Combined, these factors force states to cut services to their neediest residents during a time when the need is greatest. The perversity of that equation hasn’t been lost on Paul Krugman, the Nobel Prize-winning economist, who uses his column in The New York Times today to push for a Medicaid program funded solely by the federal government, which can borrow money in a recession to meet the budget challenges when more and more people become Medicaid-eligible. From the column:

[S]hredding the social safety net at a moment when many more Americans need help isn’t just cruel. It adds to the sense of insecurity that is one important factor driving the economy down. [...]

As a nation, we don’t believe that our fellow citizens should go without essential health care. Why, then, does a large share of funding for Medicaid come from state governments, which are forced to cut the program precisely when it’s needed most?

This is hardly a change of heart for Krugman, who has long-advocated for the creation of a nationalized health care system. But reforms of such magnitude don’t happen in times of non-crisis (Just ask the Clintons). Whether the current recession will force Washington policymakers to consider some reworking of Medicaid’s funding mechanism has yet to be seen. But you can bet that roughly 50 state governors would be behind such a change.

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.

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.

Headlines noted that Greenspan acknowledged his misplaced faith in the ability of free markets to correct themselves. But he also did something else — he didn’t point to the Community Reinvestment Act as the cause of the foreclosure crisis, a belief widely embraced by many conservatives.

According to the New York Times, Greenspan told Congress that “excess demand from securitizers” fueled the subprime bubble. He didn’t contend that civil- rights activists had overrun the administrations of Bill Clinton and George W. Bush to force the government to make loans to poor borrowers.

So now it’s all on the record.  Let’s put the whole blame-the-CRA thing to rest. Greenspan’s credibility might not be what it once was, but he’s hardly a bleeding heart, either. And even he’s not blaming low-income borrowers.

Or, as Morris put it:

“The Maestro has spoken. As the sportscasters say, ‘Put it in the books.’”

With a credit crisis that deepens and changes in scope almost daily, you can’t blame candidates for trying out new ways to address the country’s problems. But these new economic plans, coming just three weeks before the election, don’t have the feel of solutions carefully thought out to tackle complex, global difficulties for an economy on the brink.

McCain announced over the weekend he had a plan for Monday, then he didn’t, then he does, but it’s for Tuesday.

Obama included an idea for a 90-day moratorium on foreclosures that his primary opponent, Sen. Hillary Rodham Clinton, introduced last spring, with no explanation for why it’s suddenly a good idea now. All this makes McCain and Obama seem less like statesmen and more like two candidates standing in a kitchen next to a pot of boiling water on the stove, throwing spaghetti at the wall to see if it sticks.

When Clinton put forward her moratorium idea during the primary, economist Dean Baker correctly pointed out that it could lead to a wave of foreclosures as lenders would rush to take action before the moratorium. Obama’s camp says his proposal would apply only to banks that participate in the government’s $700-billion rescue package, and is meant for people who are making some payments on their mortgages, but can’t cover the full amount.

So if I’m someone struggling every month to meet my mortgage payment, wouldn’t I be slightly tempted to pay just a portion, knowing I won’t be foreclosed on, at least for 90 days? And why 90 days, anyway? Why not 95 days? Or nine months?

And what happens when the next wave of resets for adjustable rate mortgages rolls around? More moratoriums?

Today is McCain’s turn to take a crack at this, but this late in the game for both candidates, I can’t say we should expect the kind of well-thought out plans voters deserve.

Consider all that’s happening right now. We just nationalized nine banks, essentially. As Charles R. Morris points out on TWI today, the Federal Reserve in the last three weeks extended $650 billion in credit, nearly the total of the entire bailout plan. But we’re not talking about that. Instead, the candidates are quibbling over the margins of the tax code for retirement savings accounts and offering “relief” to the middle class.

It’s undignified to come up with gimmicks in the middle of a crisis. If you want to test the pasta, take out a few stands with a fork and let it cool in the strainer. Don’t take shortcuts in your kitchen.

Demand the same of your candidates.

You’ll remember that he canceled an appearance on the show last month when he dramatically “suspended” his campaign to fly to Washington to save the country from financial ruin.

One has to wonder what kind of reception McCain will receive from Letterman.

In phoning Letterman to cancel his appearance, the Arizona senator had told the comedian that he was headed straight from New York to Washington. But when Letterman caught him in a makeup room at CBS studios preparing for an interview with news anchor Katie Couric, he turned more than a little hostile toward McCain and his campaign.

He ranted continuously about McCain’s duplicity. He questioned what had happened to the man he had respected. He wondered openly if McCain had not come on his show because of dropping poll numbers.

But now McCain will return….we think.

He won’t be the same man who was booked in September. Since then, the tenor of McCain’s campaign has grown darker and darker, and the Arizona senator has morphed from an affable, friendly face into a man who exudes flashes of anger and resentment. During the presidential debates, he has appeared at times  to  seethe at Obama, trying his best not to look at him directly. In the town-hall style debate moderated by Tom Brokaw, he referred to his Democratic counterpart as “That One.”

While McCain preps with one-liners, one can only think that Letterman will be ready to pounce on McCain, whose campaign he has said more than once was starting to “smell.”

During these final weeks of the campaign, McCain could use some friends in the media. But he probably won’t find one on Thursday, and maybe, considering what’s happened these recent weeks, one wonders whether he’ll ever find one again.

The list of major subprime lenders for 2006 and 2007 resembles the casualty roster from the Battle of Verdun in World War I. Only difference: way fewer walking wounded this time.

Of the 30 biggest subprime home lenders in 2006, measured by dollar volume, 22 have gone bankrupt, shut down, been sold or been seized by Uncle Sam. Most of the survivors have scaled back.

I guess the warnings all those years from the housing and consumer groups who regularly testified before the Federal Reserve were right on the mark after all. Too bad no one ever listened. The only bright spot here: It’s not like we’ll miss any of these lenders.

RIP, subprime.

And remember about the door on your way out.

Treasury Secretary Henry Paulson (WDCpix)

Congress’s failure to pass the Bush administration’s financial plan has triggered a wave of scare commentary -– “financial Armageddon,” a leap “off the cliff” or “into the abyss,” the trigger for “the Depression of the 2010s.”

There have been good background analyses of the $700 bailout plan in both The Economist and The Wall Street Journal. Two weeks ago, after Federal Reserve Chairman Ben Bernanke and Treasury Sec. Henry Paulson Jr. refused to rescue Lehman Brothers from bankruptcy, they were shocked at the subsequent reaction in credit markets. Sorting out claims was far harder than expected, and the losses on Lehman paper had a nasty snapback on supposedly safe money market funds.

Illustration by: Matt Mahurin

Shaken, Bernanke and Paulson decided that they couldn’t risk any more major bank failures. Instead, they decided to re-capitalize the industry by buying up its bad assets. The $700-billion price tag was just a guess. The terms of the purchase were intentionally loose to make it an offer that the banks couldn’t refuse, or even haggle over.

Paulson was called “The Hammer” on Wall Street. In a classic “bear hug” acquisition, you stampede the target’s board by the early release of an attractive proposal to shareholders. He used the same tactics with the U.S. Congress. To less effect.

By announcing the bailout to the public even before the congressional briefings, Paulson counted on, and got, a huge market recovery. He was essentially daring Congress to turn him down. But it did.

The plan was misrepresented from the start. The core problem is that banks are carrying toxic assets at far more than their true market value. If they mark them correctly, however, the accounting losses will wipe out their capital.

So the only way a bailout can “recapitalize” them is by vacuuming up the bad assets at much more than their true value. Taxpayers will get some money back at some point — but not much.

Nor does the plan have anything to do with preventing a recession. Major-market house prices more than doubled from 2000 through 2005; that’s about a 14 percent annual growth rate, the highest on record. If you bought a house with 1 percent down, which was easy, you got your investment back sevenfold in just three years!

With the value of the underlying assets growing so fast, banks lent to anyone on anything, and mounted second mortgage marketing campaigns to get current homeowners to cash in their paper gains. There were similar, if smaller scale, bubbles in corporate takeover loans, commercial real estate and auto loans.

Home-equity loans paid for 6 percent of all consumer spending from 2000-2007. Now that consumers are maxed out on debt and house prices are dropping back toward normal levels, that source of cash is gone. Consumer spending must go down — a lot. That’s why we’re in a recession, and the bailout can’t do much, if anything, about it.

How many votes would the bailout plan have gotten if the administration and the congressional leaders had told the truth — that this is a bank bailout that won’t prevent a recession or help homeowners?

Saleability aside, is the Bernanke-Paulson plan really such a good idea? One leading economist insists that it’s necessary to avoid the “destructive power of deleveraging.”

But excessive leverage is what the crisis is all about. Deleveraging, however painful, is the solution, not the problem.

Today, panicky interbank markets pushed the overnight lending rates to 7 percent. But a quarter-century ago, then-Federal Reserve Chairman Paul Volcker intentionally pushed the overnight lending rate to 19 percent(!). He had chosen to spike inflation by choking off the supply of money and credit, knowing that he would trigger a vicious recession.

Real gross domestic product dropped 1.9 percent in 1982 — the worst downturn in postwar history. President Ronald Reagan, Republicans might note, supported Volcker all the way. Together, they laid the groundwork for the strong growth of the 1980s and 1990s.

Bernanke and Paulson talk about a recession as if it’s the equivalent of a nuclear holocaust. It’s not.

The whole country has grossly overspent its income for the last half decade and is wallowing in unpayable debt. The leveraging-up process has also created a bloated and omnivorous financial sector that needs to be shrunk drastically.

In short, it’s about the same scale of problem that Volcker faced in 1982, and warrants similar resolve. Many banks will doubtless fail without the bailout, with possibly severe short-term consequences. The long-term cost of a zombie financial sector on life support might be even higher.

The bailout was a questionable idea at best, made worse by the ram-through attempt and the misleading sales pitch. And neither presidential candidate has any stake in delaying the start of a recession until he takes office, and gets stuck with the blame.

So Congress did the right thing. It’s time to let the bailout die.

Charles R. Morris, a lawyer and former banker, is the author of “The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash.” His other books include “The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy” and “Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

The Democratic nominee spoke with the president “about the need to push for a package that Congress can agree on,” Obama spokesman Robert Gibbs told the traveling press corps. “Sen. Obama specifically brought up his proposal to increase the amount of money that is federally insured in order to more fully protect small businesses and families concerned about their savings,” he added, “believing that such a proposal can broaden the coalition supporting the package.” 

There was no word, of course, on Bush’s side of the conversation.

While Obama is not shifting any campaign events in response to the failed bailout vote, his aides arranged a trio of taped interviews with the TV networks after today’s rally. Obama will take questions from ABC, NBC and CBS on what comes next for the bailout plan.

“While the decline of the stock market is devastating,” Obama is planning to say at today’s rally, according to prepared remarks, “the consequences of the credit crisis that caused it will be even worse if we do not act — and act immediately.”

Unlike his rival, Obama thinks he can be most effective galvanizing support for that immediate action by taking his message to the public — through events and national media appearances — rather than whipping votes in Washington.