who cannot remember the past are condemned to repeat it.� --George
�The bill gives [Sec.] Paulson the ability to nationalize an unlimited
amount of private debt and force you and your children to pay for it. . . . I
predict that if this passes it will precipitate the mother and father of all
financial panics.� --Karl Denninger (Market Ticker)
�Decisions by the Secretary pursuant to
the authority of this Act are non-reviewable and committed to agency
discretion, and may not be reviewed by any court of law or any administrative
�Section 8, Bush�s administration proposed legislation to bailout U.S.
banks [Legislative Proposal for Treasury Authority to Purchase Mortgage-Related
�The Fed is merely trying to inject
money to keep prices not supported by fundamentals from falling. It is a
prescription for hyperinflation. The only way to keep prices of worthless
assets high is to lower the value of money. And that appears to be the Fed
unspoken strategy.� --Henry Liu, economist
If I may
simplify somewhat the situation (but only slightly), we can say that over the
last quarter of century Wall Street firms bought out
Congress and the White House (and paid at wholesale prices). Now, they want the
U.S. government to buy them back
(and they want to sell at retail prices).
Over the years, indeed, Wall Street firms have lavished
hundreds of millions of dollars in lobbying Washington, D.C., so that their
more and more complicated financial businesses would be less and less
regulated. During the 1980s, the savings & loan industry
(S&Ls) was the recipient of Washington largesse. The epitome was the
lobbying by five prominent U.S. senators, one of them Sen. John McCain, to deregulate the borrowing and lending
practices of savings & loan banks. During the Reagan-Bush era of the 1980s,
such deregulation encouraged unsound real estate lending by savings & loan financial institutions
and this led to the 1986-1995 savings & loan crisis. Some
747 savings & loan banks failed and about $160 billion was lost, most of it
through a $124.6 billion bailout by the U.S. government.
During the Clinton and Bush-Cheney eras, large banks were
allowed to buy relatively long-term subprime home mortgages from regional banks
and other mortgage lending firms and repackage them, �securitize� them and resell them as mortgage-backed securities. The banks sold them as short term-like
commercial paper, but without guaranteeing them. In 1999, for example, the
banking industry spent more than $300 million in lobbying Congress and the
White House to repeal the 1933 Glass-Steagall Act
that closely regulated banking activities. In November 1999, the
Glass-Steagall Act was eviscerated after many years of lobbying efforts. It was
replaced by the Gramm-Leach-Bliley Act
which established the new market-driven unregulated system for many
financial institutions, the largest ones being the New York-based investment banks.
With scant regulation, banks could engage in highly
leveraged new banking practices, in violation of sound banking practices. For
example, regulated commercial banks normally keep a 1:10 ratio between reserves
and loans. But U.S. unregulated entities embarked upon highly leveraged
finance, keeping a 1:30, 1:40 or even 1:50 ratio between reserves and risky
loans. In so doing, the unregulated banks raked in huge fees at what (they
thought) was very little risk for them, because they had hoped to transfer the
inherent risk to the buyers of their repackaged securities.
However, when some of the original mortgages downstream
became delinquent as the housing price bubble burst, in the spring of 2005, and
home foreclosures began to rise, more than $1 trillion of the artificial
mortgage-backed securities previously created thus became less secure and less
liquid. As time went on, the market for such artificial securities dried up. As
a consequence, the issuing banks were left with a large inventory of now toxic
securities that nobody wanted to buy. Huge permanent losses replaced huge but
illusory short-term profits, although bank CEOs kept
receiving large (some would say obscene) corporate compensations.
The incestuous relationship between unregulated high finance
and Washington politics is coming to a climax with the U.S. Treasury secretary,
a former Wall Street CEO of one of the Wall Street banks in relative distress,
being declared by legislation a de facto economic tsar and a public Santa
Claus. According to proposed legislation, indeed, Henry Paulson, the former chairman and chief executive
officer (June 1998�July 3,
2006) of Goldman Sachs, would be entrusted with the power to buy from
troubled banks, at his discretion, the bad financial assets they now have on
their books. To accomplish that task, as much as $700 billion would be placed
in his hands. It is said that Congress, in this election period, does not have
time to create an independently-run Bank Resolution Trust under the model of
the 1989 Resolution Trust Corp, and all the power to intervene has
to be concentrated in the person of the Treasury secretary.
There you have it. This is the overall feature of the Bush
administration�s plan to place hundreds of billion dollars of public money at
risk to shore up the U.S. banking industry and prevent the unstable financial
house of cards from collapsing.
At the bottom of the problem is the fact that American banks
are presently very short of capital, to the
point of being insolvent, because of overleveraged investments in the past and
because of the huge losses they have suffered in illiquid mortgage-backed
securities. The purchase by government of the most illiquid financial assets
they have on their books could have the effect of providing some badly need
capital to banks through some form of public subsidies, provided it is done in
a not too transparent way.
Indeed, the government rescue of U.S. banks comes down to
this: How many of the toxic financial assets is Sec. Henry Paulson willing to
buy from banks and at what prices?
The �Paulson put�
Henry Paulson is being placed in
the role of a government financial plumber who promises to unplug the pipes of
finance and cleanse them of the mortgage-backed sludge. He is asking taxpayers�
representatives for a blank check, to create a huge slush fund, $700 billion,
that he would be free to use to buy toxic depreciated securities from troubled
banks and relieve their balance sheets from this undesirable load.
If Sec. Paulson were to pay a high price for the most
illiquid bank-owned mortgage-backed securities, this would amount to a �Paulson put� because it would have the effect of guaranteeing
the profitability of many risky financial operations that otherwise would have
failed. As a matter of fact, at what price would Sec. Paulson buy the illiquid
bank toxic assets? At 70 percent of initial book value, or at a price closer to
market value which may be 20 to 30 percent of face value? Who would know? When?
Under what guidance?
Answers to these questions are crucial because they will
help to calculate what could be the final cost to the public purse of the bank
bailout. But there is a fundamental dilemma here for the government. If Sec.
Paulson were to overpay for the banks� garbage securities, the bailout would
amount to a recapitalization of the banks,
with taxpayers� money. This would not be a popular move, considering how much
money the banks� CEOs made in driving their institutions into the ground. On
the other hand, if Sec. Paulson were to pay strictly fair market value for
those bad debts, priced at a substantial discount to reflect their poor
liquidity and marketability, then the troubled banks would have to write down
their losses and would still remain weak
There is something surreal and profoundly immoral that the
individuals who were front and center in creating the subprime financial meltdown are also those who have been
entrusted by the government to solve the mess they have created. Are there not
independent economic and financial experts in the United States who could have
been assigned this task?
Even though it is the primary responsibility of a government
to make sure that financial markets and institutions function properly, the
Bush administration�s bank rescue plan leaves a lot to be desired before being
called economically efficient, and socially and politically acceptable.
Rodrigue Tremblay lives in Montreal and can be reached at firstname.lastname@example.org. He is the author of the book ��The New American Empire.� His new book,
�The Code for Global Ethics,� will be published in 2008. Visit his blog site at thenewamericanempire.com/blog.