What can we do?

Editorial 19 Oct 2008

Since we are not economists, the following relies on some economists we can believe in. They are not hard to find; they rest mainly in academia and foundations with links to the media. Paul Krugman, 2008 Nobel winner in economics, is one example. We also reference commentators with experience in the issues.

In 2006, Nouriel Roubini, Professor of economics at New York University, sounded an alarm at an International Fund Meeting that the US was facing a severe housing crash, soaring oil prices, declining consumer prices, and defaults on mortgages. He forecast trillions of dollars could evaporate. And so it came to pass. And for that reason, we think his advice on any fix is rather better than that of any politician. Yet his advice was not sought by the Administration or the Congress according to the Washington Spectator, 15 Oct 2008. There are some 200 in academia alone, including Roubini.

There is a conflict of interest for Paulson at the treasury. He came to the Treasury from Goldman Sachs, where he was CEO and a partner. Conflict of interest situations are common in government and honorable people in such situations recuse themselves. Far from recusing himself, Paulson attempted to take complete charge of the financial recovery, with not a string attached! Not all people are devious or blind. Dennis Kucinich is one of them. He asked a key question that still has not been answered:

“I want to know if Paulson used his position as Secretary of the Treasury to push Lehman Brothers off a cliff and help Goldman Sachs.”

Of course, those at Lehman Brothers were not saints. They set aside a $2,500,000,000 bonus fund for their executives BEFORE filing for bankruptcy! Of course Goldman Sachs would never to that.

Bush didn’t create this mess all by himself; he had a lot of help from hand-picked toadies eager to show the world that blindness-to-risk is the fount of wisdom. Henry Paulson is one of those, joining the likes of Cheney, Rumsfeld, Gonzales, and Wolfowitz. Paulson, like his boss, spurns professional advice. No professional economist was called in to help with restructuring America’s financial system. NONE! The core problem is so obvious:

Cronyism can be no better than the top crony; this one is near zero. When times are tough, all heads are needed. All options must be considered and prepared for ahead of time.

---

Resources for what follows:

• Lou Dubose -- The Washington Spectator.
• Chris Meyer, -- The Wall Street Journal
• Tom Englehardt -- The Nation
• Robert E. Litan -- The Atlantic

Now that the predicted, but unthinkable, has happened, what is needed is a sober assessment of where and how to proceed from here. As it happened, politicians took control of a situation that requires experts. For example, Henry Paulson correctly recognized the danger signals, then offered a three-page solution of an unprecedented and complex problem that gave him sole authority to proceed with no oversight from Congress or anyone else. But then what should we expect from a man who was CEO of Goldman Sachs until 2006 when he was recruited by Bush to be Treasury Secretary. Goldman Sachs is one of the big banks in line for bailout. It is rare that a CEO is actually held accountable for anything, but history is likely to decide otherwise for the Bush era.

“I want to know if Paulson used his position to push Lehman Brothers off a cliff to help Goldman Sachs?

The bailout package just signed into law is less seriously flawed than Paulson's original three-page proposal.

• One error in Paulson proposal was that most of the 700 billion dollars would have been used to buy up bad housing loans instead of for capitalization such as buying stock. The chosen route didn’t even help on the needed capitalization. The bank reserves would still remain precarious, subject to the moods of the public, lenders and borrowers. However, the bill that passed enabled the Treasury to buy stock in banks to quickly increase their capitalization. The Treasury seems likely now to do just that. If it does not, confidence in our financial system will deteriorate further. The up or down side, depending on your politics, is that to the extent government takes equity positions in banks, to that extent our financial system will be nationalized. This, from an Republican Administration!
• Pricing the bad loans is another problem the Paulson's proposal ignored. If the Treasury buys loans at less than fair value, it does nothing for bank capitalization, the downturn can only worsen. Priced above fair value, banks benefit, and their managers benefit. The public ends up paying cash for trash. What fair value is, is a sticky wicket. It depends on the market which in turn is a variable dependent on the mood of investors and the public. Paulson wanted to do as he pleased with immunity from future legal action!
  
  From Chris Meyer:
  
  
  ”We propose that the Bush Administration and Congress allow all residential mortgages on primary residences to be refinanced into thirty-year fixed-rate mortgages at 5.25 percent (matching the lowest the lowest mortgage rate in the last thirty years), and place those mortgages with Fannie Mae and Freddy Mac. Investors and speculators should not be allowed to qualify. . . . Rising mortgage spreads and down-payment requirements are what’s still driving down housing prices. We need to stop this decline.”
  
  
  So how should we proceed?
  Listen to Roubini and other true experts.
  Look for the logic and historic precedents.
  
  Engelhardt on Bush’s Financial Surge.
  
  
  The administration is ambushed, not by Sunni militants or Shiite radicals but by its own people: investment bankers, lenders, hedge-fund managers, financial management types--the very people for whom they organized the world and who had long been playing fast and loose (and profitably) with our economic system. The ambush, of course, took the form of a financial meltdown of massive proportions for which, as in Iraq in 2003, the administration had clearly done no significant preplanning or war-gaming. And, as with the insurgency then, so now they operated by the increasingly worn seats of their pants. Their attempted $700 billion "surge," as stock exchanges around the world indicated yesterday, wasn’t likely to pacify a global financial system near cardiac arrest.
  
  Excerpt from Robert Litan
  
  
  “The bailout bill has passed. But how will we know if it succeeds?
  
  “So, will it work? Now that Congress has passed the bailout bill -- an unprecedented riverboat gamble aimed at preventing financial meltdown in the United States and possibly around the world -- that's the question on everyone's minds.
  
  In the short run, we'll know if it works by looking at the "TED Spread" -- the difference between the most commonly used interest rate for inter-bank lending and the interest rate on short-term government debt. This spread is essentially a measure of credit risk: because short-term government debt is considered almost risk free, the difference between the rate for government debt and the rate for bank lending is a good indicator of how risky it is for banks to lend to one another. The higher the spread, the greater the fear of default on inter-bank loans. It was when the TED spread spiked near an unheard of four percent that Treasury proposed the massive bailout in the first place, a bailout that will hopefully soothe the rattled nerves of banks and so they can resume lending to each other in confidence. If the TED comes down, we'll know that this has happened.
  
  “But we may not know immediately, since the devil is in the details -- and not just in the legislative details. The Treasury Department must still issue guidelines on how it's going to buy up the troubled mortgage-related and other asset-backed securities covered by the bill. Those guidelines may very well determine how eager the intended participants -- banks, insurance companies, pension plans, and so on -- will be to sell to the Treasury. In addition, the bill's well-intentioned provisions limiting executive compensation and giving the government an equity stake in firms that sell the securities may also discourage some of those firms from showing up at the bailout party -- to what extent, we simply won't know. And it may even be some time after the election before we really have a good idea about participation, because the Treasury's purchasing guidelines might change when the new Administration takes office. And the uncertainty doesn't end there. I doubt the public is aware that even the adoption of the Treasury plan may not avert the need for the Treasury and the Fed to do more institution-specific deals like the ones already done for AIG, Fannie and Freddie. This is because even if the plan can quiet the inter-bank lending market, the institutions selling the securities may only gain added liquidity -- that is, they'll have an easier time buying and selling assets -- but will not necessarily gain additional capital. There may be a large hue and cry if the government gives the financial institutions prices for the troubled securities that exceed the already marked-down values on the institutions' books. But unless that is the case, there is no way (at least that I can see) how this plan will add to the institutions' capital. Conversely, if the sale prices fall below the values currently shown on the books, then the banks and other sellers will actually lose capital, at least as measured under conventional accounting rules. As a result, institutions in need of capital now are still likely to need capital after the plan is in place. If they can't raise it in private markets -- and in this environment, it may be a miracle if anyone can -- then the Treasury and the Fed will have to decide again, on a case by case basis, whether to inject public funds into ailing companies in exchange for stock. I'm not sure many in the public or on Capital Hill realize these hard decisions may be coming, especially if the economy continues to sink as rapidly as the latest jobs and other economic indicators suggest. But I'll bet this prospect is keeping beleaguered officials at the Treasury and the Fed up at night. I fear they (or their successors) won't sleep easy for a while.”
  
  The economic meltdown we find ourselves in would have come at some time anyway, given the absence of any controls of oversight. What these two guys did was hasten the day.
  
  
  What irony is there here?
  THE arch conservative president who uses government to effect the largest bailout ever--a liberal idea if there ever was one.
  
  Of course a close read of Paulson's three pages can lead to another conclusion--yet another leap toward dictatorship (Paulson wanted a free hand, no oversight and legal immunity to come with $700 Billion. In otherwords, he would have essential control of the US economy.)
  
  Fortunately, Congress put the control issue to right. Unfortunately, Congress did not go far enough in other directions; more may have to be done and soon.
  
  Given this situation and problems of dealing with it, we arrive at a larger question that perhaps only history can answer. There is a possible perspective:
  
  
  Mr Bush, the self-styled warrior,
  was looking for a war to fight.
  His "I am a war President" statement
  was heard by millions.
  
  Mr. Bin Laden tried to weaken mighty America.
  His fatwas were heard/read by even more people.
  
  Did each serve the other’s purpose?
  
  Whether intended or not, each, in high irony, served his own--and the other's--purpose.
  
  See: Text of Draft Proposal for Bailout Plan for the actual wording of the bailout.

  Posted by RoadToPeace on Sunday, October 19, 2008.

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