James Pethokoukis

Politics and policy from inside Washington

Two years into the credit crunch: a status report

Jul 17, 2009 14:30 UTC

Where is the US economy, some two years into the credit crunch (numbers gathered by David Rosenberg of Gluskin Sheff)?:


Is China experiencing a credit bubble?

Jul 17, 2009 14:08 UTC

Here are several great charts from Wachovia looking at the Chinese economy in an effort to determine if the nation is experiencing a lending bubble. The firm doesn’t think so — at least not yet — but given government influence in its capital allocation system and the need to keep growth high in a weak global economy, I have to wonder.




Frozen credit markets continue to pink up nicely

Jul 17, 2009 13:50 UTC

Yes, credit markets are healthier, though clearly not back to normal (chart from Pimco):


Reassessing Hank Paulson

Jul 16, 2009 20:05 UTC

Imagining that Henry Paulson would threaten Bank of America CEO Ken Lewis into completing the Merrill Lynch acquisition late last year never required a huge mental leap. “I intended to deliver a strong message,” Paulson anticlimactically acknowledged in congressional testimony.

This is the same treasury secretary, after all, who last October summoned the CEOs of the nation’s nine largest banks to Washington and told them that it wasn’t in their financial self interest to refuse government capital infusions. And if the executives happened to disagree with Uncle Sam’s assessment, regulators would force the money on them anyway. Consider it another “strong message” delivered. Yup, the former football lineman makes for an awfully persuasive tough guy.

The drilldown on BofA-Merrill, however, is a transitory issue. And Paulson surely realizes this. He started his testimony before the House Committee on Oversight and Government Reform with a broad defense of his role in the government’s handling of the 2008 financial crisis. Today was legacy enhancing time for Paulson. And the former Goldman Sachs CEO gave a convenient standard by which economic historians and second guessers everywhere could judge him: “Having had the benefit of some time to reflect, and to consider views expressed by others, I am confident that our responses were substantially correct and that they saved this nation from great peril.”

OK, then, were Paulson’s efforts to deal with the horrific collapse of the twin housing and credit market bubbles “substantially correct”? Refusing to support the suspension of mark-to-market  accounting may have been Paulson’s biggest mistake. (Accounting forbearance is letting the banks hold on to the “toxic assets,” rake in the cashflows, and muddle their way back to health so as to avoid a market-eviscerating nationalization.)

But there were other mistakes as well, such as saving the unsecured creditors at Bear Stearns and helping set up false expectations of government salvation when Lehman started to implode. Or the repeated assurances that Fannie and Freddie were solvent.

Then there’s Lehman. Letting the investment bank go down often gets cited as Paulson’s biggest blunder. But Treasury officials seem to believe a) they had no authority to save it, and b) they had given management and the markets plenty of warning that no federal help was coming.

Anyway, “event” analysis of interest rate spreads (serving as risk indicators) by Stanford University economist John Taylor, provides strong evidence that Lehman’s failure was merely another milestone in an ongoing credit freeze. But Taylor does blame Paulson in the poor public communication efforts surrounding TARP that made the program seem like a rushed and panicky response to the crisis. The bad-mouthing of the economy that Paulson and Ben Bernanke undertook to get Congress to fund TARP also unnerved markets and American consumers.

Then with markets quickly deteriorating, Paulson decided to use TARP to inject capital into banks rather than buying bank assets. Taylor concludes: “At a minimum a great deal of uncertainty about what the government would do to aid financial institutions, and under what circumstances, was revealed and thereby added to business and investment decisions at that time.”

Of course, Paulson and Bernanke could have skipped TARP altogether, letting a combination of accounting changes, bank bond and money market guarantees, and Fed lending facilities do the heavy lifting. Former Treasury official Phillip Swagel, though, rejects that counterfactual approach in a recent paper: “With financial institutions beyond Lehman weakening as asset performance deteriorated, it seems likely that the lockup would have taken place, and perhaps sooner than later.”

Perhaps, but TARP has also served to give government an unhealthy foothold into America’s capital allocation system and  furthered the costly bailout fever (and accompanying moral hazard) that hopefully may have finally broken with the government’s decision to not save CIT Group.

Yet any errors must be placed in the context of a fast-evolving financial crisis. It would have taken a cool hand indeed (as well as a strong stomach) to have not attempted something like a $700 billion toxic asset buy. Hey, had that silver-bullet plan had enough time to be put into effect, Uncle Sam could be sitting on some potentially quite profitable assets today.

In the end, however, if the U.S. economy avoids both bank nationalization and a long period of economic stagnation following the double bubble trouble, Paulson may well be judged “substantially correct.”


With Paulson as SecTres and Bernake as FedChair the astonishing trading of specious investment banks has no parallel.

Bear(just a lousy investment bank) fails into the arms of JP Morgan(Fed Shareholder) with Fed loan guarantees.

Lehman(just a lousy investment bank) fails into dust. Treasury says they can’t do anything to save it. The Fed says they can’t either. What they’re really saying is none of our Fed shareholders are at risk if Lehman fails.

Goldman and Merrill start to teeter because the markets get wind of the exposure of AIG to Bear and Lehman for selling insurance on securities that “don’t fail”. AIG panics and calls the Fed and Treas. Shockingly, now both of them have the powers to save AIG which extends the life of Goldman and Merrill.

Weeks later, Merrill fails into Bank of America(Fed shareholder). Goldman asks the Fed if they can become a bank holding company(makes them a Fed shareholder) and poof, the Fed says “no problem”. Then GMAC asks if it too can become a bank holding company. “Why not” says the Fed.

Goldman Sachs has pulled off one of the greatest cons ever. This is just incredible. And this is the second time they have done this to save themselves.

Just stop pretending as if the Fed and Treas do not have these powers to do whatever the heck they want. They do have these powers. They should just tell it like it is. The United States capital equity is being mortgaged by the Federal Reserve to create cheap and easy credit for the emerging economies in China, India, and Brazil.

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Pelosi: If surtax passes, it’s staying, get used to it

Jul 16, 2009 19:40 UTC

Madam Speaker speaks (via The Hill) about the surtax and what it might be used for:

I hope we can change that percentage and get much more coming from savings,” Pelosi said. “In fact, I believe that all of the cost of the healthcare reform bill can come from squeezing more savings out of the system.”

Asked why Democrats were proposing more than $500 billion in new taxes if savings alone could fund their healthcare plan, Pelosi said: “We have to have a revenue stream to ensure that the bill will be paid for. If we don’t need that money we can use it to reduce the deficit. … There is going to be a revenue change at the high end. It will be directed to reduce the deficit or … to help reduce the cost of this initiative.

Me: So it really isn’t a surtax is it? It is just a plain-old tax increase — and a big one at that.

How ‘hedge fund’ Democrats are influencing tax bill

Jul 16, 2009 18:23 UTC

I just got this email on the markup of the House healthcare bill:

The healthcare surtax would apply before any tax deductions are allowed (charitable, mortgage, etc.), save one: margin loan interest. So if you want to take out a loan to buy stock, the interest on that will still be deductible against the surtax. But if you want to give to charity or pay your mortgage, you’re out of luck. Those aren’t deductible against the surtax.


Why do we continue to encourage indebtedness with the tax code? So many wonderful things would happen if we did away with mortgage interest deductibility!

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Ouch! CBO says Dem healthcare plan worsens budget picture

Jul 16, 2009 17:28 UTC

Is history repeating itself?  High-cost estimates by the Congressional Budget Office helped kill Clintoncare back in the 1990s. Now here is what Doug Elmendorf of the CBO said today about Obamacare:

In the legislation that has been reported we do not see the sort of fundamental changes that would be necessary to reduce the trajectory of federal health spending by a significant amount.  And on the contrary, the legislation significantly expands the federal responsibility for health care costs. …  the creation of a new subsidy for health insurance, which is a critical part of expanding health insurance coverage in our judgement, would by itself increase the federal responsibility for health care that raises federal spending on health care.  It raises the amount of activity that is growing at this unsustainable rate and to offset that there has to be very substantial reductions in other parts of the federal commitment to health care, either on the tax revenue side through changes in the tax exclusion or on the spending side through reforms in Medicare and Medicaid.  Certainly reforms of that sort are included in some of the packages, and we are still analyzing the reforms in the House package.  Legislation was only released as you know two days ago.  But changes we have looked at so far do not represent the fundamental change on the order of magnitude that would be necessary to offset the direct increase in federal health costs from the insurance coverage proposals.

Would America have collapsed without TARP?

Jul 16, 2009 15:21 UTC

A fascinating exchange just occur ed during Hank Paulson’s testimony on Capitol Hill about the Bank of America-Merrill Lynch merger. (Paulson admitted in his testimony that he more or less threatened Ken Lewis with dismissal if Lewis scuttled the deal late last year.)

Rep. Kanjorski, a Pennsylvania Democrat, pushed Paulson hard to clearly state what would have happened to the nation’s financial system and to America without the TARP. Kanjorski related a incident where another Treasury official had told that a “return to the 16th century” was an optimistic scenario.

Paulson wouldn’t take the bait, though he did say that unemployment would be far worse than the numbers we are talking about today. And he also related a cryptic conversation with German officials where it seemed that they were hinting Germany would dissolve back into East and West Germany. Or something like that. ( Paulson and Bernanke did brief congressional leaders last fall and told them the financial system would shut down.)

Oh, and another Dem on the panel, Stephen Lynch of Massachusetts, said Paulson knew all along that TARP would involve capital injections rather than the purchase of toxic assets. Basically he called Paulson a liar.

Obama’s self-defeating war on the wealthy

Jul 16, 2009 14:02 UTC

The push by the Justice Department, along with the Internal Revenue Service, to compel UBS  to fork over the names of some 52,000 American taxpayers with banking accounts in Switzerland may produce an important benefit for the Obama administration — or so it might think. How so? Those presumably wealthy 52,000 taxpayers, along with some two million other upper-income Americans, can be drafted to help pay for U.S. healthcare reform.

Under the $1.2 trillion plan passed by the Democratic-controlled House of Representatives, the wealthiest 1.2 percent of U.S. households would have to pay an additional $540 billion in taxes over the next 10 years via an income surtax of between 1 and 5.4 percent.

For the super-elite, those in the top 10th of 1 percent (and presumably the type of taxpayers who have Swiss bank accounts), that works out to an additional $280,000 a year in taxes on an average annual income of $2.3 million a year, according to the Tax Policy Center. If it wasn’t for those record earnings, office corridors inside Goldman Sachs would surely be overflowing with tears today.

Then again, maybe not. The wealthy have the means to manipulate tax laws to their advantage through various — sometimes outlandish — tax sheltering strategies. As Howard Gleckman of the Tax Policy Center puts it, ‘The bad old days of bull semen partnerships may not return, but I suspect the financial Merlins are already cooking up new shelters for what promises to be a booming new market.’

And just as the ‘financial innovation’ of recent years took a terrible economic toll, so might this next wave. Not only is Uncle Sam unlikely to raise as much money as he expects — thereby forcing the government to push surtax rates even higher — but more and more capital allocation decisions are likely to be driven by tax considerations as opposed to economic return.

This is why tax reformers prefer lower rates with fewer deductions as a way of raising revenue. There is far less economic distortion that way. The Tax Reform Act of 1986, for instance, slashed the number of tax brackets from 14 to 2, winnowed the top marginal rate from 50 percent to 28 percent and eliminated many tax sheltering strategies. The House bill would increase the number of brackets to a post-1986 high of nine while raising the top rate to 45 percent.

Surely the Obama administration must know this sort of thing makes for terrible tax policy, though it would create more jobs for certified tax planners. As Obama himself wrote in the “Audacity of Hope”: “The high marginal tax rates that existed when Reagan took office may not have curbed incentives to work or invest, but they did distort investment decisions — and did lead to the wasteful industry of setting up tax shelters.”

Faced with huge and growing budget deficits, the White House and congressional Democrats needed to pay for healthcare reform in the worst way. And that’s just how they did it.


Lets look at this another way. The government raises cigarette taxes. That’s good right?

Well, a funny thing happens. People decide they are going to smoke less or quit all together. Revenue drops. Yes, cigarette taxes pay for social programs.

Then what? Well you can’t raise taxes more, you can’t raise taxes on the company, so what next?

Nothing.. it ceases to be a profitable tax to pay for those social programs.

Same thing happens when you raise taxes on the wealthy, sure they will still continue to remain wealthy. They will simply find ways around the taxes, they will move to other countries, or decide to invest less. They can still be filthy stinking rich they just lose their incentive to spend more and get even richer!

And those making 2 million or more per year. Well, they simply make less than that. Does the wealth go somewhere else? Do the middle class benefit?


It goes to the lower classes that rely on social welfare. They simply remain consumers..they do not create jobs they maintain jobs.

Raise taxes on the rich, it trickles down to the middle class because the government eventually needs to find more sources of revenue.

Enjoy your money and freedoms while they last. I’m already poor by most peoples standards with no kids, and no real debt. But I fear for those who make it possible for me to make as much money as I do.

US top tax rate would be 52% with health surtax

Jul 15, 2009 19:52 UTC

Curtis Dubay of the Heritage Foundation emails me:

As calculated by the Tax Foundation, when factoring in the expiration of the 2001 and 2003 tax cuts, average state and local income taxes, Medicare taxes, and the new surtax, the average top marginal income tax rate in the U.S. would be 52 percent!

The top rate in the U.S. would then be higher than countries like France, Canada, Italy, Spain and Germany. Only 3 countries in the 30-member OECD, an association of the most economically developed countries in the world, would have a higher rate. Taxpayers in the 6 highest taxed U.S. states would pay higher rates than every country in the OECD except Denmark. Taxpayers in every state, even the 9 that do not levy a state income tax, would face a higher top marginal rate than taxpayers in 21 out of the 30 OECD countries.

Read the whole paper here: http://www.heritage.org/Research/Taxes/wm2544.cfm


I’m one of the many Americans without healthcare. And yes, I would appreciate having it, but I’m not in need of going to the doctor often because I focus on preventative healthcare and proper diet. I would rather see this money go towards better food quality for low-income people rather than healthcare. I have a friend who, in their mid-30′s, is diabetic because he didn’t eat good food because he’s poor. Let’s cut down on the corn and sugar in our processed foods, make organic fruit and vegetables more affordable and teach people the importance of eating right, with proper proportions. Let’s alleviate stress in American’s lives to make ends meet by lowering the costs of the basics: phone, gas, food and housing. Stress is the leading factor in any kind of sickness, physical or mental. To financially stabilize our society and keep them healthy, let’s try to bring the middle class back….and taxing American’s over 50% won’t solve that.

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