.  They were targets, not hard conditions.  It is an overstatement to say that they “are in virtually every respect more aggressive than what the previous Administration demanded,” unless “virtually every respect” means “except for compensation and work rules.”  (I am happy to be corrected if I have just missed the changes.)

The Washington Post then further flubbed it by writing:

Critics say it is unfair that the restructuring plan gives the union health trust a larger share of the new GM than the bondholders. But administration officials defend the plan, offering several justifications.

First, they note that the terms of the proposed GM restructuring echo the terms laid out by the Bush administration in December, when it extended $13.4 billion in loans to GM.

The Bush administration’s loan agreement required a 50 percent reduction or “haircut” for the union trust, but a 66 percent cut for the bondholders. The Obama deal requires larger cuts for both sides, though more for the bondholders.

The agreement does more than meet three of the five targets laid out by the Administration.  It appears to make no progress on the other two targets.  Thus the terms do not “echo the terms laid out by the Bush administration in December.”

More importantly, the targets we (Bush team) laid out said nothing about the distribution of equity shares.  The criticism is not that the deal doesn’t cut the VEBA enough, or reduce unsecured debt enough.  The criticism is that someone lower in the capital structure (UAW’s VEBA) got a much greater equity share than someone higher in the structure (unsecured creditors).  It is disingenuous to point to the targets in the Bush Administration’s December loans to justify this inequity.

The deal is unfair to unsecured creditors, because they get a worse deal than someone standing behind them in line (the UAW’s VEBA).  It has nothing to do with who those parties are (labor vs. creditors).  It is about the importance of maintaining a stable and predictable set of rules to govern the capital structure of a firm, and the value that stability creates for firms’ ability to raise capital.  All these arguments boil down to the cardinal rule of waiting in line for the kindergarten bus:  it’s not fair to cut in line.  If that rule is broken too often, chaos ensues.

The Administration could be arguing, “Sure it’s unfair, but UAW had more leverage on us than the creditors, so we struck the best deal that we could.  We needed UAW to sign onto the deal, while we thought we could roll the creditors in court.”  This would better justify the disproportionate equity shares than claiming, “This is a fair deal.”

The objecting creditors will now defend their rights in court.  If the Chrysler precedent is an example, you should bet against them.  It is interesting that the President did not attack them as “speculators” this time, so at least the rhetorical leverage against them is weakened.

My view:  I am more concerned with the signals this unfair treatment sends to future investors. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain firms.  I wish I knew whether a different prepackaging was possible, one which would have maintained the precedence of the capital structure and did not stretch the bankruptcy process again.  Unfortunately, it is impossible to know.

5.  Did the government structure the taxpayer financing correctly?

Judge Richard Posner argues the government should have provided a loan rather than taken an equity stake in GM.  The President suggested one reason why they preferred an equity stake:  a loan would further burden GM with a stream of near-term interest payments to the government.

I think Judge Posner strikes a nerve with his suggestion.  It seems that much of the public discomfort comes from the government now being the owner of GM.  It’s the 60% number that made me gasp.  It highlights a tradeoff between two goals on which conservatives focus:  value for the taxpayer, and avoiding government interference and control.  There is a tradeoff between the two.

I believe the U.S. government could auction its equity shares late this year and divest itself completely from General Motors.  This would solve the government ownership problem.  In doing so, I presume that taxpayers would recoup far less than the $30 B of cash provided.

Question for conservatives:  How much of a loss are you willing to take on the $30 B to get the U.S. government out of GM quickly?

My view:  I assume there is a non-trivial chance that GM may still fail in the next several years.  I like the President’s and his team’s strong language today that this $30 B is the last taxpayer aid, but I would like to reinforce that by ending the government’s ongoing involvement in GM as quickly as possible.  I am willing to sacrifice a significant portion of the $30 B to achieve that goal.  I therefore recommend that, if GM emerges from bankruptcy, the Administration then establish a much more rapid timetable for selling its equity stake, even if that means the taxpayer loses much of the $30 B.  Get us out of GM before the end of 2010.  This will strengthen the bulwark against providing additional taxpayer funds if GM fails again.

Note:

• Under current law, the authority to provide any firm with additional TARP funding expires December 31, 2009. Correction:  Secretary Geithner can, after notifying Congress, extend the TARP authorities to October 3, 2010.
• The “set a timeline” argument has direct parallels to a certain national security debate…

6.  Will the Administration run GM?

Here I give the Administration credit for good intent and good initial execution.  I take at face value the President’s statement that he does not want to run or control GM, and I give him points for saying so explicitly.  I am sure there are others, including some in his Administration and some on Capitol Hill, that would love to run GM as Government Motors.  I will trust the President when he says he is not one of those people.

I further give the Administration credit for the “Principles for Managing Ownership Stake” they released in today’s fact sheet.  While they are being released in the specific context of the U.S. government’s new equity stake in GM, the White House writes more generally “(T)he Obama Administration has established four core principles that will guide the government’s management of ownership interests in private firms.”

• The government has no desire to own equity stakes in companies any longer than necessary, and will seek to dispose of its ownership interests as soon as practicable. Our goal is to promote strong and viable companies that can quickly be profitable and contribute to economic growth and jobs without government involvement.
• In exceptional cases where the U.S. government feels it is necessary to respond to a company’s request for substantial assistance, the government will reserve the right to set upfront conditions to protect taxpayers, promote financial stability and encourage growth. When necessary, these conditions may include restructurings similar to that now underway at GM as well as changes to ensure a strong board of directors that selects management with a sound long-term vision to restore their companies to profitability and to end the need for government support as quickly as is practically feasible.
• After any up-front conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations. No government employees will serve on the boards or be employed by these companies.
• As a common shareholder, the government will only vote on core governance issues, including the selection of a company’s board of directors and major corporate events or transactions. While protecting taxpayer resources, the government intends to be extremely disciplined as to how it intends to use even these limited rights.

Given that I trust the President’s statements on this point, the risks here are unintended consequences, from within his own Administration and from the Congress.  They are big risks, and these are dangerous waters.  I hope the Administration treads carefully.

My view:  Given the undesirable situation of government equity stakes in, and even controlling ownership of, firms like GM and AIG, as well as potentially Citigroup and other banks, these are good principles. They are also easy to monitor.  It is interesting and good that the White House fact sheet says, “The [UAW’s] VEBA will have the right to select one independent director and will have no right to vote its shares or other governance rights.” (emphasis added)

I urge the President to:

• Enshrine the principles from today’s fact sheet in the term sheets for the taxpayer investments in GM (and other firms). We did this last December in the GM and Chrysler term sheets. Tie yourself to the mast. This will give you an easy excuse later when someone pressures you to vote those shares in a way that conflicts with the taxpayer’s interest.
• Set clear rules for Administration contacts with GM – it’s probably best to funnel all contacts through specific Treasury or NEC officials on the autos task force.  No freelancing phone calls to the Administration-appointed directors or “informal chats” with them from White House staff, or from DOT, EPA, USTR, DOE, even State.  Put a firewall around interactions with GM.
• Come out hard and quickly against the first proposal from a Member of Congress to leverage the ownership stake for a non-taxpayer goal.  Nip it in the bud, especially if the idea comes from a friend.

It’s easy to criticize a huge decision like the one made by the President today.  I strongly disagree with where we are headed, and I am concerned with the precedent that this deal sets for capital investment in American firms.  The alternative, however, is that you have to be willing to allow GM to fail.  I would be willing to do so, and it is therefore easy for me to express my views.  In summary, they are:

1. I am extremely uncomfortable with the President’s expanded argument for today’s government intervention. 
   
2. My first choice would have been to push GM to get private DIP financing.  Assuming that was infeasible, I would have recommended denying GM the DIP financing, even if that meant they would liquidate.  The economy is sufficiently healthier now than it was last December that I would be willing to risk the additional shock.  But I agree the President crossed this bridge at the end of March.
   
3. I would bet in favor of GM emerging from bankruptcy, and against them surviving as an intact firm for 5 years without additional taxpayer funding.
   
4. The pre-packaging deal was unfair to unsecured creditors, to the benefit of UAW retirees.  The Administration loses credibility with me by trying to argue this was a fair deal.  They would have been more credible if they had argued it was the only deal they could get.  I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain U.S. firms.
   
5. If a loan rather than an equity purchase had been possible, I would have preferred that – I find Judge Posner’s arguments persuasive.  Given the equity investment, I urge the Administration to divest as quickly as possible, even if it means a loss to the taxpayer.
   
6. Given the undesirable situation of the U.S. government owning GM and other large firms, the Administration’s new “Principles for Managing Ownership Stake” are solid.  They need to lock them in, and corral or beat back all those people who work in the Executive Branch and Congress who have other goals in mind for GM and will be tempted to exert some leverage.

I thank you for making it through this extremely long post, and again want to thank all of the fantastic commenters.  If you dislike the President’s announcement, I urge you to consider this question:  Suppose the deal announced today were the only possible pre-packaged bankruptcy, and your choice was to take it or allow GM to liquidate now.  What would you do?

Understanding the GM bankruptcy

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Auto loans: a deadline looms
2. Dr. Goolsbee gets it wrong on the auto loans
3. Basic facts on the General Motors bankruptcy

1. They don’t have enough capital.
2. They have on their balance sheet downside risk that is creating uncertainty about how much the firm is worth and is scaring away investors.

I will use a simple example constructed by former Council of Economic Advisers member Donald Marron.

Imagine that you run Large Bank.  You collect deposits and you borrow on the debt market, and you use both sources of funds to make loans.  Here is what your balance sheet looked like three years ago when you made these loans.

To keep it simple, let us assume that all 1,000 of loans were for home mortgages.

We measure the health of your bank in three ways:

1. You have 100 of capital — the equity from the shareholders who invested in your bank.
2. Your leverage ratio is 10 to 1 — you are supporting 1,000 of loans with 100 of capital.
3. Can you roll over your debt and issue new debt when you need/want to?  Do creditors have enough confidence in your bank that they are willing to loan you money?

A healthy bank is one with a lot of capital, with a leverage ratio that is not too high, and that can borrow when it needs to at reasonable interest rates.  Of course, the higher the leverage ratio, the more profit you make on each dollar of capital.

Now let us assume that you screwed up three years ago.  200 of the 1,000 of loans you made were “no documentation” loans.  Some (many? most?) of those 200 of loans are going to default, or at least be late with some of their payments.  They are clearly not worth the 200 of face value.  First let’s separate out the good and bad loans.

Now in present day, you estimate that 80% of those bad loans will default, with a 50% recovery rate, so they are worth only 120 (60% of 200).  You write down the value of the bad loans to 120, losing 80 on the assets side.  This means the value of your equity has dropped from 100 to 20.

Writing down these loans has wiped out 80% of your capital.  Problem #1 is that you only have 20 left of capital.  This also leaves you with a very high leverage ratio of 46:1 (920 of loans divided by 20 of capital).  Large Bank is clearly not in good shape.  Creditors will start charging you higher interest rates for new debt (or to roll over existing debt), and any uninsured depositors may get nervous and pull their money out.

If you can raise more capital by selling more equity, you can give yourself more protection against insolvency and reduce your leverage ratio.  Your existing shareholders will be upset, because before they owned 100% of the profits, and after raising more capital they will own a much smaller share.  If you raise new private capital, you will be “diluting” your existing shareholders.  This is one possible explanation why some banks have not raised capital so far.

You have a second problem, however.  As you try to raise more capital and sell equity to new private investors, they are questioning the value of those bad loans.  Sure they might be worth 120, but they might be worth only 100, or 80, or even 60.  A private investor thinking of putting 60 of his own capital into Large Bank could see that get wiped out if the bad loans are only worth 40 rather than 120.  The downside risk associated with those bad loans may deter private investors from putting in their own capital.

So Large Bank has two problems.  You don’t have enough capital, either to satisfy your regulator or to reassure yourself that you won’t soon go insolvent if things get even worse.

You also have downside risk which makes the health of your bank even shakier than the above balance sheet suggests, and which scares away private investors.

Tomorrow we will look at three different ways to address your problems, aka TARP I, II, and III.

Intro to TARP: Banks have two problems

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Intro to TARP — TARP I: Buying bad assets
2. Intro to TARP — TARP II: Direct investment
3. Intro to TARP — TARP III: The Geithner Plan

I think the senior economic policymakers in the Administration are overconstrained and have several bad options in front of them.  This is not an unusual situation, but to a certain extent they put themselves into this box by spending TARP money on every problem that popped up.  $50 B on housing, $5 B on auto parts suppliers, $15 B on small business loans, additional unspecified sums for GM and Chrysler, and new as well as old mortgage-backed securities — things add up.  I think they’re in a box.

The box has three sides:

1. They have created expectations among various constituencies for programs announced over the past two months.  These expectations would consume most of the remaining $700 B of TARP funds.  If their new programs are successful, they will want to expand them to further strengthen financial institutions and markets.  If they are unsuccessful, they will need more TARP funds to try something else.
2. They are justifiably afraid of asking Congress for more TARP funds.
3. They could create some room for themselves by taking taxpayer funds back from some of the healthy big banks, but they may be worried about the signals that sends about the others.

It appears that they are testing all three sides of this triangular box to figure out which is their least worst option.

Senior Administration policymakers are operating in an ever-changing financial, economic, and legislative environment.  When they developed the President’s budget in February, asking Congress for more TARP funds probably seemed difficult but not necessarily impossible.  In that circumstance, it was reasonable and responsible for them to put a $250 B placeholder in their budget for a potential future TARP request.

The legislative environment is now much more hostile.  It would not surprise me if, for the moment, they have ruled out asking Congress for more TARP funds, and are instead trying to figure out how to create as much room as possible within their existing constraint.

Commenter Wayne Marr asked a good question.

… But the main point is that Obama and team (Larry, Christy, Austan, Geithner, etc) can simply go to [the] well (Congress) since Democrats can pass pretty much what they want. The recovery plan was not named the “Great Bailout:” but the “American Reconstruction and Recovery Plan” or some such nonsense for a reason.

Why not another funding program called “The Better Banking Plan for the 21th Century” to provide more cash for technically insolvent banks? Or those that posed a systemic risk? So does it really matter that we have 30B left of TARP or 100B left for TARP?

While I generally agree that the President has tremendous leverage to get Congress to pass his agenda on a wide range of topics, I seriously doubt that is the case here:

• 95 of 235 House Democrats voted no the first time on TARP (on September 29, 2008), and 63 House Democrats voted no on the successful vote four days later.  Speaker Pelosi now has a significantly larger majority (254), but she would still need Republican votes.
• TARP is far more unpopular now than last Fall.
• President Obama could undoubtedly get some House D votes who we (the Bush Administration) could not, but not enough to pass such a bill.
• I surmise that House Republicans are in no mood to go out of their way to help the majority or the White House, given how aggressively the Speaker and White House have been in passing other legislation without their input.  That does not mean that all of them would vote no, merely that the Administration will have a hard sell to make.
• Finally, even if she had the votes, I would bet heavily against the Speaker bringing up such a bill if she thought the vote would be partisan, because she would conclude that such a vote would expose her House Democrats to too great of a political risk in the next election.  I think that she thinks that she would need bipartisan cover from Republicans as a condition for bringing such a bill to the floor.

As background, the Temporary Asset-Backed Securities Loan Facility (TALF) is what the Fed and Treasury are doing together to keep securitization markets going for things like student loans and car loans.  They now want to expand it to include securitizations for new mortgages, and to use it to buy toxic mortgage-backed securities.  TALF was created during the Bush Administration.  This is the second major expansion since President Obama took office.

PPIP is the Public-Private Investment Partnership, Secretary Geithner’s plan to buy toxic assets from banks.  It has two parts, one of which works in conjunction with the Fed, and the other with the FDIC.

Secretary Geithner’s comments that they have $135 B of room left in the TARP is testing side #1 of the triangular box to its maximum possible extent.  In an attempt to convince people that they have sufficient room, to reassure both markets and the Congress, I think his staff put together the biggest number they could plausibly say with a straight face.  They have not, to my knowledge, explained what $135 B of room would mean for the TALF and buying toxic assets, and I fear that such an answer would tremendously disappoint market participants who are expecting a $1+ trillion TALF and a $100 B PPIP.  If the Administration has made policy decisions that lock in $135 B of room, then they have scaled something way back beyond what they had previously said publicly.

The Administration faces a choice:  scale back these two programs to be smaller than what they had previously suggested to market participants, or squeeze something else hard to create more room within the $700 B limit.

The other option is to get some TARP funds back from the healthiest big banks.  Since the law allows the Administration to recycle returned funds for other purposes, every invested dollar repaid can be spent again.

Certain large banks (e.g., JP Morgan Chase and Goldman Sachs) are publicly signaling that they would like to repay the Treasury.  It is hard to blame them, considering the political and legislative environment.  Martha MacCallum of Fox News pushed me on this point, correctly pointing out that it seems un-American to dissuade banks from paying back the taxpayer.

The banks are reportedly being told “not yet” by the Administration.  I will guess that the Administration is concerned about something that worried some of our experts –  if healthy banks return their funds, then investors will conclude that every bank who is not returning their funds must therefore be unhealthy.

This logic becomes strained, however, when those banks find other avenues for signaling to the market that they are healthy, as they are doing now by screaming “WE WANT TO GIVE IT BACK.”

At some point the banking policy concern may be overwhelmed by the near-impossibility of getting more funding from Congress and the policy and political undesirability of scaling back on PPIP, TALF, or the housing commitment.  If this happens, then the Administration will happily start accepting funds from banks.  The numbers are large enough that this could create room for them to do other things, and as a long-run policy matter, we want the taxpayer to be paid back.  These are supposed to be temporary investments in the banks, in which public capital substitutes for private capital that was unwilling to show up last Fall.

There is another outside-the-box possibility that I am sure the White House has considered.  Part of their resource constraint arises from having made a $50 B TARP commitment to housing.

They could push this program out of the TARP, and ask Congress for these housing funds anew.  It would be much easier for a heavily Democratic Congress to pass $50 B for housing than for them to pass the same amount (or much more) for “Wall Streeet banks.”

I would oppose such a request, because I oppose this housing spending inside or outside of TARP.  But I’m sure they could pass it, given their large partisan majorities in both bodies.  This option would cause the White House political pain on its left, which pushed hard for these programs, and could cause FDIC Chairman Bair heartburn, given her impassioned support for these housing programs.

Things probably look a little different to the folks sitting inside the West Wing and at Treasury than I have described here, but I would wager heavily that a discussion at least similar to this is ongoing within the senior ranks of the Administration.  As long as that decision is unresolved, it will be confusing as we try to interpret statements like Secretary Geithner’s that he has $135 B of room within the $700 B TARP allocation.  Those policymakers need to balance the benefits of decision-making flexibility with the costs and repercussions, from markets and/or Congress, of the bad news when it is eventually delivered.  They may be waiting for the right time to signal that a previous commitment will be scaled back, or instead for the right time to ask Congress for more funds. I think it is better for market participants and Congress to have early clarity, especially if it’s bad news.

In my experience, it is better to deliver the bad news as soon as you have made the decision.  Rip off the band-aid quickly.

I will end with a thought experiment.  Suppose my analysis is roughly correct.  It is easy to figure out what you don’t want to do.  It is much more difficult to decide what you do want to do.  If the President asked you for your recommendation, what would it be?

1. Scale back on PPIP and TALF as necessary to avoid having to ask Congress for more funds.
2. Ask Congress for more funds.  Follow-up:  how much more?
3. Tell banks that you welcome them repaying the Treasury early.
4. Push housing outside of TARP and make a separate request of Congress for those funds.
5. Wait and hope.

Four unpleasant options for TARP funding

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Is $700 billion enough?
2. Is $700 billion enough? Part 3: Secretary Geithner says we have more room
3. Auto loans, part 2: options for the President

This sounds like a technical question of concern only to “those of us wearing the green eyeshades,” but the Director’s suggested answer has dangerous ramifications, and could mislead or at least confuse taxpayers and financial market participants.

The Director’s answer makes the federal debt appear $1.4 trillion smaller than the way it is traditionally measured.  He argues that we should, in effect, ignore 1.4 million million dollars borrowed by the federal government.  That is breathtaking.

Let’s look at the Director’s argument and why I think it’s dangerous.

Most budget experts focus on debt held by the public, which Director Orszag accurately describes as “the amount that the federal government owes to others.”  I will expand on that a bit with some concrete numbers:

• Take the total amount the Federal government will spend this year.  Specifically, we’re looking at cash paid by the U.S. government to someone outside the government in 2009.  A budget wonk would call these outlays.  I’ll use the nonpartisan Congressional Budget Office’s numbers for current law, so I get $3.85 trillion of outlays for 2009.  That is way (way) above historic norms, in part due to the financial stabilization efforts, and in part due to the new “stimulus” law.
• Now take the amount the Federal government will collect in revenues this year.  This is cash coming into the U.S. government from someone outside it.  Almost all of this is taxes.  CBO says this is $2.186 trillion of revenues for 2009.
• If the U.S. government is paying out $3.85 trillion in cash (outlays) this year, but collecting “only” <sigh> $2.186 trillion in cash, then we need to come up with the difference somewhere.  That difference is $1.667 trillion for 2009.  This is what CBO says is the federal budget deficit for 2009.
• The U.S. government gets this cash by issuing IOU’s to people outside the government, aka Treasury bonds.  The government gets cash from anyone who buys Treasury bonds – individuals, firms, and foreign governments.
• The debt held by the public is simply the accumulation of these IOU’s.  It is the sum of money owed by the U.S. government to others.  (Update:  See the caveat at the bottom.)

Nothing I have said so far is the slightest bit controversial, but this is where Director Orszag and I part ways.  Tuesday he wrote:

As I said at the beginning of this post, I think the most meaningful measure of federal debt is debt held by the public net of financial assets.  If I take a $100 loan from my bank and stick that amount into my bank account without spending any of it, my family and I aren’t poorer, because even as I owe $100 to my bank, my bank owes $100 to me.  On net, and as long as the new asset is equal in value to the new liability, there’s no change in my overall financial state.  There’s a similar effect when the federal government borrows money in order to invest in financial assets.

Suppose I tweak the Director’s metaphor to make it better fit the current situation and illustrate my point.  If he takes a $100 loan from his bank and invests it in the business of his deadbeat neighbor Alan I. Gorp, he still owes the bank $100.  The bank cannot loan that $100 to anyone else.  His (the government’s) borrowing has “crowded out” borrowing by someone else.  And who knows how much his $100 investment will be worth next month?  We should care not just about his net position, but also about his total liabilities, and especially about how much he (the government) is borrowing from the bank (private sector).

In normal times this would not be a big difference, because the U.S. government in large part stays away from owning financial assets.  Now, however, the federal government is buying equity stakes in banks and other large financial firms, and issuing loans to financial and non-financial firms.  Director Orszag’s numbers show that the U.S. government owned $506 billion of financial assets last year, and will buy another $915 billion this year.  (I’m subtracting “Debt net of financial assets” from “Debt held by the public” on Table S-1 of the President’s budget.)  Those are huge numbers, and have a huge effect on what figure you cite for the federal debt.

If you look at the traditional measure of debt held by the public, which you’ll remember is the sum of all IOU’s (Treasury bonds) issued by the Federal government, then under the President’s budget and using OMB numbers, that’s equal to $8.36 trillion.  Compared to one year of our entire national output (GDP), that’s almost 59% of GDP.

If, however, you net out OMB’s estimate of the value of the financial assets, then the debt held by the public net of financial assets, is “only” $6.94 trillion, equivalent to almost 49% of GDP.  That’s still a big bad number, but it’s $1.4 trillion and 10% of GDP less bad than the debt held by the public numbers.  That’s a convenient way to make the problem look much smaller.  Director Orszag argues that it is also the “most meaningful measure of current federal debt.”

Here is his key paragraph:

As the federal government has acted to stabilize the financial sector amidst the worst financial crisis since the Great Depression, the federal government has purchased significant financial assets—such as preferred equity stakes in Fannie Mae and Freddie Mac.  The federal government will likely take a loss on these purchases, but the assets have value.  And just as what my bank owes me should be netted against what I owe the bank in determining the health of my personal finances, the value of these assets should be netted against publicly held debt in determining the health of the government’s finances.  …  Debt held by the public net of financial assets is the most meaningful measure of current federal debt …  (emphasis added)

I disagree with this last statement, but I think I understand why he says it.  From his perspective of the federal budget, he’s netting out some of his liabilities with a somewhat liquid asset that he now holds and hopes someday to sell.  He  concedes the point, however, that he is including some assets and liabilities with his new measure, but excluding others.  This makes his new metric suspect.

From the perspective of the U.S. economy, the “netting” comes from different places.  The U.S. Treasury has to issue $905 billion of Treasury bonds this year to raise the cash to buy those financial assets.  This makes it harder for private firms and individuals to borrow, because they are competing with the government for cash, so they have to pay a higher interest rate.  Those funds are then invested in other parts of the economy.

Another way to see why this is a poor metric is to imagine that the U.S. government were to borrow another trillion dollars by issuing even more Treasuries, and then immediately buy one trillion dollars of credit default swaps with the cash raised.  According to Director Orszag’s preferred measure, nothing would have changed, because the two transactions would net out.  But clearly we would have just had a major impact on the U.S. (and global) financial economies.  U.S. government borrowing in these enormous amounts hurts financial markets, no matter what is done with the funds raised.

Director Orszag touches on another problem with his new metric when he writes “The federal government will likely take a loss on these purchases, but the assets have value.”  He’s right, but the value of the particular assets being purchased by the government is highly uncertain.  How much is he counting as the value of the $19.4 B loaned (so far) to General Motors?  I sure hope he is not counting it at face value.  What about the $70 B “invested” in AIG, or the $5.5 B in Chrysler?  Any private firm valuing these assets would say their values need to be discounted.

The values of these financial assets are highly uncertain and depend heavily on what assumptions OMB uses about the likelihood of them being repaid.  For people to trust this metric, they need to understand how it is calculated, which means that OMB should divulge the discounts they are applying to their financial assets.  I will guess that he does not want to divulge those assumptions.  I wouldn’t if I had his job.

I think the most meaningful measure of current federal debt is still debt held by the public.  I think the public policy debate can be further informed by also disclosing the estimated value of the financial assets held by the U.S. government.  But policymakers should not net out the two and use that measure instead of the one that most directly measures how much the U.S. government is borrowing from the private sector.  This is particularly true when that new measure hides $1.4 trillion of debt borrowed by the U.S. government from the private sector.

Director Orszag, and those measuring his performance, should continue to use debt held by the public as the most meaningful measure of current federal debt.  Budget projections will account for that measure to come down over time as the financial assets are sold and funds recouped.

Net measures can hide meaningful information.  This is a theme I will return to often.  Any time someone in economic policy gives you a net figure, see if you can learn something more by asking about the components that make up the net calculation.

The President’s Budget is titled “A New Era of Responsibility.”  In his February 24th Address to the Congress, the President said,

The only way this century will be another American century is if we confront … the mountain of debt they stand to inherit.  That is our responsibility.

A new era of responsibility does not begin with hiding $1.4 trillion of that mountain of debt.  These IOU’s will not go away just because we ignore them.

Update (12:20 PM Wed): A friend corrects my statement that the debt is simply the accumulation of past deficits.  It’s not.  The Credit Reform Act measures credit subsidies (like for federal loan or loan guarantee programs) differently than it measures cash flows, and the deficit does not capture “means of financing and cash management, like when Treasury borrows funds and deposits the cash at the Fed.”  I stand corrected on these points.  I don’t think this changes my logic above about whether to net out the purchase or sale of financial assets.

Let’s not hide $1.4 trillion of IOU’s

© 2010 Keith Hennessey - Your guide to American economic policy

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