Mark Zaccaria on the Big Bailout

On Saturday, I had the chance to interview Second District Congressional candidate Mark Zaccaria on the big bailout plan that was taking shape. Details were still emerging and not yet final, so I still wanted to keep the questions general.

I opened with a reference to Federalist 52. Mr. Zaccaria responded with the best explanation that I've heard so far of how the financial crisis has spread from the housing market to the wider economy…

I think that one of the reasons that you are seeing such a quick and deep response on the part of the Executive Branch is that the people like secretary Paulson stopped breathing a week ago Wednesday, when basically credit came to a halt in this country. We think of this in terms of the sub-prime mortgages and people buying houses they couldn't afford, and so forth and so on, but there is also this huge credit market in the United States.

When McDonald's needs hamburger, they use short-term paper and overnight loans. They call Merrill Lynch and say I need a billion dollars until noontime…

When UPS buys diesel fuel, they do it that way. Their cash flows on a cyclical basis, and their expenses are on a cyclical basis, and if the waves are out-of-synch, they use very short term borrowing.

That all stopped a week ago Wednesday. They just couldn't get it. That would have brought the entire economy to its knees very, very rapidly, and that's what made Secretary Paulson leap out of his chair and do something.

The real problem that they really don't talk about in the media quite a lot, was that [the bailout plan] was an opportunity for members of the majority party in both the House and Senate to say let's hang a couple of ornaments on this Christmas tree. So, there were provisions inserted into the plan to use a certain amount of the money to fund future proposed low-cost housing authorities, and to do a variety of other things that were not directly related to resolving the crisis. Now, Paulson agreed to these things -- I'll give him the benefit of the doubt and say he grudgingly agreed – because of how important it was to restore confidence in the marketplace, by starting to buy up some of those bad loans, so that banks didn't just sit on their cash and started it moving around the track again.

Rep. Hensarling and the House Republicans didn't want to take 15 or 20% of 700 billion dollars and divert it to pork. For that, my hat is off to them.

(p.s. McCainiacs will want to click here).

Anchor Rising: Federalist 52 says that the House of Representatives is supposed to be the branch of government with the most intimate sympathy with the interests of the regular American people. Based on what you know of the big bailout plan, do you think that the House is performing that function well, and that the House Republican Caucus is performing that function well?

Mark Zaccaria: I would say that, as a body in general, the House appears to have been caught pretty flat-footed by this, the way just about every other branch of government was.

I think that one of the reasons that you are seeing such a quick and deep response on the part of the Executive Branch is that the people like secretary Paulson stopped breathing a week ago Wednesday, when basically credit came to a halt in this country. We think of this in terms of the sub-prime mortgages and people buying houses they couldn't afford, and so forth and so on, but there is also this huge credit market in the United States.

When McDonald's needs hamburger, they use short-term paper and overnight loans. They call Merrill Lynch and say I need a billion dollars until noontime, how much is that going to cost? They have cash flow issues that are multiplied.

When UPS buys diesel fuel, they do it that way. Their cash flows on a cyclical basis, and their expenses are on a cyclical basis, and if those waves are out-of-synch, they use very short term borrowing. That all stopped a week ago Wednesday. They just couldn't get it. That would have brought the entire economy to its knees very, very rapidly, and that's what made Secretary Paulson leap out of his chair and do something. I'd venture to say that nobody in the House of Representatives knew about this until well after the fact, when the financial insiders sat them down and made them listen to a briefing on this.

In retrospect, there were plenty of signals that this was going to happen, but we humans like to ignore things like that, because we think it's going to happen some other time.

A week ago Wednesday was that some other time.

We've been hearing about the San Andreas Fault through Los Angeles for 40 years that I can remember, and the big one being right around the corner. Guess what, if you want to go start a real estate development in the San Fernando valley tomorrow, you'd find plenty of support. Someday there will be a big one along the fault line, and everyone will say Oh my God, what's the government going to do about this. It's sort of a natural human trait to bet that things are going to be as they are now.

In retrospect, I think that a body like the House of Representatives should exert a little bit of leadership in a case like this – that's why people hire representatives, to take care of things like this in advance. I think that there were so many different facets that went into making a short term crisis. It was like having the ocean open up and be about to engulf the entire country, then burp once, close, and say not now.

I was that kind of a shock to the people who really know inside finance. It's a situation where any of a number of things need to be done to correct it. I don't believe that clamping down harsh regulations on 50 different facets of our society is the right way to go. I have sympathy with representative Hensarling from Texas and his colleagues in the Republican House Caucus who basically said wait a minute, wait a minute, government's going to own all this stuff? You are supposed to have private ownership. This is America.

The kind of thing that regulation is not going to help quite so much is leadership. Rep. Hensarling is one of my favorite guys down there, and I hope I get to meet him and work with him starting in the next session. But the fact is that we need to exert leadership. This is a perfect example of how we don't necessarily have a cohesive society that agrees on a number of subjects broadly or deeply, finance being one that's key to all of us.

In the past, we used to have bankers who were little bit like physicians. If you came in and said can I please have a loan for 10 times more than I'm worth, they had a fiduciary responsibility to their bank to say, "I'm sorry, you can't afford that". That's exactly what I was told, when I tried buying my first house. My first house was a typical starter house, and a few years later when I could, I was able to move on and I did.

With the sub-prime mortgages, people were trying to jump into these big houses. They were basically being encouraged to do so, by a number of forces. One factor was that the bankers of the type I just described were gone and they were replaced with loan-originators who were commissioned salespeople. Those salespeople get some number of points on whatever happens. What they want is to have a closing. They don't really care if you're going to pay it back. They don't care if they sell you something where a balloom payment doubles your monthly mortgage payment 12 or 14 months in. They just want to get you started and will blow through all the legalities of a closing. Everyone tells you that it's in your best interests to read all that stuff before you sign it, but if you recall how much paper there is at a closing, it's a practical matter that you're not going to do that. You're just going to rely on legal counsel, and how many people do you know who don't bother to hire a lawyer, and just rely on the one who's there anyway – the one that the bank is paying for.

People say the don't want to spend the extra $200 or $300. They say they don't know a lawyer or they don't have one. They don't know how to go about finding one or evaluating one. Well shame on you for all of that stuff. But you need that protection, and it's a $200 life insurance policy. If more people had taken it, we would be having fewer problems now. There were other problems, but that was one.

Anyway, what's happened is that, because of the global nature of the economy, and because the loan orginators have begun essentially using derivates as an insurance policy to lay off their own exposure, because those derivatives are backed by U.S. real estate -- that gotta be good, right! -- they have gone and sold those derivatives world wide, and the whole sub-prime mortgage question was raised by some little bank in Germany that was the first domino that went over in that whole line.

When the U.S. credit market came to a standstill, it sent tremors everywhere. It sent financial people not just running for the doors but diving for the exits. That's the thing that Paulson probably got faster than anybody in the administration. That's why he's been so aggressive in trying to get all of this done.

AR: [As of Saturday], from what I understand, the President, the Senate, and the House Democrats wanted to do one thing, and the House Republicans were saying not-so-fast…

MZ: As I understand it, when Paulson came down and said, quick, we need to inject a bucket of money into this economy, the government essentially has to buy these securities, it has to take these things into ownership, that's exactly the model we used in the 80s and the early 90s with the savings and loan crisis. The Resolution Trust Corporation was created to do that and has done it. They've even done it profitably – we made money on that deal. A similar situation potentially exists here. The government obviously could wait a little while, but if we give it four or five years as a cycle, the government can almost certainly make money back from owning all those things.

The real problem, that they really don't talk about in the media quite a lot, was that this was an opportunity for members of the majority party in both the House and Senate to say let's hang a couple of ornaments on this Christmas tree. So, there were provisions inserted into the plan to use a certain amount of the money to fund future proposed low-cost housing authorities, and to do a variety of other things that were not directly related to resolving the crisis. Now, Paulson agreed to these things -- I'll give him the benefit of the doubt and say he grudgingly agreed – because of how important it was to restore confidence in the marketplace, by starting to buy up some of those bad loans, so that banks didn't just sit on their cash and started it moving around the track again.

Rep. Hensarling and the House Republicans didn't want to take 15 or 20% of 700 billion dollars and divert it to pork. For that, my hat is off to them.

There's another interesting piece. Even the casual observer may recall that late last week, the Democrats were specifically naming John McCain as somebody who had to be on board. They said there is no deal, unless McCain says there is a deal. He turned the tables on them and said, fine, I'll suspend my campaign, come to Washington and let's go solve this thing. I don't think they were ready for that.

What they really were saying was that since this plan has so much of the money being skimmed – frankly, so much so that the plan had the potential not to really work – the Democrats didn't want to be left twisting in the wind as the sole proprietors of this thing if and when it failed. They wanted to get everyone in on the dirty little secret, so that nobody would tell. The House Republican caucus, specifically Rep. Hensarling's wing of that caucus, specifically may have been encouraged by McCain, because he saw very clearly that there was something else going on. So I think that what you might have seen, although it's all inside baseball, and the kind of thing that may never hit the headlines, is that McCain has done the country quite a favor by in essence playing a game of chicken over this thing, to get them to take the pork out of it to make it more successful.