The Paulson Trillion-Dollar Bonanza: What’s Not to Like, Part III

I’ve been giving some thought as to the actual value of continuing with this series, because a)over the weekends the bailout proposal has changed considerably, and as of the time of my writing this this newer agreement has already been turned down by the House of Representatives.

So the points I made last week about this proposal have actually been rectified by a number of clauses in the new agreement. There would be *some* oversight, and the funding for the program would actually be limited to $700B, and that money would not be allocated in one fell swoop (I suppose I should change the title of this post, but then one would lose the continuity with the previous two entries in the series). Some anti-golden-parachute clauses were added (which, it must be said, would do nothing to prevent the banks being helped from funneling millions of the taxpayers’ money into existing golden parachute contracts) and there is at least an agreement in principle that some measures should be enacted to prevent people losing their homes. Still, that doesn’t make this proposal a good one, for several more reasons.

Reason 5: the Markets Aren’t Actually Broken

I’ve always been a big believer in not fixing things that aren’t broke — especially when the cost of fixing it promises to grow to rival the size of the entire Federal budget. And the markets, although in a struggle, just aren’t broken. In fact they were a lot more broken just two years ago.

How’s that possible? Well, to me the idea that one could go around selling CDOs tainted with what bankers themselves referred to as “toxic waste” is an indication of a broken market, which is to say a market that has lost its ability to valuate securities. It appears that the situation has already rectified itself. There is some healthy skepticism out there about the value of mortgage-backed bonds; that’s actually a good thing.

Having the Treasury step in at this point would actually be a mistake, in my view, because it would actively reward the sort of risk-disregarding move that lead to the portioning and sale of CDOs which are now the market’s chief problem. It would literally be a corruption of the market, and one which would certainly lead to more such risky investment behavior in the long-term; after all, if the US Treasury was willing to step in and give out free money because of risks to the health of the market, it’s most likely that they’re not just going to do it once. Should the situation arise again, it would be in a situation where it would have to go through this same exercise in spending all over again, if only to make sure that the first instance “didn’t go to waste”.

The markets are undergoing a serious correction because that’s what bonds markets are supposed to do when it becomes clear that assets have been traded which are not nearly as well-collateralized or secure as they should be.

Reason 6: It’s Not Nearly Enough Anyway

The derivatives market, which has a strong role to play with what’s going on now, is not only larger than $700B, it makes it seem insignificant. As of 2006 the market size of mortgage-backed securities overall was over $6 trillion, and the derivative CDO market is said to be over $2 trillion in size. The sort of money we’re talking about will only make a dent in the problem, and as a whole can not solve the issue but will only forestall it for some time. Which brings us to the next reason why it’s still a bad proposal…

Reason 7: It’s Politically Motivated

Whatever else is true, the current US Administration will go out in late January and be replaced by another one. It’s pretty keen on finding a solution which can prevent a market crash for at least the next four months. The goal of the proposed bailout will provide some buoyancy to the market for a few months, but the market will remain in need of a correction. The bailout package simply cannot cleanse a market 10 times the package size and which is made up of “franken-securities” in which so-called “toxic waste” has deliberately been camouflaged in higher-quality credit packages. What the bailout does is make the looming market correction the next President’s problem.

Reason 8: Look Who’s Against the Proposal

It seems to me that the people who are clamoring for this proposal to be adopted can be placed into one of three categories:

  • investment bankers, traders, and in general the people who got the economy into this mess in the first place
  • politicians keen to be seen as “doing something” no matter what it is
  • people outside the financial markets who have been frightened by politicians into begging for something to be done, again no matter what the solution is.

You wouldn’t know it from watching the news, but there’s an incredibly large number of prominent economists who are arguing against a bailout at this point. I’ve already had links to two of them, but there are many more. Here is a link to a petition by 100 prominent economists against the bailout. Itulip clearly doesn’t think much of the plan.  Karl Denninger has been speaking out against the bailout from the get-go via his Market Ticker site. Economists from both the right and the left are against this. It’s time to start ignoring the shrill panicked voices of media conglomerates and start listening to people who know what they’re talking about.

Reason 9: Look Who’s For The Proposal

When it comes down to it, the plan’s single biggest backer is Treasury Secretary Henry Paulson. He was, before he took that job, CEO of Goldman Sachs, a career investment banker. This is a problem in two ways:

  • no one will benefit more from this plan than investment bankers. When you consider the basics of the plan — and how it will have to work — it’s literally about taking money out of taxpayers’ pockets and putting it straight into investment bankers’ pockets by erasing their bad decisions over the past 8 years.
  • certain people see his letting Lehman Brothers wither to bankruptcy to be a case of opportunism, coming as it did one day before his bailout of insurance giant AIG (a long-time Goldman Sachs partner).
  • it’s investment bankers who got the economy into this mess, more than anyone else. There’s a lot of bad bonds out there that have Paulson’s fingerprints all over them. And now we’re supposed to think that by giving him virtually unlimited money and almost unlimited power he will have the magical solution to the whole problem, when he doesn’t seem particularly forthcoming on the specifics to the bailout plan?..

Come on here. As the subprime crisis hit he was adamant that the problem was contained and wouldn’t cause much more trouble after the year was out. In July of this year, after Indymac’s failure, Paulson had this to say: “it’s a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation.” A month before the FNMA And FRMC bailout, he told Meet The Press that there was no plan to rescue the mortgage giants. You only get so many strikes before people stop believing that all your insights are brilliant. It’s time for Paulson to be more of an explainer and less of a salesman.

Reason 10: The Cost

I hate to harp on little things like this, but even with “only” $250B in the game at the initial stage this bailout is still all about the taxpayer taking a bath. Granted that the gradual approach to funding the proposal is better than the vague wording of the original, that’s still a pretty big amount. Combine this figure with the almost $200B that the Fed and Treasury have already spent on bailouts this year alone, and you’ll come to the realization that the United States, with the bailout plan in place, would be running a trillion-dollar real deficit… if you ignore the smoke-and-mirrors approach to calculating the official deficit figures, of course.

And I thought the GOP was supposed to be the party of fiscal responsibility…

Reason 11: It’s Flawed From The Beginning

This is probably the best reason to be against the bailout — the evaluation of its success is conditional on ignoring its very goal and central approach to economic well-being: to continue the free-wheeling credit economy that has been driving American economic growth since the turn of the millenium.

Yes, I do talk of deficit spending and credit addiction like it’s a bad thing, but that’s because it is a bad thing. But that’s been the driving force of the American economy at all levels (public and private) for far too long, and it’s having a very pernicious cultural effect not only on America but on the entire world. In Shanghai right now it’s widely acknowledged that virtually nobody can buy property on cash terms — but you can get a loan for it. This is Shanghai, a place that was entirely Communist and free of property and consumerism a mere 30 years ago. That’s what drives bubbles: people borrow so they can buy, which drives prices up and, given time, makes it impossible to buy without borrowing. Look at housing costs in areas such as, well, most of California, and New York City. In the City in particular the median price of home transactions has surpassed a million dollars (it’s surpassed it many years ago). Who can afford that? We used to be able to say “investment bankers” but now that’s not exactly the case anymore, is it?

Yes, we all want to have nice things. It’s part of the human condition, really. At some point, however, there has to be a realization that our north American society is living far beyond its means, and that getting things back to the point where credit is flowing freely is no answer at all. The answer, for an alcoholic, is to stop drinking — and the proposal is the equivalent of a binge. The only promise that comes with it is that the problem will continue to exist and will likely be even bigger the next time around.

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