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

Yesterday I wrote at some length about how the US economy has gotten to the point where Paulson and Bernanke decided it would be worth spending 5 hours promising Congress gloom & doom unless they got a record-busting bailout measure passed. So, why not like this (theoretically) $700B plan to “save the markets”? There are a number of reasons, which I shall put forward here. For reference, here is the draft proposal for the bailout so you can follow along.

Reason 1: it vastly expands the powers of the Treasury.

If anyone is a little unsettled by the imperial tone of this White House — and after these past seven-and-a-half years, one would be a fool not to be — one will notice these provisions of the proposal as being a power-grab the likes of which America has never seen:

Section 2, for a start, establishes a whole new slew of discretionary powers for the Treasury Secretary, who is granted power to not only buy mortgage-related securities from American banks (and by the way this provision has been expanded to also cover banks from outside the USA), but also to appoint any number of employees, enter into any contract regardless of other applicable laws, and issue any number of regulations regarding the actions taken by the Treasury with regards to the proposal. Section 5 reinforces that not only will the Secretary be in complete control, but he will continue being in control of those agreements entered into under this proposal beyond the actual time span covered by the same proposal.

This not only puts the Treasury Secretary outside the law, this puts him far, far above the law.

Reason 2: it actually has anti-accountability clauses built right in.

In case Sections 2 and 5 weren’t enough, Section 8 was added to reinforce the Secretary’s “above any law past, present or future” status:

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 agency.

Not only is the Secretary in complete control, his decisions cannot be reviewed by anyone at any time. You’ve got to be kidding.

Reason 3: look at what this proposal doesn’t include

The proposal says absolutely nothing about the following issues, which are at the core of this crisis:

  • predatory lending practices
  • executive compensation
  • protection for homeowners facing foreclosure
  • credit availability for individuals

That’s right. While the Treasury will be more than happy to buy bad debt from banks at inflated and unrealistic prices (this is unreviewable, as previously mentioned), it will take no regulatory measures on the banks that ultimately profit from its largesse. Continue paying your executives hundreds of millions of dollars in bonuses, continue selling people mortgages you know they can’t afford, continue foreclosing on the people you shouldn’t have sold houses to, hell, you can even keep the cash in your vaults if you if you feel like it.

This isn’t a rescue plan because it has no regulatory mandate whatsoever. Essentially Paulson is trusting the banks to “do the right thing” with their portion of the proceeds from this plan and the hoped-for market upswing, while conveniently sweeping under the rug the facts that a)these are the very same bankers who made such a mess that the Treasury now supposedly has to spend unimaginable amounts of money to fix, and b)that banks are now even less than regulated than they were after the passage of the Gramm bill. If you want to read truly frightening things, use google and dig up information about the current reserve holdings of commercial banks, and the holdings of the Federal Deposit Insurance Corporation (FDIC). You won’t sleep well after, I guarantee you that.

Reason 4: The Bill

While the number most tossed around in connection with this bailout plan is $700 billion, this is a gross understatement of what this proposal will actually cost the United States. In fact Section 6 is where it is mentioned specifically:

Section 6. The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

This only says that the Secretary can only have $700B invested into this operation at any given time. Now this is a peculiar problem of the way this proposal is structured. The theory behind how this bailout works is this:

  1. The Treasury will buy bad securities at “fair market value” from commercial banks (and brokers such as Paulson alma mater Goldman Sachs, which have been designated banks for the purpose of this bailout).
  2. ???
  3. The securities will be sold out again.

Because of the complete lack of accountability in the proposal, and even the lack of a consensus as to what constitutes “fair market value” for securities backed by the “toxic waste” (a banking term, believe it or not) of subprime loans, even that enormous $700B figure is meaningless. How exactly is the Treasury going to measure their on-the-books securities holding in this context?

The big issue here is that no one can tell what step 2 is going to be. Paulson is betting on “really good asset managers”. Which is nice, but there’s no walking away from the fact that no matter what the Treasury wants to do with these securities, it’s going to have to absorb a lot of bad debt that it will not be able to resell. What I think will happen is that this bad debt will be quietly dropped off the books. The more such debt is acquired, the more “space” the Treasury ends up with on its $700B credit card (which is financed, according to Section 7, by issuing additional T-bills). The “good debt” remaining will be sold off, but again there are no mechanisms built in to determine pricing or even a passage in the proposal that even hints at what approach will be taken in determining the outgoing price in securities.

Potentially the Treasury could be buying securities at full cost, then turn right around and sell it back to the bank from which it purchased it for pennies on the dollar. There is absolutely nothing in this bill that prevents this situation from occurring, or even that would provide any sort of oversight by any judicial or regulatory body. And once the sale is made the security is off the books, so it’s no longer a part of the $700B outstanding bailout debt limit.

You would never invest in a company that did business in such an opaque way. Notwithstanding this “$700B at any given time” limit, there is effectively no cost ceiling to this proposal. I say it’ll cost at least one trillion dollars ($1,000,000,000,000), but it could just as easily be 10 times as much.

Reason 5: The Bill, Part 2

This measure is, according to Section 7, paid for by issuing Treasury Bills — essentially creating new money. Well there’s a downside to creating new money, and it’s called inflation. Robert Mugabe’s Zimbabwe government knows all about this: it thought it could just print enough money to satisfy everyone, and now the ZD literally is worth less in the evening than it was in the morning. They recently issued a new Zimbabwean dollar because the old Zimbabwean dollar was so worthless that you needed a $10 trillion bill to purchase a loaf of bread.

Things are very unlikely indeed to reach these extremes in the United States, because it already has a very large money supply. But let’s look at the numbers here.

According to the Federal Reserve Bank of New York, the M2 figure (M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds) totals $7.7 trillion dollars as of April of this year. The Paulson plan calls for the initial creation of $700B of new money. This means that M2 will be bumbed to $8.4T. This means an immediate 9.1% increase in the money supply. There used to be an additional measure of the money supply, M3, which the Fed stopped publishing in 2006 (why?).

This can’t be good for the USD as a currency of exchange. If this proposal is planned the greenback is going to take a big hit. It’s nothing it hasn’t seen recently, however. In fact if we have a quick look at how the USD has fared against the Canadian dollar, we see a 25.7% drop in value since 2004. That being said, this occurred over a number of years. The devaluation that would result from such a massive effort at money creation would have to occur very quickly if the bailout plan is to be effective.

All this is good and fine and frankly irrelevant in an economy that is self-sustaining. That’s not the case of the United States, which imports an enormous proportion of what it consumes and has run a deficit in its current accounts since times immemorial. This means that the “perpetually falling prices” that Americans are used to could well be a thing of the past.


I must away now. More things not to like about this bailout coming tomorrow… after all I have a day job, you know.

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