Not substantively important, since Obama said nothing surprising in Berlin, but I enjoy well-constructed speeches, so here are a few things I noticed.

In the run-up to Obama's Berlin speech, much has been made of the obvious echos of JFK and Reagan. As the speech is picked over (now and for years to come), all sorts of allusions will be identified, starting with the obvious "walls that cannot stand": "These now are the walls we must tear down."

There are also the familiar little Lincoln motifs -- used less for content than because they are so evocative to our ear, a bit like the King James version for earlier centuries: "now the world will watch and remember what we do here," "form a more perfect union."

What I find continually interesting in Obama's speeches, however, are not just the individual quotations or flourishes, but the way he uses references or allusions to other famous and familiar speeches to structure his own in unexpected ways. His national security speech of July 15 used George Marshall's Harvard speech, but not as a cliched call for another Marshall Plan. Rather, he invoked Marshall as an example of someone who responded with imagination and judgment to a world that presented an entirely new set of challenges -- that changing our "mentality" about our role in the world is as important as any specific policy or Marshall Plan.

Today, a central "structuring" reference comes at the end of Obama's speech. It's not from a speech by an American in Berlin but is equally relevant for the Berlin location because it was from FDR's Four Freedoms speech, delivered in January 1941 when Nazi Germany was FDR's primary concern.

Here's FDR's State of the Union in January 1941:

In the future days, which we seek to make secure, we look forward to a world founded upon four essential human freedoms.

The first is freedom of speech and expression--everywhere in the world.

The second is freedom of every person to worship God in his own way--everywhere in the world.

The third is freedom from want--which, translated into universal terms, means economic understandings which will secure to every nation a healthy peacetime life for its inhabitants-everywhere in the world.

The fourth is freedom from fear--which, translated into world terms, means a world-wide reduction of armaments to such a point and in such a thorough fashion that no nation will be in a position to commit an act of physical aggression against any neighbor--anywhere in the world.

Obama uses the Four Freedoms to wind up his remarks, presenting them as the ideals that both form the basis of American identity and that are shared with the world -- and via his own father, how he personally came to be both a proud American and, echoing JFK's inaugural,* a "fellow citizen of the world." This links back directly to how he identified himself when he began the speech:

I come to Berlin as so many of my countrymen have come before. Tonight, I speak to you not as a candidate for President, but as a citizen – a proud citizen of the United States, and a fellow citizen of the world.

.
And then the Four Freedoms and how they connect to both his personal identity and that of his audience:

>What has always united us – what has always driven our people; what drew my father to America’s shores – is a set of ideals that speak to aspirations shared by all people: that we can live free from fear and free from want; that we can speak our minds and assemble with whomever we choose and worship as we please.

He then segues to reinvoke Berlin's history, which he had earlier described extensively. The Berlin reference hooks the end of his speech back to his introduction of himself to the audience via an echo of JFK's "Ich bin ein Berliner". When Obama says at the outset he is "a fellow citizen of the world", he shows us by the end of the speech that it is the same claim of citizenship that JFK made.

Rather than repeat explicitly JFK's self-identification as a Berliner, Obama gets to the same place at the end of his speech by connecting the Four Freedoms with the world's response to the Berlin airlift:

It is because of these aspirations that all free people – everywhere – became citizens of Berlin.

So the rhetorical connections are:

• Obama via his father: and JFK Four Freedoms = proud citizen of US + fellow citizen of the world and


• Obama via JFK and Cold War generations:Four Freedoms and Berlin airlift = citizen of Berlin

The final formula, linking the opening and concluding paragraphs, is: FDR's Four Freedoms (American ideals and universal aspirations) plus shared historical experience (JFK and Cold War generations in Berlin) plus a partnership for the future (Obama and audience in US and Europe.

Here are the final paragraphs of Obama's speech.

But I also know how much I love America. I know that for more than two centuries, we have strived – at great cost and great sacrifice – to form a more perfect union; to seek, with other nations, a more hopeful world. Our allegiance has never been to any particular tribe or kingdom – indeed, every language is spoken in our country; every culture has left its imprint on ours; every point of view is expressed in our public squares. What has always united us – what has always driven our people; what drew my father to America’s shores – is a set of ideals that speak to aspirations shared by all people: that we can live free from fear and free from want; that we can speak our minds and assemble with whomever we choose and worship as we please.

These are the aspirations that joined the fates of all nations in this city. These aspirations are bigger than anything that drives us apart. It is because of these aspirations that the airlift began. It is because of these aspirations that all free people – everywhere – became citizens of Berlin. It is in pursuit of these aspirations that a new generation – our generation – must make our mark on the world.

People of Berlin – and people of the world – the scale of our challenge is great. The road ahead will be long. But I come before you to say that we are heirs to a struggle for freedom. We are a people of improbable hope. With an eye toward the future, with resolve in our hearts, let us remember this history, and answer our destiny, and remake the world once again.

---

* Given all today's right-wing ruckus over "fellow citizen of the world", here's the quote from JFK's inaugural address:

And so, my fellow Americans: ask not what your country can do for you—ask what you can do for your country.

My fellow citizens of the world: ask not what America will do for you, but what together we can do for the freedom of man.

I don't know what has been more fun to follow over the past few days -- the McCain campaign's scramble to play catch-up with Maliki's suppport of an Obama-esque timetable, or the US media starting to go all-meta on their own coverage of the Obama trip. There are too many gems for a single QOTD, so here are a few highlights.

The first stage of "We're f**ked" is Denial

Even though McCain was given an extra 24-hour news cycle -- the delay in coverage by the NYT and WaPo was, as Steve Benen remarked, journalistic malpractice -- he and his campaign are running around like ham-handed headless chickens. They seem to be stuck in the Denial Stage even though the evidence was clear from the outset that Maliki was serious.

The focus in the media and in the McCain campaign's (various) responses has been on whether Maliki really gave a quasi-endorsement of Obama's "sixteen months" -- the whole walkback nonsense. However, the interview has been on Spiegel's site since Saturday, and in the interview Maliki expresses several times the need for an end-date, the sooner the "more realistic". There could have been no confusion on McCain's staff about the overall thrust of Maliki's position if they read the interview. The "mistranslation" excuse was transparently feeble from the outset.

For all McCain's vaunted international experience, this episode is displaying him as someone who isn't what we might call "agile" at handling an unexpected international curveball. Joe Klein hit exactly what I've been thinking:

I suppose that McCain's stubborn brittleness on this subject isn't news. But his inability to respond to a major change in policy from our Iraqi allies -- the announcement that they can take it from here -- certainly is newsworthy. There are three possibilities:

• McCain doesn't believe the Iraqis can take it from here. (In the most benign reading, he may see this new position as mere domestic political posturing on Maliki's part, which is no doubt part of the truth.)


• McCain doesn't want the Iraqis to take it from here. He still wants long-term, 100 year, military bases.


• McCain doesn't move very quickly to adapt to changing facts on the ground. None of them speak very well of the guy. [emph. added]

I think it's "all of the above" -- but especially the last factor. McCain is so wedded to a particular view of the Iraq War, the GWOT, and the US role in the Middle East, that he can't adapt. If he had had a more realistic understanding of the situation, Maliki's remarks wouldn't have -- or more accurately, shouldn't have -- come as such a bombshell.

The second stage of "We're f**ked" is Anger

Some of McCain's supporters are ahead of their candidate and acknowledging that Maliki appears to mean what he says. But that's not to suggest they're to the Acceptance stage yet. They're getting mad that "our guy" isn't following the script. Rob Farley's been tracking the emergence of the Anger crowd at the Corner.

At 11:38 AM EDT, Rob remarked (echoing a constant refrain of our own Eric Martin):

The conservative media and Right Blogistan have been undertaken to steadfastly ignore any hint that Prime Minister Maliki might and his political allies might have connections with Iran, preferring instead to assert that Iran influences events in Iraq through Sadrist militia and Sunni tribes (!). Given Maliki's statements on withdrawal, I wonder this: How long it will take for an anti-Maliki trope to develop on the American right that concentrates on his Iranian connections?

Ask and ye shall receive! Less than two hours later, Rob noted:

Andrew McCarthy answers my question:

As I've mentioned before, Maliki, of the Shiite Dawa Party which opposed the 2003 U.S. invasion of Iraq in the first place, has long-standing ties to Iran and Syria -- and has expressed support for Hezbollah. The only thing that surprises me about this story is that anyone is surprised.

McCarthy also chides Maliki for being insufficiently grateful for the awesomeness of the Surge. Look for more of this as Maliki fails to walk back his statements...

But as Daniel Larison points out, maybe John McCain is simply too confused to be angry.

McCarthy is entirely right in what he says here, but that raises a couple questions. First, there is the obvious question of why the U.S. is attempting to pursue a strategy premised on limiting Iranian influence in Iraq and the region while actively backing a government that has no intention of limiting Iranian influence in Iraq and very clearly is led by a sectarian party.

[snip]

Even more than creating a political problem for McCain back home, Maliki’s recent statements have revealed both the untenability of a continued U.S. presence in Iraq and the complete incoherence of U.S. strategy in that country.

Serious ouch! And then John Derbyshire added his two cents. Again from Rob:

Shorter Derb:

All of your country are belong to us now.

Verbatim Derb:

We should tell Maliki, loudly and in public, that he owes his job to us, and that further prosecution of our military operations in his country will be conducted with regard only to U.S. interests, as determined in consensus by our established domestic political processes. And if he doesn't like that, he can go to hell.

God, I am so glad that this incident has caused the right to discard its phony interest in democracy promotion...

To be fair to Derb, he's always been a "To Hell With Them" Hawk, so his sentiments should come as no surprise. As he remarked today: "This absurd and insane desire to be loved and admired by foreigners will be the death of this republic." Derb doesn't have to do Denial -- he starts (and finishes) with Anger.

Those "Listening to Commanders on the Ground" C-i-C Credentials

If there was one piece of Conventional Wisdom we've heard for the last week about Obama's Grand Tour it was that the trip was risky but necessary. Obama had to show voters he would be "acceptable" as Commander-in-Chief. Obviously, he wouldn't be better at foreign relations than the tough, seasoned veteran, John McCain, but Obama had to somehow find his way across the "acceptability barrier."

So here's the Photo of the Day (photo released by US Army via Mark Halperin).

As Michael Crowley notes: "Hmmm, Petraeus doesn't look like he's been telling Obama he's a defeatmonger. "

Worse yet for McCain image-wise are these photos paired together by Ben Smith of Politico: "It's not really close," says Ben. Heh, indeed!






And what would be a Circus without Coverage of the Coverage of the Coverage...

Jesse Taylor is back!

Despite the fact that his foreign policy vision has been largely validated in the past week - McCain caught up to Obama on Afghanistan and the aforementioned endorsement by Maliki - the main discussion today and over the past few days has been whether or not the press is covering Obama’s trip too much and whether or not the coverage of them talking about the coverage results in too much (and too favorable) coverage for Obama. It’s a tesseract of inanity - a new fourth dimension of coverage about the coverage of the coverage will soon emerge, with Jessica Yellin invited on to discuss how she talked about her in-depth discussion of the impact of Obama’s trip on the race...without ever mentioning what Obama did, how he did it or who he did it with.

Call it the Fafblogging of the media: CNN is the whole world’s only source for CNN! [emph added]

Now if we only still had Billmon!

This item from Mark Murray at MSNBC's First Read is worth copying in full:

Remember that letter that South Carolina Sen. Jim DeMint (R) sent to Obama -- over the fact that the Foreign Relations subcommittee that Obama chairs hasn't held a hearing on the issue of Afghanistan?

Well, Foreign Relations Committee chairman Joe Biden -- a possible Obama veep pick -- responds to DeMint with his own letter. "As you are aware, under my chairmanship the Foreign Relations Committee has addressed most Afghanistan issues at the full committee level. I believe that this is the best way of ensuring the most comprehensive examination of the complex issues involved, and of ensuring the highest-level Administration participation," he writes.

"On the particular issue of NATO’s mission in Afghanistan, we have held three full committee hearings in the last 22 months... At all three of these hearings, we were fortunate enough to have the expert testimony ... of former NATO commander and Supreme Allied Commander-Europe, Gen. James R. Jones (USMC, ret.). At my request, Sen. Obama chaired the confirmation hearing for our next ambassador to NATO, which he focused on NATO’s mission in Afghanistan."

Biden concludes, "Sen. Obama has displayed great leadership on this issue: he called nearly a year ago for the deployment of at least two additional combat brigades to Afghanistan -- it has since become the accepted position of a wide range of U.S. military officials, including the Chairman of the Joint Chiefs of Staff. I look forward to working closely with him, and with you, on any future Afghanistan hearings that might be held in our committee."

---

UPDATE: And the Pentagon seems to have Obama's back as well. From the AP.

Pentagon leaders on Wednesday signaled a surge in U.S. forces in Afghanistan "sooner rather than later," a shift that could send some units there within weeks, as officials prepare to cut troop levels in Iraq.

Senior military officials are looking across the services to identify smaller units and other equipment that could be sent to Afghanistan, according to a defense official.

Although there are no brigade-sized units that can be deployed quickly into Afghanistan, military leaders believe they can find a number of smaller units such as aviation, engineering and surveillance troops that can be moved more swiftly, said the official, who requested anonymity because the discussions are private.

The moves are expected to happen within weeks rather than months, the official said.

The decisions are being made against the backdrop of shifting priorities for the U.S. military, and were discussed during a meeting Wednesday of the Joint Chiefs of Staff.

Military leaders are weighing requests from commanders in Afghanistan for more troops, aircraft and other assistance. And they are trying to determine the right balance between the needs of the force in Iraq, versus troops in Afghanistan who are facing a Taliban resurgence.

To date, the fight in Afghanistan has taken a back seat to Iraq, which has been the strategic priority. While Iraq will remains the top goal, it now appears the military believes there should be a more urgent emphasis on Afghanistan than there has been.

Cross-posted at American Footprints

To follow up on Armchair General's post on Burns' announced participation in talks with the Iranians and Haggai's comment that this may be following the North Korea multilateral pattern.

One further thought on the mini-"opening" to Iran, especially if the Guardian is right that State is going to get its way finally and be allowed by the White House to open a US interests section in Teheran.

I think the White House has finally become seriously spooked about Pakistan. When Benazir was assassinated, they lost Plan A and there never was a Plan B. They've been treading water while watching things go from bad to worse in both Pakistan's domestic political chaos and in the border areas with Afghanistan. The US doesn't have more troops to put in, and even if there were a few more brigades available, everybody (except Mr "I authored the Surge(TM)" McCain) seems to realize that the military isn't going to solve this problem, it's only a finger in the dike.

Whoever is the new President come January, US-Pakistan policies are going to have to be reworked entirely. The Biden-Lugar economic aid package, which Obama is sponsoring, is just the first step.

But one factor surely is common to any options for dealing with Af-Pak -- keep western Pakistan stable. Which means having cooperative, if not cordial, relations with the Iranians re Afghanistan has become more than just desirable -- it's an absolute imperative.

Bill Varner at Bloomberg reports today on this topic, although it's framed as the sorts of trouble Iran could cause if it were attacked. However, Varner's observations are equally relevant to the options the US faces in adjusting its approach to the Afghanistan-Pakistan gordian knot.

Khalizad is making noises about the potential mischief Iran could make, and US Ambassador William Wood is claiming that Iran is helping arm the Taliban, under the "fingers in every pot" theory of influence. The Iranians themselves are miffed that the US didn't build on their initial cooperation when the US first invaded Afghanistan, so they're not rushing to help the US counter the Taliban. One assumes, however, that the Iranians aren't eager for western Afghanistan to become a Sunni fundamentalist hotbed. So the US objective should be to persuade the Iranians to shift back to their more cooperative mode on the Taliban.

While the world focuses on tensions between Afghanistan and Pakistan 800 miles to the east, U.S. officials keep watch on Iran's expanding presence in Herat and the surrounding province of 2 million people. The region might play a major role if conflict erupts over Iran's nuclear program.

Should Iran's nuclear ambitions spark hostilities, it would use its sway in western Afghanistan as a ``bargaining chip,'' said Afghan-born Zalmay Khalilzad, the U.S. ambassador to the United Nations and former envoy to Kabul. If attacked, Iran ``could make life difficult for us'' in Afghanistan, he said in an interview.

Iran has ``intelligence operatives everywhere, military commanders who work for them'' in the region who could be deployed to stir up trouble, including riots, said Barnett Rubin, an Afghanistan specialist at New York University's Center on International Cooperation.

For now, Tehran's investment of $500 million in the region has helped the U.S. by minimizing the influence of the Taliban extremists who once ruled the country and the sort of violence they have inflicted on southern and eastern Afghanistan. Iran paved half of Herat's streets and 40 miles of highway leading north, built schools and health clinics and partnered with Afghan companies in an industrial park.

``It's not just investments, but also trade,'' said Ali Shah Ahmedi, the 43-year-old manager of Herat's Tejarat Hotel. ``I have Iranian businessmen staying here all the time, coming to buy or sell goods'' such as packaged foods and motorcycles.

Sana, 42, holds forth from his office in the Herat Trade Center, a modern nine-story building of gleaming blue glass that helped inspire residents' nickname for their city: ``the Dubai of Afghanistan.'' A hotel, law offices and a finance company that supports farmers are connected by an Afghanistan rarity: an elevator.

Traffic lights in Herat work, in contrast to the capital, Kabul, so vehicles flow smoothly around the Blue Mosque, an 800- year-old, blue-tiled landmark. Herat is cleaner than Kabul, with more trees and parks, and less dangerous, with fewer visible police and troops.

Ties between Iran and Herat run deep. The city was the capital of 15th-century Persia, and Iran held Herat until midway through the 19th century. Heratis, mostly Sunni Muslims, today speak a dialect closer to the Farsi spoken in Tehran than the Dari used in Kabul.

Predominantly Shiite Iran opposed the Sunni Taliban -- who refused to educate girls when they ran Afghanistan, among other strictures -- as extreme.

After the Taliban were toppled for harboring the terrorists behind the Sept. 11, 2001, attacks, Tehran's government helped the U.S. and the UN begin the political transition that led to Hamid Karzai's election as president.

Iran's leaders feel that contribution wasn't properly acknowledged, said Manouchehr Mottaki, its foreign minister. The slight explains their refusal to help fight the Taliban's current insurgency, he said.

``We limit our cooperation with Afghanistan to helping reconstruct the country,'' Mottaki told reporters at the UN on July 2.

William Wood, the U.S. Ambassador to Afghanistan, said Iran now helps arm the Taliban. Tehran's policy is to ``make everyone a loser'' in Afghanistan, he said in a Kabul interview.

Karzai is ``walking a very fine line'' and doesn't accuse Iran of actively supporting the insurgents, said Humayun Hamidzada, the president's chief spokesman.

``President Karzai believes Iran has a positive role to play in Afghanistan,'' Hamidzada said last week in Kabul. ``We are working with the U.S. and Iran, and don't want to become the battleground for their conflict.''

Iran's presence in Afghanistan will be an issue for the next U.S. president.[No kidding!!!]

I would be astonished if the Bush Administration were able to make significant headway with the Iranians on Afghanistan, even though it's clearly in both nations' interest to cooperate. The calendar is increasingly becoming a tyrant for the Bush Admin. There are too many interrelated regional issues within which the nuclear matters (and Iran's long-term security interests) will have to be addressed, and too few months until the height of the election campaign. It's too hard to break the Iranian relations into discrete pieces -- nuclear, Iraq, Afghanistan, Lebanon, etc. -- because they're so intertwined. So there's really no way to avoid linkage.

The Bush Administration would also have to go a long way to convince the Iranians they should deal with Bush now rather than wait for the new US President. And whoever the elected President is, he's going to want to have his own say in any overall deal with the Iranians.

However, W seems to be heavily invested in "legacy" planning. I expect he'd like to be able to claim credit for having "laid the foundations" for future progress on these issues to mitigate the blame for leaving an unholy mess behind in Af-Pak. Hence his stated intention, as Haggai noted, that "he expected his remaining months in office to 'leave behind a multilateral framework' for dealing with Iran."

It will be interesting to see how far Bush's commitment to his own "legacy" leaves McCain dangling in the wind on the campaign trail.

---

UPDATED:  Another sign that the White House is increasingly spooked by Afghanistan-Pakistan is this AP interview yesterday with an unidentified "defense official." It suggests the intensity of the scramble underway to meet the needs for additional forces in Afghanistan, which Sec Gates and Adm Mullen have been discussing with the press:

Senior military officials are looking across the services to identify smaller units and other equipment that could be sent to Afghanistan, according to a defense official.

Although there are no brigade-sized units that can be deployed quickly into Afghanistan, military leaders believe they can find a number of smaller units such as aviation, engineering and surveillance troops that can be moved more swiftly, said the official, who requested anonymity because the discussions are private.

The moves are expected to happen within weeks rather than months, the official said.

The decisions are being made against the backdrop of shifting priorities for the U.S. military, and were discussed during a meeting Wednesday of the Joint Chiefs of Staff.

No wonder McCain suddenly announced the need for one of his Surges(TM) for Afghanistan on Tuesday.


Cross-posted at American Footprints.

At his press conference yesterday, President Bush assured his listeners that he won't do financial sector bail-outs.

President Bush also wanted fast action on his latest proposal to rescue Fannie Mae and Freddie Mac in Congress. He strongly endorsed Treasury Secretary Henry Paulson's plan but asserted definitively that the two companies would continue to be held by private investors. Bush also rejected the notion that the government would bail out any private enterprise.

But, but... government support for Fannie Mae and Freddie Mac that doesn't wash out current equity holders is... ummm, how shall we say this... exactly what a "bail-out" is. If we provide financing to keep Fannie and Freddie up and running but leave the equity holders in place, when their shares are underwater, we are bailing them out!

The best summary I've seen of the Fannie/Freddie situaton -- history and current problems -- is by Tanta at Calculated Risk. As they say, read the whole thing. Looking at the core function of the GSEs (government sponsored enterprises) -- which is to provide liquidity to the mortgage origination markets -- she explains:

They have always been about recycling lending capital and taking long-term fixed interest rate risk off depository (and eventually non-depository) lenders much more than about merely absorbing credit risk. This goes against the grain of much current media over-simplification of "securitization" of mortgage loans that sees laying off credit risk as the main or even the only point of selling loans. The GSEs do take on the credit guarantee obligation of the securities they issue, but nobody sells loans to the GSEs just to offload credit risk--in fact, more than a few lenders work hard to negotiate contracts with the GSEs that leave quite a substantial part of the credit risk with the original lender: recourse agreements, indemnifications, servicing options that put a lot of the cost of default on the seller/servicer, not the GSE. They have historically done this because the credit risk of GSE-eligible loans has always been modest, but the benefits of getting 30-year fixed interest rate loans off your balance sheet has been substantial.

For decades, I have believed that Fannie and Freddie either should not have been privatized or should have been more strictly reined in. They serve, and must continue to serve, a critical function for US (and gobal) debt markets. But they're not ordinary financial institutions. They are public utilities which shouldn't be managed, as private financial institutions are, primarily for the benefit of the holders of their capital base (as currently structured, common and preferred shareholders) and their management.

The backing of the Federal government is the sine qua non of these institutions' existence and successful functioning. Without that implicit guarantee, they would never have fulfilled their public roles -- providing reliable liquidity to the mortgage markets in good times and bad, and setting widely-adopted standards for loan origination and servicing, which made the development of a healthy mortgage-backed securities market possible in the first place.

In recent years, managers and shareholders of the GSEs grew sloppy and forgetful about the real nature of these institutions. They forgot the instiutions were public utilities and that they had a duty to protect the implicit guarantee which made their business possible. Instead, they adopted the same expectations as typical corporate management and equity holders, with a focus on growth, retaining market share in a rapidly growing and increasingly risky market, and pumping up earnings, in order to justify huge executive compensation packages and higher share prices. They also had a lousy corporate governance structure, about which critics on both left and right have complained for years.

When housing market innovations started leaving them behind, instead of sticking to their knitting, they went running to Capitol Hill, where they enjoy enormous power on both sides of the aisle. They were allowed to stray into parts of the housing bubble where they didn't belong while simultaneously ignoring and taking advantage of the implicit government guarantee. Their behavior helped to magnify the overall size of the housing bubble and delay its bursting. (See Tanta for a nice summary of recent history.)

Today, the leverage ratio of Fannie's equity to on- and off-balance-sheet liabilities is, depending on which measure one uses, between 68:1 and 128:1. By comparison, leverage for a healthy private financial institution is likely to be in the range of 10:1 to 20:1, depending on what lines of business it is in. The implications of that excessive leverage are spelled out in a restructuring plan proposed by hedge fund manager William Ackman of Pershing Square Capital Management. (See attached pdf, which is an excellent view of the situation, regardless of what you think of Ackman's proposed solution). As Christine Richard of Bloomberg explains:

Ackman, 42, has his own plan that would see Fannie Mae raise about $86 billion in capital by giving investors in $750 billion of senior unsecured notes 90 cents on the dollar in debt of a new company, with the balance in equity. Investors in Fannie Mae's $11 billion of junior debt would get warrants, while common and preferred shareholders would get nothing, according to Ackman.

``We've not yet heard Secretary Paulson's plan but it would be a grave error for the government to invest in the equity of Fannie Mae and Freddie Mac as they are currently capitalized,'' Ackman, who oversees $6 billion at Pershing Square Capital Management in New York, said in a telephone interview.

[snip]

``The good news is that Fannie Mae has all the capital that it needs,'' Ackman said. ``It just has the capital in the wrong form with too much debt and not enough equity.''

Ackman also suggested the government put in place a stand-by purchase commitment for the new common stock for three years. The government is unlikely to be asked to buy any shares as there would be market demand for equity in the better-capitalized companies, Ackman said.

Although much has been made of the declining quality of the GSEs' portfolio, Ackman's plan shows how the structure of their balance sheets is at the heart of their current difficulties. Even if they hadn't wandered into high risk business, given how highly leveraged they are, Fannie and Freddie would today be nearing the point where the government guarantee would be called into play simply because the drop in housing prices nationally has been so large. The rule of thumb for Fannie's plain vanilla mortgage financing is a minimum 80% Loan to Value (LTV) ratio. That means, in some regions of the country, a large number of mortgages will now exceed the current value of the underlying real estate even if they continue to be performing. That's not the "fault" of the GSEs and doesn't suggest they should stop doing business -- as the housing sector continues to collapse, they are needed now more than ever. Being able to ride through periods of large drops in underlying asset values and growth in non-performing assets is one of the reasons why we have the GSEs in the first place.

In effect, the GSEs are designed to be "bailed out" by the government when market conditions demand. When the government steps in, the GSEs require restructuring and new capital, with existing equity being heavily diluted if not wiped out. That didn't really matter when the government owned the institutions. But when they were privatized and the equity in the GSEs was sold to private investors, the share price should have reflected the risk of dilution if the goverment's implicit guarantee was called. Yet that wasn't the case -- the GSEs behaved, and the market priced their shares, as if there was no risk that the guarantee would be necessary even though their balance sheets were built on the basis of the implicit guarantee. The recent plunge in their share prices is simply the market finally pricing the GSE equity to reflect the central fact that defines their business.

As many have observed today, yesterday's prohibition by the SEC against naked short positions in the shares of the GSEs is either simply political theatre or a case of the panics. (See e.g., Dean Baker, Dealbreaker, Felix Salmon). There are other ways than naked shorts for investors to bet, so the objective of the move is unclear. In any event, even if it Cox's game slows the price decline, it isn't going to make those shares worth any more than they already are, which fundamentally is zero.

The only thing which allows the shares to retain any market value is the political optics against "nationalization" of the GSEs. Together with President Bush's comment, the SEC's concern with the declining market price of GSE shares suggests that, although Treasury Sec Paulson hasn't described the conditions under which the government would provide an equity injection, nonetheless a figleaf of private equity will have some sort of role.

By trying to discourage a fall in share price, the government seems to be encouraging investors to believe in fairy tales -- that a restructuring may not be necessary or that current equity holders may not get washed away entirely in the restructuring-to-come. But if leverage ratios are to be brought down to somewhere closer to earth, new private equity won't come in without the existing equity being washed out. If existing equity holders retain a place in a new capital structure, it will be only because, in effect, the government has provided equity financing at rates far below what the private sector would demand.

Contra President Bush, there's going to be a bail-out. The only questions are how and how much. Retaining a role for private investors in the GSEs as Bush and Cox appear to suggest -- without restructuring the roles of the GSEs and their balance sheets -- is the very essence of the worst kind of government bail-out. Privatize the profits and socialize the costs.

Cross-posted at American Fooprints.