Following "Dutch" versus "Going Dutch"

Over the weekend, South Carolina Senator Jim DeMint, in an op/ed in the Wall Street Journal ("How Republicans Can Build a Big-Tent Party"), argued that small government, low tax conservatism (which he summarized as "freedom") should be the focus of Republicans as they work to expand the party:

[T]he organizing principle and the crucial alternative to the Democrats -- must be freedom. The federal government is too big, takes too much of our money, and makes too many of our decisions. If Republicans can't agree on that, elections are the least of our problems.

In other words, the GOP should advocate the policies of President Ronald "Dutch" Reagan today. The "freedom" agenda -- the smaller government, lower taxes, and fewer regulations¹ -- advocated by Reagan did (along with his spectacular political talents) win him the presidency, and a landslide reelection, but it's worth remembering that when he won the presidency in 1980, it was after decades of government overreach that built upon FDR's activist response to the Great Depression; during the Depression, Reagan himself voted for FDR.

Sen. DeMint continued:

If the American people want a European-style social democracy, the Democratic Party will give it to them. We can't win a bidding war with Democrats.

Coincidentally, the New York Times Magazine published an article on a European-style social democracy over the weekend, a report by Russel Shorto, an American ex-pat living in The Netherlands, on his experiences with the Dutch welfare state ("Going Dutch"). I'm going to address a few points from that article in another post, but first I'll make two meta-points.

The first meta-point is that Sen. DeMint's focus on freedom (with respect to economic policy) despite its merits, may be a tough sale today, given that we are in the longest post-WWII recession, unemployment is headed for double digits, and most Americans have seen the values of their homes and retirement accounts drop more steeply than they have in generations. I think a more common response to this sort of economic uncertainty is a desire for more security, not more freedom. If I were a Democratic political strategist, I'd have a field day with DeMint; the talking points almost write themselves. E.g., "We want to give you affordable health care; Sen DeMint and the Republicans want you to have the freedom to pay for it yourself." Certainly, Republicans ought to propose market-based alternatives where possible, but keeping in mind the current economic uncertainty, a better way to frame these alternatives might be to use a phrase such as "choice² and security".

The second meta-point is that, despite the views of hardcore libertarians, capitalism can and does coexist with welfare state policies of one form or another. Social democracies such as Denmark and The Netherlands score highly on the Heritage Foundation's Index of Economic Freedom (numbers 8 and 12, respectively, out of 179 countries ranked), and even Hong Kong and Singapore -- the highest rated countries on the index -- have social safety net policies (although they are based more on enforced savings than income redistribution). To his credit, Shorto makes a similar point in his New York Times Magazine article, noting that the Dutch have a long history of being innovative capitalists, and remain capitalists today.

¹Today, "regulation" often connotes a law designed to promote public safety, but it's worth remembering that a number of the regulations Reagan (and Carter before him) opposed were ones designed more to limit competition and fix prices (e.g., regulations on airfares and stock commissions).

²Conservative advocates of school vouchers have already co-opted the word "choice" from liberal advocates of unrestricted abortion by calling voucher plans "school choice".

John Hussman's Latest: "Buckle Up"

In his latest market commentary ("Buckle Up") Dr. Hussman reiterates his call for the government to make bank bond holders take eat some losses:

The misguided policy response from Washington has focused almost exclusively on squandering public money and burdening our children with indebtedness in order to defend the bondholders of mismanaged financial institutions (blame Paulson and Geithner – I've got a lot of respect for our President, but he's been sold a load of garbage by banking insiders). Meanwhile, I suspect that the little tapes in Bernanke's head playing “we let the banks fail in the Great Depression” and “we let Lehman fail and look what happened” are so loud that he is making no distinction about the form of those failures. Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to “fail.” Nobody is advocating an uncontrolled unraveling of major financial institutions or permanent nationalization as if we've suddenly become Venezuela.


[...]

The course of defending the bondholders of insolvent institutions is not sustainable. Do the math. The collateral behind private market debt is being marked down by easily 20-30%. That debt represents about 3.5 times GDP. That implies collateral losses on the order of 70-100% of GDP, which itself is $14 trillion. Unless Congress is actually willing to commit that amount of public funds to defend the bondholders of mismanaged financials so they can avoid any loss, this crisis simply cannot be addressed through bailouts. Bondholders have to take losses. Debt has to be restructured. There is no other option – but the markets are going to suffer interminably until our leaders figure that out.

[...]

Yes, some pension funds, insurance companies, mutual funds, and other investors who hold the corporate bonds of mismanaged financial institutions will take a haircut on those investments. As they should. But if we ignore the need to restructure debt obligations, we risk allowing this downturn to move aggressively into 2010.

The dot drawing of Hussman above comes from a Wall Street Journal article about him last week, "Outfoxing a Bear?". Hussman linked to this article in his market commentary.

"You Can't Rescue the Financial System If You Can't Read a Balance Sheet "

In his weekly market commentary published this morning ("You Can't Rescue the Financial System If You Can't Read a Balance Sheet"), John Hussman, Ph.D., of Hussman Funds opposed the Paulson rescue plan that was voted down by the House of Representatives earlier today. It's worth clicking on the link to read Hussman's lucid explanation of his position, but in summary, his objection to the Paulson plan is that if the government buys distressed assets at their market value, that won't do anything to boost financial institutions' assets, since the distressed assets should have been already written down to their market value. Hence,

The only way that buying the questionable assets will increase capital on the liability side of the balance sheet is if the Treasury overpays for them.

Of course, if the Treasury overpays for distressed assets, there's less chance it will eventually recoup its investment in them. Hussman's preferred solution would be for the government to infuse capital directly into firms as needed, in the form of a "super-bond" senior to all of a company's existing debt but subordinate to customer liabilities:

The “super-bond” would [...] be seen by customers as a legitimate cushion of protection. However, in the event of bankruptcy, it would have a senior claim in front of both stockholders and even senior bondholders. Do that, and you've actually got a mechanism to protect the financial system while at the same time protecting customers and taxpayers. Ideally, the super-bond accrues a relatively high rate of interest so that financials have an incentive to shift to private financing as soon as possible, but you would also defer the interest until the bank meets a minimal level of profitability to make sure that the financing doesn't strain the institution's liquidity.

But then, Congress didn't do this because nobody thinks in terms of balance sheets.

Hussman isn't the first to suggest direct government investment in financial firms as a way of recapitalizing them; John Paulson, of Paulson & Co. -- the man who made billions of dollars last year shorting sub-primes -- recommended something similar in a Wall Street Journal op/ed last week ("The Public Deserves a Better Deal"); both Hussman and Paulson point to Buffett's investment in Goldman Sachs last week and suggest the government should follow a similar tack in any rescue. Others (including the editors of the Financial Times, if memory serves) have advocated both approaches: buying distressed assets and direct, preferred investments to recapitalize key financial firms.

A proposal along the lines of the one I or University of San Diego Professor Frank Partnoy) suggested ("Why Not This?") might have been an easier sale. Since we proposed buying only mortgages, and not the securities derived from them, this sort of proposal would have been more difficult for populists to characterize as a bail out of Wall Street at the expense of Main Street. There might have also been less concern about the government overpaying for distressed assets, since houses and first mortgages are easier to value than complex securities such as CDOs. Now that the the House has rejected the plan for the government to buy distressed assets though, perhaps it will consider a plan along the lines of what John Hussman and John Paulson have suggested.