The American Scene

An ongoing review of politics and culture

A Parable of Teshuvah, For Elul (II)

Parable #1 can be found here. Herewith, parable #2.

It is said of the four who entered the Garden, and gazed: one died; one went mad; one became apostate; and one departed in peace. But what did they see?

At the entrance to the Garden stands an angel, and he brandishes a whirling, flaming sword. For what purpose does he wield this sword?

For our righteous deeds, we are promised a share in the world to come. But for our transgressions, we are punished in the world to come. How can this be? For who among us is wholly righteous?

Some have said that when righteousness outweighs villainy, he merits a share, but when it is less, he is judged wanting. But can the man who steals from the orphan atone by giving to the widow?

The dead approach the Garden, housed in the body of their life, their deeds made flesh, and face the angel and the sword. And with a burning stroke, he cuts out the blemishes of their transgressions, and leaves their flesh gaping. For we are told, that none with a blemish may approach the Lord (Leviticus 21:23), and none with a blemish may be offered (Leviticus 22:20).

But their flesh gapes, for there is no Experience in the Garden, no way for souls to heal the gashes made by holy flame.

And this, perhaps, is what the four saw there, the maimed and crippled souls stumbling in Paradise.

The tongues that gossiped, the lips that spoke falsely, the eyes that coveted: cut out.

The hands that struck in anger, the fingers that stole, the legs that ran to do evil: lopped off.

And the poor souls who huddled in the dark, who buried themselves in their caves, so fearful of evil that they hesitated to do good; pale souls who pass almost unnoticed through the byways of the Garden, they live in the poor houses that their deeds built while they lived.

One in four? There is not one in a thousand who would not die, go mad, or lose his faith, gazing on the cauterized stumps of the saved.

Welcome to History

It’s helpful to think of how to address the current financial crisis (and I don’t use that word casually) in terms of the end-state we want to achieve, and the transition plan to get there.

The problem we face is often described as mind-bendingly complex, but in its essentials, it is simple.

It is well known, in retrospect, that we had a classic speculative bubble in home prices. As is typical in a bubble, its later stages were characterized by reckless investment, excess debt and shady-tending-to-illegal business practices. As cheap credit pushed up the market price of houses, homeowners began to incur lots of debt (i.e., promises to pay other people on Tuesday for a hamburger today), which they were comfortable doing because they believed that they had sufficient equity value in their homes to make good on the debt if required. Some of this debt was mortgage debt. Many people who previously would not have received credit for a mortgage got them. Simultaneously, many homeowners were offered and accepted mortgages that approached all-debt at floating interest rates, rather than the traditional 20% down 30-year fixed rate mortgage. In the worst instances, these mortgages had payments that were all-but-certain to rise in the future. These homeowners were betting that they would get raises, inherit money, or, more likely, would be bailed out by an increasing home price that would allow them to roll over the debt. Other debt was incurred by existing homeowners for the purpose of consumer expenditures, which had the net effect of hollowing out the equity they had in their homes. All these effects are just examples of greater levels of debt secured against the market prices of homes.

Here’s the problem with having lots and lots of debt and no savings, whether in the form of passbook savings or equity in your house: Sooner or later Tuesday comes around when you happen to have had a bad week, and the guy who sold you your hamburger wants his money, but you don’t have it. Once home prices began to decline (or for the most over-leveraged homeowners, simply stopped rising fast enough), therefore, it was a big problem when Tuesday started to come around and lenders and vendors started to ask to get paid for the hamburgers.

Normally this would have been bad for both the homeowner and the guy who wanted to get paid for his hamburger, which might very well be the mortgage lender, but not really a big deal for you or me. (If enough of this occurred, of course, it could lead to a general slowdown and hurt pretty much everybody.) But this impact was magnified by the fact that most of the mortgage lenders sold the right to the payments under the mortgage to third parties. These third parties broke up the rights to the payments from the mortgages into lots of little pieces, combined these pieces with the rights to payments for little pieces of lots of other mortgages, repacked these in “creative” ways, and re-sold them to fourth, fifth and sixth parties. Four, five and six then used these promises as their own equity in order to raise further debt of their own. This would be like you using an IOU from your neighbor as your down payment for a mortgage. So when lots of these over-leveraged homeowners started to miss mortgage payments, parties four, five and six had less money than they expected, and they had problems making their own debt payments if they themselves had taken out enough debt. Oh yeah, many of these debt contracts are in fact between parties four, five and six.

Unfortunately for you and me, parties five and six are the financial institutions where we have our life savings deposited.

The end state that we want to get to is pretty clear.

The price of the average home in America has fallen a lot, and is likely to fall further (although there will be huge regional differences). Some very over-leveraged homeowners are going to declare bankruptcy. Others are going to sell the boat and eat out less in order to avoid this. We need prices to mark to market (which they will eventually do anyway), as rapidly as possible consistent with not causing a depression caused by a collapse of consumer activity.

Many financial institutions have both profitable commercial businesses, and financial instruments that are wildly unprofitable, housed under one roof. We want the executives of these companies to lose their jobs, and the shareholders and bondholders in them to lose their money, while preserving the productive parts of the businesses and preventing a depression caused by a collapse of credit.

The trick, of course, is how we get these excesses purged from the system without tanking the economy worse than anything we have seen at least since the 1930s. What makes this especially tricky is that we don’t have a lot of visibility into how exposed each of parties four, five and six are to collapse.

This is what Paulson and Bernanke are trying to manage. They have done three big things in the past couple of days:

1. Proposed a huge RTC-like government “bad bank” that banks can dump all their bad loans into. (Apparently, though, unlike the case with the RTC, they will not need to declare bankruptcy to do it.)

2. Provided a federal guarantee on money-market accounts.

3. Promulgated a temporary ban on naked shortselling for about 800 financial stocks (in related news, the new recommended medical practice when you discover that you have a fever is to smash the thermometer against the wall, since this makes the problem go away).

All of these things are, in theory, bad. In practice, all will have very negative consequences over time. Here are some of the problems:

1. We’re getting pretty close to nationalizing (hopefully temporarily) a reasonably big piece of the U.S. housing finance market, as well as other financial sectors that are put at risk by it.

2. Time will tell, but likely medium-term implications include higher government interest payments, worse deficits and higher taxes. This certainly reduces the probability of making the Bush tax cuts permanent in a couple of years, no matter who is in the White House.

3. This is obviously unfair. It bails out irresponsible behavior, and by implication, punishes responsible behavior. Longer-term, unless there is a lot of pain felt by financial company executives – who, remember, don’t look like they have to go bankrupt to dump their bad loans on taxpayers – this creates a massive moral hazard problem. Further, if such a situation develops, it won’t be lost on voters, who will likely demand greater socialization of consequences of reasonably-foreseeable bad behavior by people who don’t make a million dollars per year. The ideological consequences of the last few weeks will take many years to play out, and conservatives are unlikely to happy about them.

4. It’s also unclear how much of the problem, and what problem, this really solves until home prices hit bottom. As the market price of the underlying assets keeps dropping, more and more debt instruments become “bad”, with cascading effects. Though not likely, it is a lot more plausible than it was five days ago that the federal government may become a buyer of the actual housing assets. In that case, welcome to the introduction of large-scale public housing for middle-class Americans.

These all sit on one side of the scale. Against all of this we have one huge consideration. If investors lose confidence in the safety of money market funds, mutual funds, demand deposit accounts and the other storehouses of value in the modern economy, we would have a problem that would make somewhat higher taxes and moral hazard seem like child’s play. Trust me – you do not want to experience a full-scale bank run in contemporary America. I’m not sure how many people realize how close we were to the wheels coming off at about noon yesterday, as major commercial-paper processing banks like State Street lost 30% – 60% of their value in about 2 hours. Want evidence: When was the last time you heard of the U.S. government identifying a problem, developing a multi-hundred-billion-dollar program and announcing it within about 48 hours?

It seems to me that these are prudent actions as temporary, emergency measures. What will be essential is that:

1. These are temporary, and these positions be unwound as rapidly as possible. This includes not just the actions of the past two days, but also getting the federal government out of the insurance business (AIG) and the home lending business (Freddie and Fannie) as rapidly as is consistent with orderly unwinding of these positions.

2. The ultimate resolution assures that prior investors in these financial institutions and their executives bear very large financial penalties. Irresponsible homeowners should as well. Expect big political battles over the definition of “irresponsible”.

If done in this way, we can (in the hopeful case) work through the problem with limited actual costs to the taxpayers as assets are sold off, while limiting moral hazard and long-run government control of financial assets. But there are many very bad downside cases.

Sunshine on a Cloudy Day

So, work life is horrible (not that everybody at the office isn’t actually being great, mutually supportive, buying each other drinks, but you know: we really need those drinks). But there is good news elsewhere in Millmanland.

Specifically: Democracy Prep Charter School, whose board I chair, just got its report card from the City’s Department of Education. And we did rather well. The news capped a nice week for DPCS, a week which began with the ribbon cutting on our new facility, adjoining historic St. Philips Episcopal Church in Harlem. So I’ve got that going for me.

I owe TAS a long post (or series of posts) about charter schools and education more generally. In the meantime, I encourage folks to check out the school’s website, and check out the school physically if you are in the area. And of course, since Matt Yglesias is right that high-performing charters do depend on additional private funds on top of their public funding (note, however, that their public funding is below that of regular public schools), if you’re looking for a way to put charitable education dollars to work, you could do a whole lot worse than a school like ours. (And, contra Matt, structural reform is neither a complement nor a substitute for more funding; it’s a prerequisite – first you have to prove that the additional funds could do good, then you have to set things up so that additional funds will do good, then you get the money.)


I see a lot of bad movies — at best, maybe half of the movies I see are worth recommending — but I only get genuinely outraged by a movie maybe two or three times a year. Watching Alan Ball’s Towelhead, a repulsive attempt at suburban satire which seems designed to confirm the worst stereotypes about liberal Hollywood, was one of those times. If culture-war instigation is what you’re looking for at the multiplex (and it certainly seems to be all the rage on the internet these days), look no further.