Education news

Had an op-ed in the NYT today on education today as part of their series offering transition suggestions to Obama -- read it here.


Happy Holidays

Won't be posting as much in next weekish fyi, but will return in force as we head toward the new year. Happy holidays to you and yours.


Ulysses S. Grant, Ponzi scheme victim

Wonderful piece in WSJ this week by John Steele Gordon on how President Grant was duped after he left office by a Madoff of his day. A great story with a happy ending of sorts -- and a reminder that cons, even of presumably savvy people, have always been with us.


Speaking of Banking Compensation

There's been no pickup that I've seen of striking news in an excellent mid-November page one profile in the Washington Post on Hank Paulson's ideological evolution. To wit:
....in the coming weeks, he is planning to announce a valedictory set of proposals to modernize Washington's aging regulations and extend their reach into matters that traditionally have fallen beyond the purview of federal officials....Paulson said he will urge Congress and the administration to grant the Fed broad discretion to examine the books of any firm, regulated or unregulated. This would require large hedge funds, private-equity firms and other now-unregulated financial entities to accept a charter from the Fed and open their financial records to its officials...

He added that executive compensation for financial firms also needs substantial reform, which could be accomplished partly through banking regulation...Paulson said he pushed the five major federal banking agencies over the past weeks to release a guidance document that would require firms to eliminate compensation that encourages risky behavior by traders and executives.
Paulson came to DC a free-market Republican; he'll leave (hopefully) with public calls for compensation reform in his old haunts. Despite the critics he'll face at the club, let's hope he really steps out on this.

Wall Street Wall of Shame, Anyone?

Front page NYT piece details the belatedly obvious about i-banker compensation leading to systemic risk because so many people got zillions in bonuses peddling mortage-related securities that were fated to implode. Now there's no ability to get the money back when the profits firms booked on all this flimflam turns out to have been illusory. Highlights:

....Wall Street’s pay structure, in which bonuses are based on short-term profits, encouraged employees to act like gamblers at a casino — and let them collect their winnings while the roulette wheel was still spinning...For now, most banks are looking forward rather than backward. Morgan Stanley and UBS are attaching new strings to bonuses, allowing them to pull back part of workers’ payouts if they turn out to have been based on illusory profits. Those policies, had they been in place in recent years, might have clawed back hundreds of millions of dollars of compensation paid out in 2006 to employees at all levels, including senior executives who are still at those banks.
It's hard to believe there's no legal theory that would let shareholders or creditors claw back some of these billions in ill-gottens gains. But even if not, there ought to be creative ways to shame these folks for their behavior. After all, it's probably only a few thousand people at these top banks (and maybe far less) who got filthy rich doing something that's soured the economy for the other 300 million of us. So here's a thought: Why can't the feds condition any use of the TARP money on access to each bank's records so that the names of people who got rich peddling stuff that later sank the national economy could be published in a very high-profile way. I'm thinking of some public display that looks like the Vietnam Memorial in DC -- a simple but devastating list of names (and maybe the amount of each person's misbegotten earnings). Except this time the people wouldn't be heroes who gave their lives, they'd be on the Wall of Wall Street Shame - people who got rich literally sinking the country.

Borowitz on Caroline

The humorist strikes again with a piece over at HuffPost.
Caroline Kennedy would like to be considered Time magazine's Person of the Year for 2009 and has let the magazine's editor know of her interest in the honor, aides to Ms. Kennedy confirmed today....In addition to the Person of the Year honors, Kerry Kennedy said that Caroline had also expressed an interest in next year's Nobel Peace Prize.
Read it and enjoy. Have to say Andy's funny-bone hit rate is very high.

Enough, Nouriel

I've been as impressed as anyone with Nouriel Roubini's prescience and insights on our current economic mess, and find his commentary at RGE Monitor must reading. But is anyone else out there getting a little irritated at the way each new Roubini piece now seems to begin with the boast that, unlike all the other fools, he predicted the situation we're in ages ago? Enough, Nouriel -- everyone who matters knows you were prophetic. Just focus on what we should be thinking about where we are and where we go from here!


Stop The Heirs!

Caroline Kennedy is a fine lady, but Nick Kristof has it right on his blog re the aristocraticization of American politics. My own entry on this demoralizing phenomenon was a column back in March 2001, reprinted below. Nothing's changed.


I know we’re all supposed to moan about “soft money” this week, but to my mind there’s a bigger campaign scourge that John McCain has missed altogther: the plague of heirs running amok on the political landscape. Surely the Heir Factor does more to undermine the morale of our democracy than a thousand Clinton coffees or Republican Eagle fundraisers ever could.

You can hardly turn on the tube these days without stumbling over some smiling scion primping himself for high office. Like most rot this starts at the top, as last year’s emblematic showdown between George Walker Bush and Albert Gore Junior proved. But the specter of inherited political power is so commonplace nowadays that it’s getting hard to keep track.

There’s Andrew Cuomo, the former housing secretary under Bill Clinton, now readying himself to run for governor of New York, like his father. Presidential wannabe Evan Bayh holds the Indiana senate seat held by his father. So too with Connecticut Senator Chris Dodd. New Hampshire Senator Judd Gregg’s daddy was governor. Lousianna Senator Mary Landrieu’s father was mayor of New Orleans. West Virginia Senator Jay Rockefeller has two uncles who were governors. And, as Ron Brownstein quipped in a 1998 look at this trend in The American Prospect, Chicago Mayor Richard Daley’s father was emperor.

Jesse Jackson Jr. waltzed into the House as Jesse Johnson never could have -- as did Rep. John Sununu (son of the former New Hampshire governor and White house chief of staff) and Charlie Gonzales (who inherited papa Henry’s Texas seat). Three generations later there are so many Kennedys in power that no one actually knows the number anymore. Does anyone think Colin Powell’s son Michael would be chairman of the Federal Communications Commission today if his last name were Powers?

This weird inventory could go on (and on). James Hahn, son of legendary Los Angeles county executive Kenneth, has a lock on this year’s mayoral race in LA. Before long we’ll doubtless see Karenna Gore, Chelsea Clinton and Jeb Bush’s son George P. join the parade.

Many of these folks are fine people. And going into the family business is a proud American tradition. But at some point the sheer volume of political heirs gets a little ridiculous for any self-respecting democracy.

It’s bad enough to have these constant reminders that the system is rigged. Yet governance by heir may also be dangerous. The men and women who inherit their power tend to be far more bland and cautious than their dashing forbears -- who had to make their name, after all, and not simply avoid squandering it.

It’s not unlike the ethos of those who inherit great wealth, who are more concerned with preserving their pile than with taking risks to build a fresh one. This means we’re increasingly led by a species of timid tacticians, groomed from birth to censor any impulse that might make them more interesting as human beings but less viable as politicians.

No wonder politics seem so dull and unimaginative, except when enlivened by political Gatsbys like Ronald Reagan and Bill Clinton [update: or obviously Obama today].

What to do? Any reform has to address the enormous built-in advantage heirs have when it comes to name recognition, the family fundraising rolodex, and opportunities for political apprenticeship.

One option would be to offer huge amounts of compensating public financing to any average Joe who finds himself in a race against an heir. Lawyers will naturally quibble over what relationship should trigger this provision, but you get the idea.

But more radical steps may be needed. Taking a page from trust and estate law, Congress could adopt a “generation skipping” rule, under which the children of high officeholders would simply be barred by law from seeking office themselves -- only the grandchildren could.

This would nip the whole Chelsea and Karenna thing in the bud.

Of course, it might also present a few little First Amendment problems -- but then that makes it a perfect fit with every other campaign finance reform being debated.

Come on, John McCain, do something before we morph entirely into an aristocracy. Flabby heirs are as big a threat as soft money!


Ed Reform Wars Move to Next Front

Now that Arne Duncan has been picked, ed reform crusaders tell me it was "inevitable" and even "brilliant" in retrospect, because Duncan has solid reform credentials while also having managed to retain good relations with the unions. But which way will Obama really go on ed policy if the top man seems able to straddle both worlds? The new fretting is over who will be Duncan's deputy secretary - a Jon Schnur (the uber-reformer who founded New Leaders for New Schools), or a Linda-Darling Hammond? Or will Arne somehow split the baby and confound the search for clarity by naming two equal deputies? And thus force ed reform angst all the way down to the critical Deputy Assistant Secretary for Blackboard and Chalk post?

Sky-High Wi-Fi

I'm writing this from the first flight I've had where they have Wi-fi on the plane and it's great (it's an American NY to LA flight). I know there are downsides -- like never being unplugged from the office etc -- but the upside is fabulous. Kind of extraordinary the world we live in, even with the coming Depression and all (kidding, kidding).

Just wanted to share.

Housing Woes Query

Yes, we're in uncharted territory with the economy dipping and the Fed making up new plays for its playbook. But one thing I don't get is the hand-wringing over housing starts. In the Daily Beast one summary noted:
...builders broke ground on the fewest number of homes in at least a half century...November housing starts were down 18.9 percent from October and 47 percent since November 2007...“The horrifying thing about the housing-starts number is we’re likely to keep going down from here,” said one economist told Bloomberg.
When we've gone through the biggest housing bubble in history -- which means the biggest oversupply of housing inventory ever -- don't housing starts have to dry up until the market settles out? Isn't that what we need? Isn't that why some folks -- like Holman Jenkins at the Wall St. Journal, or Jim Cramer -- keep saying only half in jest that the best government response would be to destroy some of the excess unoccupied housing? Housing gurus please feel free to connect my synapses here if I'm missing something.

Step Right Up

Interesting two page open letter to Obama from higher ed worthies in NYT today (not available online that I can see - will add link if find one) asking for $40-45 billion of the coming stimulus for higher ed infrastructure, research facilities, etc. They say this would be 5% of the package, so they're expecting it to come in at nearly $1 trillion. Can't fault these folks for thinking small! Someone will need to tally up all the requests as groups line up for their piece of the pie, and position their desires as "stimulating."

UPDATE: The WSJ editorial page weighs in with "Shovel-Ready On Campus"


An Air Traffic Controller Moment

One Republican-voting business leader who's been hopeful about Obama tells me his action on the Detroit bailout will tell him all he needs needs to know about the new president's mettle. Everyone knows, my friend says, that whatever the process is actually called, we need a quasi-bankruptcy result that wipes out shareholders, forces bondholders to take a haircut, gets labor costs in line with Toyota's US operations, slims down dealerships, and pushes legacy health and pension costs to the government somehow. If Obama can face down his own constituencies to make this happen, it'll be an "air traffic controller" moment in terms of the signal it sends about this president's strength. But "if he just throws money at the same old same old, there's no hope for the guy."

Open-minded Republicans are watching!

The Shoe on (Endless) Instant Replay

Whatever else you want to say about Bush, he moved pretty quickly to duck out of the way of that shoe. And he looked composed and good-humored, not afraid. Yes, he may be the worst president in American history, but this was a moment of old-fashioned American aplomb.

Chu vs. Obama on Gas Taxes

Obama's nominee for energy secretary, Steven Chu, is a man after my own heart when it comes to gas taxes. From the WSJ:
In a sign of one major internal difference [with Obama], Mr. Chu has called for gradually ramping up gasoline taxes over 15 years to coax consumers into buying more-efficient cars and living in neighborhoods closer to work. "Somehow we have to figure out how to boost the price of gasoline to the levels in Europe," Mr. Chu...said in an interview with The Wall Street Journal in September. But Mr. Obama has dismissed the idea of boosting the federal gasoline tax, a move energy experts say could be the single most effective step to promote alternative energies and temper demand. Mr. Obama said Sunday that a heightened gas tax would be a "mistake" because it would put "additional burdens on American families right now."

Note the "now," which leaves Obama wiggle room for "later." Kudos to Obama for naming Chu when his views will surely make headlines during his confirmation hearings. Can we ever have a president who on gas taxes tells us "what we need to hear, not what we want to hear"? Maybe we can!

Which Way, Arne?

Arne Duncan, Chicago schools chief and Obama hoops pal, will be education secretary. A "compromise choice," I'm told, in the first battle for Obama's education soul. The National Education Association welcomes the appointment. The NEA also loathes Michelle Rhee's landmark initiative to dramatically hike teacher pay in exchange for tenure and other reforms, to me a kind of litmus test for whether you're serious about fixing schools. Does the NEA think it knows something that we don't?


The Washington Post reports that the bailout provision meant to assure limits on executive compensation at banks being rescued by taxpayers was essentially nullified by fine print the Bush administration added when no one was looking.
Congress wanted to guarantee that the $700 billion financial bailout would limit the eye-popping pay of Wall Street executives, so lawmakers included a mechanism for reviewing executive compensation and penalizing firms that break the rules. But at the last minute, the Bush administration insisted on a one-sentence change to the provision, congressional aides said. The change stipulated that the penalty would apply only to firms that received bailout funds by selling troubled assets to the government in an auction, which was the way the Treasury Department had said it planned to use the money. Now, however, the small change looks more like a giant loophole, according to lawmakers and legal experts. In a reversal, the Bush administration has not used auctions for any of the $335 billion committed so far from the rescue package, nor does it plan to use them in the future. Lawmakers and legal experts say the change has effectively repealed the only enforcement mechanism in the law dealing with lavish pay for top executives.
For an incompetent bunch, isn't it interesting how clever Team Bush can be when it really wants to be?


Spitzer, Thinking!

The former NY governor has a smart piece in Slate today arguing that the inevitable auto bailout will be the first installment of endless billions to come unless we find a way to do this more intelligently. His answer: a competitive bid.

Why don't we tell the current Big Three that $25 billion in capital is available—but only to two of them? The surviving two will be those that submit the best, and final, binding bids, supported by all the necessary constituencies: boards, managers, suppliers, vendors, creditors, and the UAW. The plans that are the best, as judged by a panel of private- and public-sector figures—Jack Welch, Warren Buffet, or Felix Rohatyn, plus Office of Management and Budget and Congressional Budget Office officials—are the plans that will get funded...The company with the least impressive plan will be denied funding. To avoid letting the third parties—creditors, the UAW, or vendors—pick the winner by refusing to sign on with their least favorite of the Big Three, third parties will be required to offer the same deal to each of the three. This process will force the companies to bid against one another for aid, giving us the benefit of genuine competition. This is better than an "oversight board" of Cabinet members who have no real understanding of the industry.

I'm sure there are all sorts of complications with such a notion, but doesn't it immediately seem like a fresher idea than anything we've heard in days of hearings and official bloviating? Which brings us to the tragedy of Spitzer. His personal behavior (and before that his temperament in his rocky first year as governor) has left the huge promise he showed as attorney general unfulfilled. But the man is too talented and energetic to simply vanish; the question is, what plausible road to what feasible public role can he take? Spitzer did another piece recently outlining a way forward in the current crisis in the Washington Post, so it's fair to surmise we're seeing a mini-campaign for resurrection on the strength of his ideas.

That's good as far as it goes, but my wife has long had a better idea on what Spitzer should do to build himself back into a useful contributor: He should become the Ralph Nader of financial products and services. Spitzer could do for mortages, credit cards, insurance products etc what Nader did for cars and other consumer products back in his early days. Goodness knows we need some savvy entity looking out for ordinary consumers and society more broadly as we pick up the pieces of financial capitalism in the decade ahead. It's a perfect fit with the mark Spitzer made policing Wall Street as AG. Done right, Spitzer could build a new nonprofit institution devoted to this mission into an important force in American life.

Eliot, please, listen to my wife.

Bernard Madoff - Another FOE Factor Shocker

It's sad but true: not a day seems to go by without fresh examples of how the Failure Of Elites is sinking American society. The Bernard Madoff scandal is the latest. Here we have a respected Wall Street player who once served as chairman of the NASDAQ busted at 70 years of age in what turns out to have been a long-running Ponzi scheme. He may have defrauded investors of $50 billion, which has to make it the biggest Ponzi scheme in human history. It looks like he was already a very rich man when he hatched it. What's the matter with these people? Guess we'll have to wait a few months now for the definitive Vanity Fair profile or Michael Lewis assessment. See original lament on the Failure of Elites here.

Stimulus Silliness

There's a growing chorus of tut-tutters fretting that Obama's coming Super-Stimulus is dangerous because it's unfunded. "How are we going to pay for it?" they cry. These critics are either disingenuous or deeply confused. The whole idea of a stimulus is NOT to pay for it. If we paid for it (as opposed to running up a bigger deficit to do it), it wouldn't stimulate the economy. Every time you hear someone on TV saying "how is Obama going to pay for this," just imagine text popping up beneath them that reads, "I have no idea what I'm talking about."


The FOE Factor

One of my pet theories is that the depressing implosions we're experiencing are evidence of the Failure Of Elites in virtually every sector of society. Call it the FOE Factor. Obviously Governor Blagojevich is the most stunning new example, but at least his scandal ruins only his own life. The broader extent to which all of us been harmed by the failures of our "betters" includes the fallout from greedy or errant CEOs, priests, pols, ratings agencies, bankers, accountants, lawyers, you name it. These are people who by virtue of their privileged positions are supposed to act (at least in part) as stewards of the common good. Instead, every day the rot at the top produces headlines that make American society seem utterly debauched.

My new operating principle: Just when you thought there couldn't be any more emperors without clothes, another naked one pops up! Today's FOE Factor highlight comes courtesy of the WSJ from the latest post-mortem grilling of the unrepentant Fannie and Freddie CEOs.

As the hearings found:
"The emails show that the two government-backed mortgage companies were aware they were taking on more risk as the housing bubble peaked. But the companies pressed ahead with efforts to regain market share they had lost to Wall Street investment banks. They did so by buying loans and securities that increased their exposure to subprime mortgages, for people with weak credit records, and Alt-A mortgages, which typically spare borrowers from having to document their income and assets. Fannie "'has one of the weakest control processes I ever witness (sic) in my career," Enrico Dallavecchia, then chief risk officer of the company, wrote in a July 2007 email to Michael Williams, chief operating officer.
More WSJ:
Four former chief executives of Fannie and Freddie appeared before the committee to answer questions about their financial woes. They generally dodged demands by committee members that they accept the blame for those problems. "We did what we thought was the right thing at the time" but were then surprised by the most "violent" housing downturn for decades, Mr. Syron said.
Hey, coulda happened to anybody. But tell me again, why did you guys all get tens of millions of dollars for running these operations?


How Obama Can Spark An Education Revolution

Reports yesterday here and here on the latest TIMSS results (that's for Trends In International Mathematics and Science Study), one of the gold standard reports that show how we stack up against the world on student achievement. Bottom line: we've made a little progress, but still trail many other nations we generally think we're smarter than (full report here). Depressing but accurate quote from savvy Mike Cohen, who runs Achieve: "If we put our mind to it and aim high, we can get our performance up to the level of top Asian countries."

So much for another American century.

But there's one fascinating bright spot, which Barack Obama can use to spark a low-cost revolution. Massachusetts and Minnesota, who've led the way in adopting rigorous standards, arranged to get themselves measured independently from the U.S., and these two states performed on a par with the best in the world. They're the only states with the guts to have had their schools broken out separately. You see where I'm heading. As a condition of receiving their federal funding, Obama should require all states to agree to have their results broken out in TIMMS (and also to participate in another respected international comparative study known as PISA). The feds can pony up the modest costs associated with this. It's a perfect fit with Obama's money-for-reform theme. "If we're going to invest more in education," he can say, "we need to know how we're doing. That's just common sense."

Why do this? The idea would be to assure periodic but regular headlines across the country like, "Alabama Schools Rated Worse Than Uganda's," or "California Trails Uzbekhistan Again In Math And Science." Polls show today that most people think the education system is a mess, but that their own schools are fine. They're wrong to be complacent, and with this little step Obama could go a long way to provoke the reality-based uproar we need. I'm hoping my favorite Eduwonk, Andy Rotherham, who has the ear of the transition team (and who would make a great senior DOE appointment), gets this into the mix asap.

Better Than Under the Mattress?

Investors rush to put their money in short-term Treasury bills yielding 0%. That's right, zero. Safety trumps yield. At least you won't lose money. (And the feds can finance the coming trillion dollar deficits on the cheap). Tell your grandchildren you were there for this.

The Glamour of Travel

Stuck in New Orleans airport for about 6 hours trying to get home to LA today because Houston (where I was to connect) seems totally shut down. Maybe it's weather, but I've had so many of these sit-on-the-tarmac-for-hours delays in the last year that I'd prefer to blame our increasingly Third World-style infrastructure. That massive Obama public works plan can't come soon enough for me! At least there's Wi-Fi in the airport...

Tom Tomorrow on The Invisible Hand Run Wild!

Fab cartoon that captures so much. Thanks to (newly crowned Nobelist) Paul Krugman for flagging it.


Gladwell's Blindspot on Teachers

Typically interesting piece by Gladwell on why it's hard to identify who will be a good teacher before they’re in the classroom, which bolsters the case for abolishing tenure, opening the field of entry wide, and being tough-minded about developing people and deciding who’ll make the cut in the first few years. That’s fine as far as it goes. But as often happens with Malcolm, his elegant storytelling obscures a vital truth about today’s teacher crisis. Especially for poor kids, we’re recruiting teachers from the bottom third of the college class, a stark change from the 1960s and 1970s, when we recruited from the top-third because women and minorities didn’t have as many career options outside the classroom. The quality of the teacher corps was subsidized by discrimination. That wave of talent is now set to retire in droves, but teaching simply isn’t an attractive career for today’s better college grads. Yes, they may try it via Teach for America for two years, but as Wendy Kopp would be the first to admit, the scale of TFA is puny compared to the national need.

Bottom line: unless we make the profession of teaching more attractive as a career, we’ll never lure the talent we need to lift student achievement (and sustain U.S. living standards) in an era of global competition. And while money isn’t the only answer, it has to be a big part of it, because starting salaries of $35,000 to $45,000 that top out after 25 years at $80,000 simply won’t change the choices that today’s better college students make. This is a policy fetish of mine – a chunk of my first book was about how to get starting salaries in high poverty districts to $65,000, and top salaries toward $150,000, in ways all sides could support. When a smart young couple graduating from college sees that if they’re good in the classroom they could aspire together to earn $200,000 to $250,000 before too long, the societal benefit would be enormous. (It's not just two more good teachers, after all -- it’s two less lawyers). DC chancellor Michelle Rhee’s current plan is the one serious hope on the scene right now for getting the breakthrough we need.

Micro-management defined

NYT today notes that under the Democratic proposal, "the automakers...must seek permission from the car czar for any business transaction of $25 million or more." You probably can’t buy new pencils and paper clips for firms on the scale of the Big Three for less than $25 million a year. Quick, somebody please tell us what level of executive at well-run companies typically has the authority to make $25 million decisions. If it’s the Assistant VP for Purchasing, do we really want the Car Czar saddled with this kind of minutia, when he needs to be busy issuing diktats on body designs and new fuel cell technology?

Waiting for Gigot

Classic fear-mongering editorial today in the WSJ about the dangers of what Dems will try to do re universal coverage. Look, it’s fine for conservatives to raise questions about Democratic hubris given the power they’ll have starting in January, and I don’t rule out the prospect that editorial page editor Paul Gigot & his team will raise some useful cautions. But the striking thing about today’s latest in the genre is that it acts as if the paramount public priority of the coming health care debate is restraining Democratic excess. What about solving the scandal of the 50 million uninsured and the 25 million underinsured? Or costs that our private sector-centric system has pushed to 16% of GDP on their way to 20%? Memo to Gigot: instead of just taking predictable potshots, why not lay out what comprehensive reforms the WSJ would endorse that would (1) assure basic health coverage for every American while (2) restraining cost growth and (3) boosting quality. Put out a plan that meets those goals in ways that honor the WSJ’s values, and it would help kickstart a conversation that eventually brings a bipartisan deal. Come on, Paul. As Washington Monthly guru (and one of my mentors) Charlie Peters always told me, "Don’t just tell people what you’re against – tell them what you’re for."

Not So Super

Looking for more bad news on the schools front? Consider the pathetic tenure and now departure of LA schools chief David Brewer. Two years ago the former admiral was jammed in as a hire by then-school board president Marlene Canter in a power play meant to upstage Mayor Antonio Villaraigosa, who was trying to wrest control from the school board at the time (he failed to get Bloomberg-style control, but finally got a group of schools to supervise; in my consulting life I played a small role in helping develop the reform blueprint for them). At the time, Canter said it was so urgent that a talent like Brewer be brought in that he had to be named while the Mayor was out of town and unable to meet with him. Some talent. Brewer has been virtually a cipher; as an LA resident and reform-watcher I can’t name a single important thing he did for two years. Now, with a critical mass of civic leaders finally demanding something better, he’s gotten what looks to be a $500,000 buyout of his contract. Meanwhile the clock has counted off two more ineffective years of education for hundreds of thousands of kids stuck in low-performing schools – losses that will blight their life chances merely because of where they happened to be born. As usual, it’s all about the children.


CDS anxiety

For two weeks I've been in a state of rising anxiety about Credit Default Swaps. Now I'd like you to join me.

The question is whether CDSes are the last huge bubble left to pop, and how much further economic damage that will cause. After being vaguely aware of CDS issues but not anything like alarmed, my fears were stoked on November 24 by a report on one of the blogs I find indispensable in following the financial mess, Barry Ritholz's The Big Picture. The report featured an analyis by Chris Whalen of Institutional Risk Analytics, a guy (and firm) I've never heard of but whose analysis seemed plausible enough to frighten me.

It started by filling in the blanks on AIG, because I had not understood what all that money going into AIG's black hole was being used for. Had you?

Whalen: "Few observers outside Wall Street understand that the hundreds of billions of dollars pumped into AIG by the Fed of NY and Treasury, funds used to keep the creditors from a default, has been used to fund the payout at face value of credit default swap contracts or “CDS,” insurance written by AIG against senior traunches of collateralized debt obligations or “CDOs.” The Paulson/Geithner model for dealing with troubled financial institutions such as AIG with net unfunded obligations to pay CDS contracts seems to be to simply provide the needed liquidity and hope for the best."

I guess I had vaguely known we were bailing out gambling activities (which is how CDSes strike me) but hadn't focused on the fact that so much of the federal money is being used to honor these CDSes, or, more precisely, the collateral calls AIG faces as they go south.

Then Whalen had this chilling scenario:

1) Start with the $50 trillion or so in extant CDS.

2) Assume that as default rates for all types of collateral rise over next 24-36 months, 40% of the $50 trillion in CDS goes into the money. That is $20 trillion gross notional of CDS which must be funded.

3) Now assume a 25% recovery rate against that portion of all CDS that goes into the money.

4) That leaves you with a $15 trillion net amount that must be paid by providers of protection in CDS. And remember, a 40% in the money assumption for CDS is VERY conservative. The rise in loss rates for all type of collateral over the next 24 months could easily make the portion of CDS in the money grow to more like 60-70%. That is $40 plus trillion in notional payments vs. a recovery rate in single digits.

Q: Does anybody really believe that the global central banks and the politicians that stand behind them are going to provide the liquidity to fund $15 trillion or more in CDS payouts? Remember, only a small portion of these positions are actually hedging exposure in the form of the underlying securities. The rest are speculative, in some cases 10, 20 of 30 times the underlying basis. Yet the position taken by Treasury Secretary Paulson and implemented by Tim Geithner (and the Fed Board in Washington, to be fair) is that these leveraged wagers should be paid in full.

Our answer to this cowardly view is that AIG needs to be put into bankruptcy. As we wrote on TheBigPicture over the weekend, we’ll take our cue from NY State Insurance Commissioner Eric Dinalo and stipulate that we pay true hedge positions at face value, but the specs get pennies on the dollar of the face of CDS. And the specs should take the pennies gratefully and run before the crowd of angry citizens with the torches and pitchforks catch up to them.

President-elect Obama and the American people have a choice: embrace financial sanity and safety and soundness by deflating the last, biggest speculative bubble using the time-tested mechanism of insolvency. Or we can muddle along for the next decade or more, using the Paulson/Geithner model of financial rescue for the AIG CDS Ponzi scheme and embrace the Japanese model of economic stagnation.

(Whalen's whole post is here if you want to read for yourself).

Every since reading this I've been asking smart financial people if they think he's right and CDS is the Next Huge Awful Shoe To Drop. First I asked Pete Peterson and Robert Greifeld, who runs the NASDAQ, on a panel at the Fortune 500 Forum in Washington last week. Pete seemed to think this was serious stuff; Greifield agreed but felt the amounts were likely overstated. But I didn't take comfort from their body language.

Then I asked Alan Blinder at Princeton when in his office last Friday. Blinder agreed it was serious but it was hard to know just how serious. When he was at the Fed in the 90s, he said, they developed a rule of thumb, which may or may not apply in today's situation, to discount the "notional value" of outstanding CDSes to real exposure (after netting out, for example, contracts through which some firms bet on both sides of the same development). Back then they reckoned that 4% of the notional value represented real risk.

If that rule of thumb held today we'd thus be looking at around $2 trillion of potential losses governments could be asked to bail out, not $15 trillion. This is what passes for good news nowadays!

The truth is no one knows. Presumably the Obama team has to have a handle on this or they can't think intelligently about where we go from here. But the problem is that because these instruments are unregulated there's no one place to get a handle on the exposure. Tim Geithner & Co ought to immediately (like, by close of business today) require an inventory of this exposure. I'd like to think this was happening -- but after all we've been through, who can assume anything sensible is happening? The big question is whether this is manageable without, as Whalen suggests, some form of massive multi-firm bankruptcy reorganization that puts these instruments behind us, once and for all.

I'll keep asking folks. But in the meantime, why haven't the WSJ and NYT gone after this last big bubble with the full court press it deserves?

Culture Corner

If you're in NY don't miss the revivial of David Mamet's "Speed The Plow," which I saw Friday night. The fabulous cast features Jeremy Piven (from Entourage), Raul Esparza (who starred as Bobby in the revival of Sondheim's Company a yearish ago) and Elisabeth Moss (the lady copywriter from Mad Men). The energy, the intense sticcato dialogue, and the theme of art vs commerce in Hollywood make it a pure joy. Here's the glowing Times review if you need more noodging.

Am reading the galley of Philip Howard's forthcoming Life Without Lawyers. It's another elegant, persuasive indictment of the American way of law from the man whose plea about The Death of Common Sense still feels timely a decade later. Read it and find out why, among other things, teachers aren't allowed to control their classes, and why the parents of a few kids with a rare allergy have been allowed to eliminate the peanut butter sandwich from American childhood. It's a cry for balance, and for the authority to counter the riot of "rights" that leave society helpless to govern with communal goals in mind, rather than placating the Individual With A Complaint.

Conscientious Objection

Since it looks like we're going to do something re the automakers, I'd like to figure out how to withhold that portion of my tax dollars that will go to bail out private equity behemoth (and Chrysler owner) Cerberus, and its billionaire leader, Stephen Feinberg. Is anything more awful than all of us paying to rescue capitalist titans who are supposed to be taking risks with their money? Ambrose Bierce had a wonderful line in The Devil's Dictionary where he defines politics as "a strife of interests masquerading as a contest of principles; the conduct of public affairs for private advantage." Keep that in mind as you hear Cerberus execs talking about why saving Detroit is about something much bigger than just them.

Great But Late

Great piece yesterday by the talented NYTer Gretchen Morgenson on the corruption of the ratings agencies and how this helped fuel our current woes. Greed ruins yet another elite institution supposedly looking out for the public. Just one question -- why couldn't this piece have run in 2005, when it might have helped prevent today's mess?


Today Rick Wagoner, tomorrow America?

Humble pie alert. While fun to watch, the humbling of the imperial auto CEOs offers a scary reminder of the power your creditors have over you. First the arrogant Wagoner, Nardelli and Mulally flew in on private jets, demanded bailouts without a turnaround plan, and scoffed at the notion of cutting their $20 million pay packages. Now, in a turnabout that is comically self-parodying, they drive their own cars from Detroit, offer at least the illusion of detailed survival plans, and trumpet their thirst to earn a dollar a year. "It’s all part of a learning experience for me," Mulally told the New York Times by phone during his road trip to DC. "I think it’s really important that I drive to Washington to show that Ford gets what Congress is saying."

All good fun. But substitute "China" for "Congress" and you get a preview of the kind of "learning experience" the entire country may go through if we don’t stop borrowing billions from the Chinese. Before long it’ll be the American president who to Chinese eyes looks like today’s clueless car guys when he tries to throw America’s weight around on Taiwan or human rights while begging for continued billions in Treasury bond purchases at the same time.


Depressing Thought

For weeks I’ve been saying that the hopeful thing about the current economic mess is how quickly a consensus has developed across the spectrum that government must spend BIG to boost demand to get us through this. After all, between 1929 and 1933 little policy action was taken, and what was done (contracting the money supply) made matters worse. Today is different. Yes, you can say the relevant officials dithered for a year or so when they should have been acting. But since then they’ve been throwing lots of spaghetti against the wall, and under Obama there’s tons more spaghetti to come. What’s more, Republicans are for it – even Reagnaut Marty Feldstein knows this is the moment for Keynes on steroids. In the 1930s, by contrast, the state of economic thinking was so confused that FDR actually raised taxes and cut spending in 1937 when we were still in trouble, ushering in a deep new recession.

Yet the fact that FDR & Co. could in 1937 commit what seems in retrospect so obvious a blunder suddenly makes me nervous. What toxic ways of economic thinking are we now in thrall to that our grandchildren will look back on with horror, just as we look back amazed at FDR’s 1937 missteps? What I’m talking about here is the economic equivalent of Rumsfeld’s "unknown unknowns." In 1937, FDR and the "smartest" advisors from that era sat in the Oval Office and made very reasonable-sounding arguments about the need for fiscal tightening, and it proved disastrous. What seemingly sound arguments by "experts" are now propelling us toward some similar fate because of things we don’t yet understand? If you’re looking for cause to be even gloomier, it’s a scary thought.

Too Timid By Half?

WSJ today says Team Obama is talking with Congress about a $500 billion stimulus over two years, and they're having at least one independent forecaster model the potential impact. But that’s just $250 billion a year – less than 2% of GDP - - when other economists this week have been talking about needing more like $600 billion per year for two years to offset the contraction in private sector demand. Here’s hoping the reporting is off and they’re planning something with more shock and awe.


Only in America

Surreal item in the NYT about United Health Care offering a new product that lets you insure against your being uninsurable in the future. What’s that mean? Apparently you’d pay 20 percent of the cost of a premium for an individual policy now to preserve the right to buy an individual policy later without the usual medical underwriting, should you find yourself sick and outside a group employment setting, and thus unable to get coverage. Only in our hall of mirrors system would anyone sense a business opportunity in peddling so weird an animal as this. "It’s a great hedge" against becoming uninsurable, one executive said. If we ever get to universal coverage this will seem funny in retrospect. For now it’s just more sad proof of how screwed up our whole health care situation is.


Obama Personnel Dept

Heard here first. I’m nominating Gene Sperling, former Clinton NEC chief, Hillary campaign advisor, and tireless wonk, for the undersecretary for economic affairs job at State. Knowing Gene both from our White House days and as current colleagues at the Center for American Progress, it’ll be a blow for him not to be in the center of the action at the White House. But he’d make it a consequential post that serves Hillary’s and Obama’s ideals as well as his own. Among other things, this job is the perfect platform for the work on girls’ education in developing countries that Gene has pursued in his years out of government (a passion Larry Summer rightly shares). If you’re interested in more on Sperling, check out the profile I wrote of him in the New Republic in 1999. Amazingly, the longer original version of this profile was initially rejected by TNR because it was considered "too favorable" in its judgments about a public official, which tells you all you need to know about the mindset of political journalism. The TNR profile as it ran is here. You can also read the longer, unpublished draft and judge for yourself. I was trying to use Gene’s story as a window into the limits and possibilities of progressive policy in the Clinton era -- and, to me, at least, it stands up well.