Sens. Carl Levin (D-Mich.) and Susan Collins (R-Maine) introduced legislation today authorizing federal regulators to oversee the credit default swaps market — which has ballooned into a $57 trillion industry.

You remember credit default swaps. These babies — in essence, private insurance contracts in which one institution pays another when a third party defaults — are used to spread financial risk. They’re just one branch of the enormous swaps market. Yet the over-leveraging they allowed are thought by many experts to be among the primary factors leading to the global economic meltdown.

You might think that, considering the sheer size of the market, federal regulators would have been examining these swaps beneath a microscope. Think again. Current federal law actually prohibits the federal government from overseeing swaps at all.

Levin, who chairs the Senate Homeland Security and Governmental Affairs investigative subcommittee, and Collins, who also sits on the panel, are hoping to change that. Their proposal would remove the regulatory prohibitions on swaps while authorizing — though not requiring — the federal government to regulate the various swaps markets.

From Collin’s statement:

While local credit unions and small community banks are subject to safety-and-soundness regulation, enormous Wall Street financial institutions that have a far greater impact on our economy have not been subject to such regulation. This legislation would clear the way for federal financial regulators to oversee the swaps market. It is a critical component of the overall reform needed to restore confidence in our financial regulatory system.

The statement also lends a sense of just how huge the swaps markets have become:

Swaps are typically an agreement between two parties placing a bet on future cash flows. Some swaps bet on whether a stock price, interest rate, commodity price, or currency value will rise or fall; others bet on whether a company will default on payment of a bond. Stock price bets are referred to as equity swaps; bets on whether companies will pay their debts are referred to as credit default swaps.

According to the latest data compiled by the Bank of International Settlements, as of June 2008, worldwide swaps markets included credit default swaps with a total notional value of $57 trillion; commodity swaps with a notional value of $13 trillion; equity swaps with a notional value of $10 trillion; foreign currency swaps with a notional value of $62 trillion; and interest rate swaps with a notional value of $458 trillion.

The real question is, with so much at stake, why regulators have been banned from monitoring these transactions to begin with.

Here’s the perspective one analyst offered to the Financial Times:

“This time next year, Obama euphoria will be crushed under the weight of the unfolding economic and market meltdown,” warned Albert Edwards, analyst at Société Générale. “The crushing weight of the ‘Great Debt Unwind’ has only just begun.”

It’s hard to think of things this way, with the good will from the election still fresh. But it’s the grim reality President-elect Barack Obama, and the rest of us, face in the days ahead.

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States that President-elect Barack Obama won had housing markets in far worse shape than states won by his rival, Sen. John McCain. All told, states carried by Obama comprised 79 percent of all foreclosures – or about four times as many as states won by McCain. His states accounted for 18 percent of all foreclosures.

The average home sales price fell by 9.4 percent in Obama’s states, while they dropped just 1.6 percent in states McCain carried.

I guess that means the old saying that all politics is local has a new twist. These days, voting decisions seem tied directly to a homeowner’s doorstep.

If that’s true, it would mark a big change from the practice of retail therapy, the popular solution all through the last decade of hitting the mall to make your troubles go away. From The Journal:

The shift began even before the credit markets broke down and the stock market plunged. Many Americans had already begun to question their “freewheeling consumption” and move toward “a culture of responsibility,” says J. Walker Smith, president of global trends researcher Yankelovich, a unit of the Futures Company. For many, he says, environmental concerns were an important factor in this shift.

Environmental consciousness has often been associated with added expenses such as solar panels and organic food. But Wendy Liebmann, chief executive of consulting firm WSL Strategic Retail, has noticed that the economic downturn is accelerating mainstream acceptance of the thriftier behaviors of the green movement, like cutting out bottled water and growing vegetables.

“People are saying, ‘We are going to save money, and we are going to save the environment,’ ” she says.

The story goes on to cite a 31-year-old book editor in Carmel, Ind., who cut out weekly trips to Target and daily cups of Starbucks to can apple butter and cherries for Christmas gifts.

Well, good for her, and all the others like her, if they actually are out there somewhere. Every now and then stories like this pop up, about the rich cutting back and living more simply. They usually are followed a few months later by all the unnecessary luxury items rich people are buying.

We’ll see if this cutting back and going green thing is a real trend. Clearly consumer confidence and spending are declining. But I’d guess it’s less a matter of turning away from consumerism than this unmistakable, solidly evidenced trend — credit card companies are cutting back on access to credit. The Federal Reserve’s October survey of bank loan officers found they are reducing credit lines for consumers, especially those with spotty credit records.

That’s a real trend. And if you see luxury items selling less well, and lots of stories about people trying to live more simply, assume that less access to plastic probably has a lot more to do with it than suddenly enlightened attitudes.

“John McCain just doesn’t get it,” read Obama’s prepared remarks. “Remember what he said when he was here on Sept. 15? That day, more than 5,000 jobs were lost and [...] former Fed Chairman Alan Greenspan said we were in a ‘once in a century’ crisis. And yet, despite our economic crisis, John McCain actually came here, to Veterans’ Memorial Arena, and repeated something he’s said at least 16 times on this campaign. He said – and I quote – ‘the fundamentals of our economy are strong.’”

Obama is planning to blast that claim, which his senior strategists believe marked a turning point in the campaign. “That’s not only fundamentally wrong, it also sums up his out-of-touch, on-your-own economic philosophy,” his preview text reads. “It’s a philosophy that says we should give a $700,000 tax cut to the average Fortune 500 CEO and $300 billion to the same Wall Street banks that got us into this mess. It’s a philosophy that says we shouldn’t give a penny of relief to more than 100 million middle-class Americans. And it’s a philosophy that will end when I am president of the United States of America!”

Obama’s chief strategist, David Axelrod, was recently asked by Time what the “defining moment” was on the campaign, “the moment when you thought Obama could win?” Axelrod’s mind went to Jacksonville.

“In a weird way, that Monday, whatever it was, Sept. 15, when the financial crisis really erupted and Sen. McCain said that the fundamentals of the economy were strong, that was a pretty decisive moment in this campaign,” said Axelord. “I think that kicked off a couple of weeks where you saw a real strong contrast between these two candidates and I think redounded to our efforts culminating in the debates.”

It looks like Axelrod’s fingerprints are on this final salvo, which the campaign released at 10:06 Monday morning. At this frantic closing period of the campaign, of course, it’s rare for anything that the candidates’ say in speeches to break through.

In Florida, however, where McCain is also campaigning today, the attack may carry extra salience — with local history that McCain would rather forget.

They’re actually thinking of curbing some of those rewards, The Wall Street Journal reports today.

From the Journal:

“To the guy in Kansas making 60 grand a year and losing his house, it seems like madness to bail out firms at a favorable interest rate and see them have thousands of people making millions of dollars a year — and it is madness,” said Alan Johnson, a New York compensation consultant.

So Wall Street may take a few steps to stop the madness. But let’s call them what they are — baby steps. The idea is to make sure bonuses for chief executive officers decline sharply. But lower-level traders and investment bankers, who could be plucked away by other firms, still will see generous bonuses.

I assume that means even if those employees played a big role in the fostering the subprime housing bubble, they’ll still get bonuses, because other firms would want their obviously invaluable services.

The Journal notes that Wall Street isn’t really going to give up without a fight:

The wide-ranging pay talks follow demands for information about compensation plans. Some firms have considered hiring one outside law firm to represent the nine companies on the Treasury Department’s initial list of capital recipients in their response to this week’s demands by New York Attorney General Andrew Cuomo. Top traders, who can out-earn CEOs in a good year, are concerned about possible disclosure of their names and pay.

There’s a lesson in here somewhere. I’m just not sure exactly what it is.

It’s an unlikely spot for a conservative White House that once lived and died railing against big-government interventionism. But these are lean times — and no town knows this better than Detroit.

Indeed, faced with free-falling sales, it appears likely that General Motors and Chrysler — two of Detroit’s struggling Big Three auto giants — will be merging, perhaps within days. The companies want Washington to pitch in billions to catalyze the deal — and administration officials are looking ever more likely to oblige.

It’s not quite how Adam Smith imagined things. By definition, businesses suffer in recessions. And true-market capitalism, at least in theory, exists only by the rules of financial Darwinism — the enduring concept that weak businesses must fail to make room for the strong.

Yet asked this week if including the automakers in Washington’s bailout plans encroaches too far on private markets, White House spokeswoman Dana Perino responded incomprehensibly:

Well, I think what I would point you back to is that decisions on whether or not — that these companies have in front of them as to how they will move forward and how they will deal with these changing market conditions and changing consumer preferences will be ones that they make. What we’re doing in the administration is working with the tools that Congress has provided us.

So when it comes to loans for retooling the factories and their floors so that they can produces more energy-efficient cars, we’re working within those means that Congress passed for us to be able to do that. And the same is true when it comes to the Troubled Asset Relief Program, where we’re looking at that.

The confusion, to an extent, is understandable. Mulling the best strategy for partial nationalization of the once-proud auto industry must be no easy position for a White House that sold itself to America as a champion of free-market conservatism. But Detroit CEOs have taken their plight directly to the Treasury, which Congress recently gifted with sweeping power to scoop up any troubled asset that threatens the nation’s economic stability.

Congress might have thought this bailout would be limited to Wall Street’s failing financial institutions. But, at this point, who would argue that Detroit’s automakers aren’t troubled assets as well?

The evidence, after all, is striking. GM’s domestic sales have fallen 18 percent this year, and Chrysler’s are down 25 percent. On Wednesday, news got bleaker when GM announced an 11.4 percent drop in global sales for the third quarter alone. The question remains whether Bush officials will deem these automakers, like Wall Street firms, too big to fail.

For some members of Congress, the answer is a no-brainer. In an Oct. 23 letter to the Treasury Sec. Henry Paulson Jr. and Federal Reserve Chairman Ben Bernanke, Michigan’s entire congressional delegation urged the administration to use its powers under the financial rescue bill to save the state’s famously regional industry.

Every segment of the U.S. automotive industry –- automobile manufacturers, dealers that are engaged in sales of autos and light-duty trucks, and auto finance companies that provide financing to dealers and to consumer and commercial purchasers of vehicles -– is experiencing devastating effects that have resulted from the worldwide crisis in financial and capital markets and the freeze-up in credit markets. … In this current economic environment it is imperative that the government ensures that liquidity is restored, so that the U.S. auto industry is able to function until normalcy is restored to credit markets.

Not everyone, though, agrees.

Steven Pearlstein, the Pulitzer Prize-winning business writer for The Washington Post, ran a piece Wednesday under the heading, “A Detroit Bankruptcy Beats a Bailout.” And an editorial in the Boston Globe Thursday points out that Detroit’s troubles go much deeper than the recent credit crisis. A historical over-reliance on gas-guzzling SUVs, for example, has disadvantaged America’s automakers as fuel costs have leapt in recent years. “A merger of GM and Chrysler would not fix these problems,” the Globe writes. “And federal backing for such a deal risks entrenching the status quo.”

Even Perino conceded this week that the failure of Detroit’s automakers is largely their own doing.

Complicating the saga, $25 billion in federal loans to help Detroit shift to more fuel-efficient vehicles could take between six and 18 months to arrive, the Bush administration announced earlier this month. To complete their merger deal, GM and Chrysler are requesting an early $10 billion from that allotment. They also want GMAC, their lending arm, to become a bank holding company, which would allow it to tap the $700-billion financial bailout program.

That merger could be finalized by Election Day, the Detroit Free Press reported Thursday.

Meanwhile, reporters might want to aim their questions about the administration’s bailout plans to someone other than Perino. Asked if any retailers offering lines of credit (Maytag was mentioned) would be eligible for bailout funding, the White House spokeswoman didn’t have the answer.

It’s a good question. It’s not one that I can answer, because I’m not part of the — I’m not an economist, that is a regulator looking at the Troubled Asset Relief Program. I don’t want to — I don’t think the White — I don’t think the White House would be open to that, but I just don’t know.

No wonder there’s so much confusion surrounding this program.

Makes you proud to be a capitalist, doesn’t it?

The New York Times reports today that insurance company AIG has already burned through $123 billion it got from the Federal Reserve. The company told the government it was solvent in September. The only explanation for running through that kind of money one month later would be hidden accounting problems, analysts say. The company could be taking the $85 billion line of credit from the Fed plus $38 billion in additional government help and using it to cover previously undisclosed losses. From the Times:

These accounting questions are of interest not only because taxpayers are footing the bill at A.I.G. but also because the post-mortems may point to a fundamental flaw in the Fed bailout: the money is buoying an insurer — and its trading partners — whose cash needs could easily exceed the existing government backstop if the housing sector continues to deteriorate.

Edward M. Liddy, the insurance executive brought in by the government to restructure A.I.G., has already said that although he does not want to seek more money from the Fed, he may have to do so.

Here’s what I’d tell Liddy, and any other banks with their hands still out, if I were in charge of this mess: Tough luck.

If AIG wasn’t honest with its books, why should it get even more money from the government? AIG wasn’t worried about those accounting losses when it spent $443,000 at a resort and spa, just after getting its loan. The securities industry isn’t the slightest bit apprehensive about doling out $20 billion in bonuses this year — which no doubt ranks as its worst year since the Great Depression. Imagine the performance reviews for top investment bank executives. Sure, our company failed or was nationalized by the government. Here’s your bonus.

The only government official taking some action on this appears to be New York Atty. Gen. Andrew Cuomo, who sent a letter to the nine banks partially nationalized by the government demanding detailed information on bonuses for top executives this year.

Good for him. As Sen. Bob Dole used to say, “Where’s the outrage? The financial industry seems to be making a joke of the dramatic and unprecedented aid it received from the government. In the meantime, homeowners with their loans underwater are on their own, with the government only now mulling a plan to help them that appears to comprise little more than offering lenders another carrot to participate in loan modifications. And the White House already is saying it’s made no decision on supporting it.

The moral hazard argument, it seems, applies only to people in foreclosure. On Wall Street it no longer exists.

For example, here’s one such idea today, in The Wall Street Journal. It’s called a Shared Appreciation Mortgage, or SAM. Lenders would take a loss as they wrote down a borrower’s mortgage debt. But should the home appreciate in value eventually, lenders would then share in the gains. The notion was described by four economics and law professors, Andrew Caplin, Thomas Cooley, Noel Cunningham and Mitchell Engler. Here’s more:

A homeowner unable to support payments on a house purchased for $200,000 that today is worth only $150,000 might be offered a write-down of up to $50,000. But this would not be a free lunch.

With the SAM, once the value began appreciating above $150,000, the mortgage holders would be due their share. The details of the write-down and the appreciation sharing could be tailored to different circumstances. But one way to give lenders a share of the upside would be to pay back some of the write-down if the house is later sold, in the scenario above, for more than $150,000. This is a model in which both parties benefit, preventing default while giving future taxpayers a fighting chance at some real upside to the investment we’re forcing on them.

The authors contend the government needs to tackle a bold solution, and this would fit that bill.

So far, the government has been making bold moves — but only when it comes to rescuing banks. Will it do the same for homeowners? The SAM authors say there’s precedent for the government to act:

Almost 75 years ago, in the depths of the Great Depression, the nation faced a housing market collapse even more brutal than today. The federal government responded with a strategy that allowed homeowners to keep their homes and kept the bottom from falling out of the real-estate market. Unprecedented at the time, the 30-year fixed rate mortgage has since become the gold standard in markets around the world.

Today, facing a similar collapse, the federal government needs to be equally bold. SAMs are the new deal in housing that our children need.

Instead of quickly passing a stimulus package, Congress should concentrate on putting some conditions on that bailout, Reich said, considering Wall Street’s recent tendency to treat it as a trip to the candy store. Banks are hoarding cash for takeovers and otherwise using it for their own purposes, rather than lending it to consumers as the bailout intended, The New York Times noted.

As TWI’s Matthew Blake noted, insurance company AIG executives spent $443,000 for a weeklong retreat at a resort and spa, just after getting an $85 billion bailout from the government.

In the middle of accepting billions of dollars of taxpayer money, the securities industry is still planning on awarding $20 billion in bonuses to top performers this year, with some getting the same amount they did last year — before they were partially nationalized.

I guess that’s Wall Street’s way of rewarding executives for their massive and unprecedented failures. From Reich:

Paulson’s taxpayer-financed bailout continues to put money into the wrong pockets. So another item Congress should get to as soon as it returns: amend the Bailout of All Bailouts (the so-called “Troubled Asset Recovery Program”) to force big banks to loan out at least 50 percent of the amounts they receive in cash from the government. In addition, because dollars are fungible — that is, a dollar received from the government functions the same as any other dollar of bank assets — the big bank beneficiaries of the bailout should be barred from (1) paying lobbyists who have anything whatever to do with administration or implementation of the bailout; (2) buying up other financial institutions; (3) paying dividends to shareholders; or (4) paying any bonuses or severance packages to any executives — as long as the bailout continues. There’s simply no excuse for using taxpayer dollars for any of these purposes.