Paul Krugman is right to be worried about the unintended consequences of the AIG bailout:

We’ve greatly increased the chance of a Japanese-style lost decade, with I would now give roughly even odds of happening. Why? Because bank-friendly policies have squandered public trust in all government action: try talking to the general public about stimulus, and it’s all confounded in their minds with the deeply unpopular bailouts.

I do fear that the Obama administration has done a bad job of separating the financial-sector bailouts, on the one hand, from the stimulus bill, on the other. And if the general public starts conflating the two, there’s no chance of any more stimulus, no matter how needed it might be.

Part of the problem is that Tim Geithner was so vocal about the urgent necessity for both of them, dating back to his tenure at the Fed during the Bush administration. If he comes out and says that a second stimulus is needed, the obvious rejoinder will be “well you said that about the AIG bailout too”. And there’s no good answer to that.

With Jon Corzine losing the governorship of New Jersey yesterday, it was yet another bad day for former heads of Goldman Sachs. It’s worth running down the list, since the venerable pairing of John Weinberg and John Whitehead came to an end in 1990.

First up there was the pairing of Robert Rubin and Stephen Friedman. Both of them attempted to become venerable eminences grises, but neither succeeded, in the end. Friedman became chairman of the New York Fed, where he helped to which put together the deal under which AIG’s CDS counterparties, foremost among them Goldman Sachs, got paid out at 100 cents on the dollar, He was also involved in approving and which also approved Goldman’s request to become a bank holding company. He then inexplicably bought tens of thousands of shares Goldman shares in the open market — a clear conflict of interest given his position at the Fed — resulting in his resignation shortly afterwards.

Rubin, of course, looks even worse. As arguably the most Wall Street-friendly Treasury secretary ever, he helped to inflate the deregulatory financial-services bubble on the basis that big banks were extremely sophisticated and more than capable of looking after their own risk books. He then moved to the ultimate cushy job at Citigroup, where he got paid $10 million a year despite having no employees, no P&L, and no defined responsibilities. In hindsight, his main contribution to the bank was to be the biggest internal cheerleader for the fixed-income group, which he encouraged to take on ever-greater amounts of risk despite the fact that no one in senior management (including himself) really had a clue what they were doing. Result: disaster.

Rubin and Friedman were succeeded by Corzine, whose post-Goldman career has been spent almost entirely in politics. He was pretty ineffective in the Senate, before moving to the governorship of New Jersey. (In a classic case of the squid’s tentacles being everywhere, he there helped oversee the incoherent mess at Ground Zero, due to New Jersey’s 50% stake in the Port Authority of New York and New Jersey. The chairman of the Lower Manhattan Development Corporation, charged with rebuilding at the site, was former Goldman senior partner John Whitehead.) Never much of a natural politician, he basically bought both jobs, which at least meant that he wasn’t corrupt. But after he was almost killed in a 91 mile-an-hour car crash where he wasn’t wearing a seatbelt, he lost a large chunk of whatever leadership ability he had formerly held. His political demise yesterday, at the hands of an oafish opponent, comes as little surprise.

Corzine, in his turn, was replaced (indeed, ousted) by Hank Paulson. Paulson’s post-Goldman career, of course, was spent as the Treasury secretary who oversaw the biggest financial meltdown since the 1929 crash. Reading Andrew Ross Sorkin’s Too Big To Fail, which was clearly written with a lot of help from Paulson, he comes across as a man who was always at least one step behind the curve, someone who could never get ahead of the unfolding crisis, who was prone to inconsistent and ad hoc decisionmaking, and who went out of his way, even before getting a waiver allowing himself to talk to Goldman Sachs, to be as helpful to them as he possibly could.

Paulson seems to have spent a large amount of the crisis throwing up in his office bathroom, and even into Nancy Pelosi’s wastebin. Of course, he couldn’t simply go see a doctor, like the rest of us, because he’s a Christian Scientist. Similarly, he hobbled his ability to communicate by refusing to ever touch email: instead, any time he wanted to say anything to anybody he’d have to do so over the phone or in person. No wonder he was semi-permanently hoarse, and his phone records are insane.

Paulson’s biggest failure, of course, was that of Lehman Brothers: he set up an emergency weekend confab at the New York Fed in an attempt to save it, but refused steadfastly to ever consider any public help at all, and also failed to keep British regulators in the loop, despite the fact that their assent would be needed in the event that Barclays were to acquire Lehman. In fact, when the fateful phone call to the Brits was made, it was the hapless Christopher Cox who made it, rather than Paulson. In general, Paulson was more of a bully than a leader, and he managed to be equally unpopular both on Capitol Hill and at the White House.

Looking at the list, it seems to comprise men who are very long on hubris, and who have no doubt that if they can run Goldman Sachs, they can do anything else, with normal rules not really applying to them. All of them, post-Goldman, have been tarnished. If Lloyd Blankfein has any sense, he’ll retire quietly.

Update: Goldman calls to say that Friedman, as chairman of the New York Fed, was not personally involved in the decisions that the Fed made involving Goldman. I’ve updated the post accordingly.

George Bush speechwriter Matt Latimer has an astonishing tale of what the economic crisis looked like from inside the White House — and it’s a must-read, even if GQ does force you to click the “next” button ten times in a row to read it.

Latimer starts off by describing Hank Paulson as “pretty much a nonperson at the White House”, and it goes downhill from there:

Pundits on TV started asking why the president wasn’t saying more and what he was going to do. The answers were: We had nothing to say and no one had any idea.

The central event in the narrative is a speech that Bush gave on the economy, trying to push the abortive first version of TARP:

The president directed us to try to put elements of his proposal back into the text. He wanted to explain what he was seeking and to defend it. He especially wanted Americans to know that his plan would likely see a return on the taxpayers’ investment. Under his proposal, he said, the federal government would buy troubled mortgages on the cheap and then resell them at a higher price when the market for them stabilized.

“We’re buying low and selling high,” he kept saying.

The problem was that his proposal didn’t work like that. One of the president’s staff members anxiously pulled a few of us aside. “The president is misunderstanding this proposal,” he warned. “He has the wrong idea in his head.” As it turned out, the plan wasn’t to buy low and sell high. In some cases, in fact, Secretary Paulson wanted to pay more than the securities were likely worth in order to put more money into the markets as soon as possible. This was not how the president’s proposal had been advertised to the public or the Congress. It wasn’t that the president didn’t understand what his administration wanted to do. It was that the treasury secretary didn’t seem to know, changed his mind, had misled the president, or some combination of the three.

Clearly Paulson didn’t much care about currying favor in the White House:

We wrote speeches nearly every time the stock market flipped. Meanwhile, the White House seemed to have ceded all of its authority on economic matters to the secretive secretary of the treasury. The president was clearly frustrated with this. I was told that at one Oval Office meeting, he got very animated and exclaimed to Paulson, “You’ve got to tell me what you’re doing!” (In the weeks that followed, Paulson changed his spending priorities two or three times. Incredibly, he’d been given the power to do with that money virtually anything he pleased. All thanks to a president who didn’t understand his proposal and a Congress that didn’t stop to think.)

If nothing else, this surely gives Paulson full license, in case he felt he needed it, to unload on Bush in his own book. There never seemed to be much light between the White House and Treasury at the time. But in hindsight, it seems that there was no love lost between them at all.

Vanity Fair scores another bullseye this month with Todd Purdum’s 8,000-word article on what Hank Paulson was thinking over the course of the financial crisis, as revealed in a series of embargoed interviews he gave at the time — VF has, improbably, become the home of the best financial journalism in the world of magazines.

There’s more good stuff in this article than can easily be excerpted — go read the whole thing, which kicks off with Paulson throwing up in his private bathroom and just gets better from there. Barney Frank comes out very well indeed — better than Paulson, actually — while Barack Obama’s choice of Tim Geithner as Treasury secretary looks more than it did already like a vote for the continuation of the Bush administration’s status quo.

This article is interesting in that it does somewhat back up the official side of the story as regards Treasury’s (in)ability to bail out Lehman Brothers:

The meltdown at Lehman was catastrophic enough, and Paulson took enormous heat for its failure. Barclays, the British bank, had hoped to buy it, but British regulators blocked the deal, and Paulson saw no alternative. “Lehman Brothers was something that we had been focused on and worked on and worried about for a year. And we knew, and Dick Fuld [the Lehman C.E.O.] knew, and we kept telling him every way we knew how that if he announced earnings like he thought he was going to announce—right after he announced the second-quarter earnings—the company would fail. And when you’ve got an investment bank, no one had any powers to deal with that. I certainly didn’t have any powers to deal with that.”

It’s not clear when exactly Paulson said this, which is important: the decision not to bail out Lehman went quite quickly from being seen as bold and decisive to being seen as utterly catastrophic, and the story about Treasury’s hands being tied only really started to emerge after the latter view became conventional wisdom. But there’s no doubt that Paulson is throwing Fuld under the train here. Which is the kind of thing which Henry Paulson, former CEO of Goldman Sachs, probably wasn’t too upset about doing. Could Henry Paulson, Treasury secretary, really silence such internal thoughts? I doubt it, somehow.

Earlier this month, 34 of Barack Obama’s first 60 ambassadorial appointments were political appointees rather than career diplomats — an astonishingly high percentage for a man who said when he took office that his “general inclination is to have civil service wherever possible serve in these posts”. Today, that ratio has gone up: it’s now 38 of the first 65, which means that four of the last five ambassadorial appointments have been political: plums given out to major fund-raisers.

The new ambassador to Paris is Charles Rivkin, whose history in the entertainment industry has him being forced to defend “the Dogg-frog flap” to the NYT:

“It’s a natural segue,” he said, referring not just to the Dogg-frog flap but to his broader background in children’s television. From the brilliant Mr. Henson, Mr. Rivkin said, he learned powerful lessons about communicating, and his background in children’s entertainment “prepared me well to engage Europe’s young generation of first-time voters”.

I’m sure the French are suitably impressed. Or not.

Matthew Yglesias attempts a partial defense of this practice, before giving up:

It’s simply in the nature of things that Spain’s ambassador in Washington will be a more senior figure in Spanish policy circles than America’s ambassador in Spain is in American policy circles. Which is to say that whether or not we appoint career professionals, government-to-government contacts that need to be run through an embassy will almost certainly be run through embassies located in Washington, where most countries are represented by very senior officials…

At the same time, for American foreign service officers heavy reliance on political appointees is extremely demoralizing.

To be fair to Mr Rivkin, Paris is something of a special case, although I’m not entirely sure why. When Obama said that “it would be disingenuous for me to suggest that there are not going to be some excellent public servants but who haven’t come through the ranks of the civil service,” I, for one, thought to myself “OK, he’s going to do Paris and maybe a couple of others”. But thirty-eight of these appointments is far too many.

Besides, I’m not at all sure that Yglesias is right that when a foreign government wants to go through an embassy it will go through its own embassy in Washington rather than through the US embassy in its own country. That might be true some of the time, for some governments. But it’s not a reliable general rule which the State Department can count on. America’s ambassadors are important — and when they’re famous mostly for their connection with the Muppets, that devalues the seriousness with which the US views the rest of the world.

I’ve been wondering for a while whether the real Treasury secretary — the person who actually makes the big decisions about US fiscal policy — is in fact not Tim Geithner but rather Rahm Emanuel. Today, we learn:

After Treasury Secretary Timothy F. Geithner stumbled in rolling out a new banking policy, Mr. Obama told Mr. Emanuel to step in, and he met for an hour each day with the economic team to develop a workable policy.

Geithner is a creature of Washington, and one would expect him to be very good at the political aspects of his job. But no one would expect Geithner to have more political nous than Rahm. And it’s hard to imagine, after Rahm is parachuted in to make US fiscal policy “workable”, that he adopted a posture of cringing obeisance towards Geithner’s policy ideas.

Speaking of which, whatever did happen to Geithner’s much-hyped bank bailout?

Rolfe Winkler has the details of the way in which both Sheila Bair and John Dugan are continuing to criticize Treasury’s regulatory-reform plan in Senate testimony today, even in the wake of Geithner’s now-famous tantrum. But what’s weird is the way that Bair, in particular, is getting explicitly political:

In light of these significant [regulatory] failings, it is difficult to see why so much effort should be expended to create a single regulator when political capital could be better spent on more important and fundamental issues which brought about the current crisis and the economic harm it has done.

The fact is that judgments as to where political capital can be best spent are political judgments, made in the White House. It looks a little odd for Sheila Bair to essentially be giving advice to Rahm Emanuel on such matters, and even odder for her to be using the vehicle of Congressional testimony to do so. If Geithner’s blow-up was a result of his seeing an advance copy of Bair’s testimony, you can see where he was coming from: Bair is treading well outside her own turf here.

Bair is right that the distinction between federally-chartered and state-chartered banks was not a proximate cause of the financial crisis — but that’s no reason to abolish a distinction which does little more than allow powerful banks to pick whichever regulator they think will smile most benignly on them. It’s a bit like high-frequency trading: just because it didn’t cause a lot of harm during the crisis doesn’t mean it won’t be responsible for great harm at some point in the future. We don’t know, and it’s generally best to cut off such possibilities before they turn into extremely unpleasant reality.

The bond market is on fire right now: Treasury is selling $115 billion of notes this week, with the 10-year bond yielding a whopping 5.1 percentage points more than the inflation rate — the widest spread since 1994. Meanwhile, total corporate bond issuance in the first half of 2009 was an all-time high of $1.791 trillion — more than anything we saw during the boom. This is what it looks like when markets clear: bond investors are seeing attractive yields, bond issuers are seeing abundant liquidity, and there’s an enormous amount of pent-up demand for financing from the long wintry months when no deals could get done at all.

Meanwhile, the S&P 500 is closing in on the 1,000 mark, after having dropped below 700 in March. The primary market in stocks is already heating up again in places like China and Brazil, and assuming that stocks manage to stay at their current levels or higher will surely reopen in the US as well in 2010. Are we really back to normal already, as far as the markets are concerned?

I fear the answer might be yes. Or, rather, I fear that the relatively happy state of the stock and bond markets has removed a necessary degree of urgency from the regulatory-reform debate, which vastly increases the chances that changes will be small and ineffective. I also worry about all this new debt: the deleveraging trend seems to be unwinding itself, and the chances of moving to a more sensible and less leveraged world of more equity and less debt are diminishing by the day.

Pace Rahm Emanuel’s famous comment, we’ve wasted our crisis. Not that I want another one, of course — although I fear that given the amount of complacency in the markets right now, the chances of a second big shoe dropping continue to rise alarmingly. But asset markets have a way of setting the mood of policymakers, and right now that mood is that things ain’t broken any more. As a result, they are pretty unlikely to get fixed.

Kevin Drum says that although we should get rid of debt’s tax advantages, we won’t:

We should get rid of it.

(We won’t, of course, any more than we’ll get rid of agricultural payments or road-building subsidies. If you scratch most free market capitalists you’ll find a socialist just below the surface. But we can still dream.)

The weird thing is that this really is within the realm of the possible — the UK, for instance, abolished mortgage-interest tax relief in 2000, a move which had no visible effect whatsoever on either house prices or homeownership, but which did wonders for the exchequer.

As for the business interest tax deduction, why not go the whole hog and replace the corporate income tax with a corporate interest tax? If you structured it to be revenue-neutral, and you phased it in over the course of say five years, then you’d have a huge number of companies trying desperately to pay down their debt and increase their equity — which is exactly what we want. As an added advantage, everybody could stop complaining about the dual taxation of corporate dividends. It might even have bipartisan support!

I’m no great fan of the Senate, and especially of the way in which you seem to need a 60-40 supermajority to get just about anything passed these days. But then along comes the House to make the Senate look great:

A majority of House members have signed onto a bill to reverse the closing of 789 Chrysler dealerships and block General Motors Corp. from closing more than 1,300.

Notes Kevin Drum:

This is a wholly nonideological porkfest, with 133 Democratic cosponsors and 88 Republican cosponsors. (So far.) Which just goes to show: under the right circumstances, bipartisanship isn’t dead after all.

In our bicameral system, this is exactly the kind of thing that the Senate was designed to stop becoming law. Congressional districts are small enough that individual auto dealers can wield a lot of power with their Congressperson; states, by contrast, are large enough that individual auto dealers have little if any clout with their Senators. But it’s still utterly depressing that Congresspeople are out signing the Automobile Dealer Economic Rights Restoration Act of 2009, which is designed to do an end-run around one of the most successful bankruptcy proceedings in living memory, and which would singlehandedly put the US auto industry onto yet another road to ruin.

I can hope only that this is gesture politics: safe in the knowledge that this act will never become a law, politicians can sponsor it without fear of its repercussions. Ah, the circus that is DC.