This is a rush transcript from "The Journal Editorial Report," December 27, 2008. This copy may not be in its final form and may be updated.

PAUL GIGOT, FOX HOST: Up next on "The Journal Editorial Report," the biggest stories of 2008. From Barack Obama's historic election to the financial and economic meltdown, our panel looks at the highs and lows, the winners and losers of the year.

"The Journal Editorial Report" begins right now!

Welcome to this special edition of "The Journal Editorial Report," our look back at the biggest stories of the year.

We begin with the financial meltdown. 2008 saw the demise of Wall Street giant's huge stock market, plunging home prices and a rapid rise in foreclosures. It adds up to a global economic panic and severe recession that may well end up defining the decade.

Here with a look why it happened and what it means going forward, Wall Street Journal columnist and deputy editor Dan Henninger; editorial board member, Dorothy Rabinowitz; columnist, Mary Anastasia O'Grady; and opinionjournal.com editor, James Taranto.

So, Mary, her we are. The worst downturn in my adult life, since the 1970s. Who do you blame? How did we get here?

MARY ANASTASIA O'GRADY, COLUMNIST: Paul, I think when the history of all this is written, we are going to look back and say a lot of it came from Washington. The Federal Reserve kept rates too low for too long. Washington — Congress decided not only were Americans entitled to life, liberty and the pursuit of happiness, but also homeownership.

GIGOT: And a cheap home and a cheap mortgage.

O'GRADY: And a cheap home. And the credit rating structure I think is a big problem. That the government designates two or three credit rating subdivisions and as soon as they put their stamp of approval on something, well, it's OK.

GIGOT: These are Standard & Poor's, Moody's and Fitch. The people who slap on AAA and sold all those mortgage-backed securities around the world. People didn't understand what CDOs were, but they did know AAA.

O'GRADY: That's the structure that didn't hold up.

DAN HENNINGER, COLUMNIST & DEPUTY EDITOR: Paul, I completely agree with Mary about the source of it. But one has to admit, what then happened in the private sector, is astounding. Never have so many smart people made so many stupid decisions. Bear Stearns, Lehman Brothers, Citigroup, which was telling us they were OK, We discovered had $306 million in toxic securities.

GIGOT: A month ago they were telling us they were OK, shortly before the government guaranteed losses, extraordinary losses.

HENNINGER: That's right. And the Bernard Madoff story. Madoff himself, a fascinating criminal. The big story in Madoff, you had respectable institutions like Banco Santander and the Bank of Scotland holding or investing in Madoff's fund. What happened here is that people simply no longer performed due diligence. And the average investor or person thinks that people in the financial industry do this kind of work. They stopped doing it.

GIGOT: Dorothy?

DOROTHY RABINOWITZ, EDITORIAL BOARD MEMBER: They became exactly like ordinary citizens, who, when you go to a doctor and you say you can't get into his office because he's so crowded. That fascination with the impenetrable, inaccessible investment counselor, that suddenly afflicted the great professions in this world.

GIGOT: They gave up their ability to do risk management. They were supposed to be able to assess risk. They told us they were.

They were masters of the universe, James. And now we have a situation where some of these companies have actually lost more in the last two years than they made throughout the whole decade. Should these executives give back their bonuses or maybe give them to charity?

JAMES TARANTO, OPINIONJOURNAL.COM EDITOR: Well, Credit Suisse had an interesting approach to this. They're giving out their bonuses in the distressed securities. So that...

GIGOT: To their investors?

TARANTO: No, to the executives.

GIGOT: Ah-ha.

TARANTO: The executives are getting a package of...

GIGOT: So if they go up in price later, they'll get something back.

TARANTO: That's right. But if they don't, the company is able to get them off their books and help stabilize. I'm not sure how you handle that for tax purposes though, how you value these things that have liabilities.

GIGOT: What about the previous bonuses locked in for 2003, 2004, 2005? Should they give those up?

TARANTO: Maybe they should.

O'GRADY: This problem, as I said, started in Washington. Yes, Wall Street got in on the party. But Washington made things worse again this year. I think that the Bear Stearns, the decision by Timothy Geithner, at the New York Fed, and Hank Paulson, at Treasury, to basically tell Bear Stearns creditors don't worry, we're going to take all this bad debt and put it on the books with the Fed, was a very bad signal to the market. It basically said that government is going to back stopped this bad stuff.

GIGOT: Do you think that set up what happened — that was in March. Do you think that set us up later in the year for the failures at Lehman and —

O'GRADY: I think the unwinding, you know, the coming to terms with reality would have happened sooner had the Fed not done that. You know, John Thain did the right thing.

GIGOT: The head of Merrill Lynch.

O'GRADY: He was the head of Merrill Lynch. He went out and sold the bad debt and he got 22 cents on the dollar. But that was the market thing to do. Instead, people hung around saying why should we do that. The Treasury's going to come in, the Fed's going to come in and back us.

GIGOT: The other thing here, the Wall Street executives — they benefited for a long Time — but they have been punished. They have lost jobs. The firms are being sold or, in some cases, eliminated. The people who did this in Washington, as Mary pointed out, now they're inheriting the universe. Barney Frank's business model worked.

HENNINGER: And that's baseball. We're going to have a big debate now. The idea is that somehow free market capitalism has been discredited by this experience and now we have to move towards something similar to what the western Europeans have, which is a social market democracy. This Congress is going to try to push that hard through enacting nationalized health insurance, for instance. The idea will be the American people need economic security. They don't need a free market system based on risk taking. That's the big debate we're going to have in 2009.

GIGOT: How much damage has been done here to the Reagan economic policy MIX, to free market ideas?

TARANTO: I think damage has been done. But just to sharpen the point you were making, what we saw here is an example how the market works in a way that government doesn't. The market did punish people that made bad decisions. People in government are being rewarded. It created a bad image for free markets but, in that sense, it's undeserved.

GIGOT: Dorothy?

RABINOWITZ: I have to throw in a primitive response too.

GIGOT: Please do.

RABINOWITZ: Who else is responsible? You've got Washington, Wall Street. How about Americans who could not afford to pay those mortgages, who nevertheless avidly and eagerly sought them out and were allowed to be talked into buying houses when they were making $40 a week and they knew everything was being — this is not irrelevant.

GIGOT: But this is what happens when you have an overall subsidy for debt, a subsidy for credit, which is what the Federal Reserve fueled with its easy money policy. You have a mania. When you have a mania, people make bad judgments because you have a misallocation of resources.

O'GRADY: And let — sorry, go ahead.

HENNINGER: The other phrase for this used to — arcane — is moral hazard. Now, everybody knows what that means, which is you reduce risk too low, people do stupid things and take unwarranted risk. That happened in a wide, enormous scale in this instance.

GIGOT: All right, everybody, thank you.

When we come back, the other big story of 2008, the triumph of Barack Obama and the return of liberal government. A look back at why Republicans failed. And a look ahead on how Democrats are likely to use their power.



GIGOT: Welcome back to this special edition of "The Journal Editorial Report," our look back at the biggest events of 2008.

The other story that dominated the headlines, of course, was Barack Obama's historic election and the shift in American politics to the left.

All right, James, now over the course of two elections, Republicans and the House have lost I think something like 50 House seats, which they haven't lost since the '30s. Was this the result of Obama's brilliance or Republican incompetence?

TARANTO: I think it was both. Republican incompetence set up with John McCain or whoever the Republican nominee was going to be for a loss. But you can't — you can't exclude Obama's brilliance. Here's a man who came in. Hillary Clinton was inevitable. Obama figured out how to use the caucuses to give himself an advantage. He narrowly beat her but he beat somebody who looked like she was the nominee.

GIGOT: What happened to the Republicans, Dorothy?

RABINOWITZ: Well, the Republicans had John McCain, who turned out to be someone who relied entirely too much on being one of the good guys of this world.

GIGOT: His personality.

RABINOWITZ: His personality was simply, basically just a little too much juvenile locker room to get by against Obama's immense and occasionally boring sincerity. But in the end, John McCain, famous words, "I'm suspending my campaign," led us down a dark path. But it was never meant to be. It would appear this is the time. And you had the financial meltdown which cannot be underestimated.

GIGOT: I think the Republicans lost for the oldest of reasons — peace and prosperity. They were the party in power, and they delivered neither.

HENNINGER: Yeah. And I think it was fundamentally a policy election. John McCain thought it would be a personality election and he thought his commitment to the war would carry him across the...

GIGOT: When you say policy, you don't mean specific policy.

HENNINGER: Yes, I do, Paul. No, no.

GIGOT: Obama proposed really specific policy? I thought it was gauzy, hope and change.

HENNINGER: Health insurance, he and Hillary Clinton debated that in detail in the primaries. The environment, he had a commitment to that. You had the economy he was able to talk about.

I thought Barack Obama had a policy play book that he absorbed and was able to talk about with sincerity and creditability. John McCain had a good agenda on taxes and on health insurance. We have talked about that on this program. Good ideas.


HENNINGER: He never absorbed it. In other words, he never seemed to believe in his own ideas. And I think that came across.

GIGOT: One of the things that Chuck Schumer, New York Senator, argues is that this is a realigning election, that this has been a realigning election in the sense that it changes the fundamental relationship of the American people to their government. A lot like 1980 did, but this would be in reverse. This is more like 1932.

Do you buy that, Mary?

O'GRADY: Paul, I see a parallel here with Bernard Madoff, believe it or not.



O'GRADY: People went to Madoff because he was giving very steady returns year after year, even though they weren't out of the park, they were there consistently. And what Obama is offering people, what the left is offering people is, you know, during a time of a lot of insecurity, the financial meltdown and rising healthcare costs, he says I'm going to expand entitlements. I think that's what people voted for. And what we need...

GIGOT: Security, safety, economic security?

O'GRADY: Yeah. Well, I think people are especially concerned about health care. I think what we need to see is how long it's going to take the American electorate to understand that this also is one of the biggest Ponzi schemes that has ever been hoisted on them, the idea that these entitlements can grow and protect everybody at no cost.

GIGOT: What about this issue of realignment. There's no question in my mind — you look at the voting results, the number of Republicans has shrunk. There's no question about that. The Republican agenda, the Republican advantage across the whole issue spectrum has shrunk. Don't they have a good argument, the Democrats, that this is a realigning election like 1980 in reverse?

TARANTO: I think they do. If you look, for example, at House seats, New England now has not a single Republican in the House. New York has three out of 29.

GIGOT: Three out of 29 in New York State? There used to be a solid Republican base 20 or 30 years ago.

TARANTO: Right. In a sense, this is like 1994 in reverse, in 1994 was when Republicans finally picked up a lot of long-held Democrat seats in the state that had trended of Republican.

HENNINGER: I think there's a question about the depth and strength of the realignment. The realignment is real. But in the age of constant television and Internet, people plugged in, impressions, views and opinions can be pushed.

There's no question that the Republicans, somehow to win, are going to have to appeal to Independents. This creates a dilemma over their principles and ideology because they tend to be very conservative. They have to come up with an idea to appeal to the center.

My proposal is economic growth, jobs, and an idea that I think everyone can identify with and it's an appeal to the center.

GIGOT: You're a big admirer of FDR. Is it another FDR moment?

RABINOWITZ: Yes. Well, it is not another FDR moment. I don't think there's any mumbo jumbo with FDR like we are the ones we've been waiting for as Obama's called, you know.

GIGOT: So you're saying his mandate — unlike Dan, you're saying his mandate a little vaguer?

O'GRADY: His mandate is completely vague but what he had was the moment of financial crisis, the absence of any Republican candidate despite his war record. We had a generational shift in voters. and we had all of that stuff. But, believe me, it is like going to Jupiter to compare FDR to Obama.


GIGOT: But this is a moment of great opportunity for the Democrats, is it not, Mary?

O'GRADY: To expand entitlements. But I think that we're going to get to a reality moment where people realize that you can't have the growth Dan is talking about without risk. If you're going to hand entitlements to the middle class, you're not going to get there.

GIGOT: All right, thank you, Mary.

Still ahead, from Palin to Petraeus, our panel picks their winners and losers" of the year.


GIGOT: Winners and losers, picks and pans, "Hits and Misses," this week, our panel calls attention to the best and the worst of the year. We'll start with the worst, our misses of 2008.

Dan, first to you.

HENNINGER: The biggest miss of the year, Hillary Clinton's presidential campaign. Remember, this election began way back in January of 2007 when her opponents were simply John Edwards and a Senator named Barack Obama, who pretty much no one had ever heard of. Fast forward to January 2008, Obama wins the Iowa caucuses by about 7 points. January 28th, Ted Kennedy and Caroline Kennedy endorsed Barack Obama, shattering Clinton aura. She was on her way to winning the biggest seat in American life. It is just a stunning miss opportunity in American presidential politics.

GIGOT: Dorothy?

RABINOWITZ: Deepak Chopra, who decided, at a certain point, when the Mumbai massacres had taken place, that it was American policy that was at fault, and everything we had done has contributed to this explosion, which even rocked the CNN interviewer. Now, this apostle of aroma therapy and regular enemas and who was himself suddenly been picked as a mediator had a most amazing response when he was attacked for his rather strange views. He then went on to assault racism and everything else. The point is, it was an astounding thing for Deepak Chopra.

GIGOT: All right.


TARANTO: Paul, my miss is for a story that the media missed: political corruption in Chicago. This has been very much in the news the past few weeks, but it wasn't earlier in the year when a Chicago politician was running for president. Why not? Because our finest investigative reporters were too busy investigating the management of the public library system in Wasilla, Alaska.

GIGOT: But they were all over that story.


All right, Mary?

O'GRADY: President Bush's rescue of the big two auto companies, G.M. and Chrysler, just last week. He lent $15 billion, nonbinding loans, from the Troubled Asset Relief Program. And he not only helped delay the inevitable with both of these companies, which is that they have to go into bankruptcy, but he also set the stage for the Democrats to come along and rationalize every bailout of every industry from here to eternity for as long as they're in power, which might be the same thing.


GIGOT: I don't know. Not if they figure out it's a Bernie Madoff scheme.

My miss goes to Eliot Spitzer, the former governor of New York, and former law enforcement chief of New York, who was forced to resign after it was discovered he was frequenting prostitutes. This was a man who was widely mentioned as somebody who could be president of the United States, was the scourge of Wall Street and righteousness. And his fall was Shakespearean, except for the fact that you could see his stricken wife on stage, and that was very painful for everybody to watch. But it was certainly a miss of the year.

Mary, how long are we going to own, you and me, the taxpayers, the auto companies?

O'GRADY: It's going to take a while to get rid of them. I think the only —

GIGOT: 50 years?


O'GRADY: The only way we can get rid of them is when they actually start to bleed and this shows up in the media, maybe there will be public pressure.

GIGOT: Mary, thanks. I think!

That was the worst of 2008. When we come back, our panelists' picks for the best of the year.


GIGOT: Even in an otherwise dreary year, good things do happen to you. So it's time now for our hits of 2008.

Dan, first to you.

HENNINGER: The hit of the year, Paul, is the Iraq war surge directed by Generals David Petraeus and Ray Odierno. It is my hit for several reasons. One, it averted a failure in Iraq and avoided the corrosive and destructive loss of self-confidence that came off the Vietnam War. Secondly, it saved the reputation of the American Officers Corps, who deserve better in this war. And finally, it has made possible the possibility of self-government in the Arab Middle East. All this success I think has given honor to the troops over there who have sacrificed for us since those awful days on September 11th.

GIGOT: Here, here.


RABINOWITZ: Yes, indeed. The triumph of the year for me was, forgetting everything else that happens, Sarah Palin's speech at the convention, which was a triumph of near perfection. It set every expectation on its ear. It was a model of grace and wit. She clearly incorporated the rather brilliant speech written for her. And that's not nothing. And, of course, it was very like Cinderella and her step-sisters, you know. Everybody growled when she was went on and they were forced to recant. A moment, but worth it.

GIGOT: All right, Mary?

O''GRADY: My hit of the year also was goes to military, but this one is for the Colombian military for its daring rescue of former presidential candidate, Ingrid Bettencourt, who was an extremely high-valued hostage, along with three American contractors and 11 others who were held in the jungle in Colombia for six years.

GIGOT: By terrorists.

O'GRADY: By the rebel group FARC. And not only did the Colombian military get them out, but they did it without firing a shot. It will go down in history as one of the most brilliant strategic moves ever against a gorilla enemy.

GIGOT: James Taranto?

TARANTO: The Bill of Rights was ratified in 1791. But for 217 years, one amendment has been largely ignored and disrespected. So my hit goes to the U.S. Supreme court or at least to five of the justices for recognizing that the Second Amendment means what it says, the right of the people to keep and bear arms shall not be infringed.

GIGOT: All right, James.

My hit goes to the humbling of Russia, Venezuela and Iran, three American enemies, due to the collapse of oil prices recently. If there's one silver lining to the recession, and there may only be one, that is it. They gloried and were anti-American and bullying when oil prices were up. As they've fallen, now they found out that the prosperity they had was fleeting and they're going to have a reckoning.

HENNINGER: I think I may go out and buy an SUV.


HENNINGER: From Detroit.

GIGOT: Dorothy, one quick question.


GIGOT: You loved her speech, but is Sarah Palin a contender for the Republican nomination in 2012?

RABINOWITZ: She's a contender. I don't think she will be a successful one. I could be wrong, just as the detractors were before her campaign speech. I think too much has happened, and I think she needs a lot more.

GIGOT: Some of those bad interviews are going to stick in the mind.

RABINOWITZ: They will be replayed and replayed. And it's a long way. And in addition to that, there are the values assaults on her.

GIGOT: All right, thanks, Dorothy.

That's it for our year-end edition of "The Journal Editorial Report."

Thanks to my panel and to all of you for watching.

I'm Paul Gigot. On behalf of everyone here, happy New Year!

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