Bridge Loan to Nowhere
In the movie Men in Black, Will Smith and Tommy Lee Jones team up to save the world by resolute preventive action. By contrast, America's real-life Men in Black--Treasury Secretary Hank Paulson, Federal Reserve Chair Ben Bernanke and New York Fed President Timothy Geithner--haven't done as well lately. Ever since that classical day of reckoning, the Ides of March 2008, when the terrifying specter of chain bankruptcy and currency collapse first loomed over lower Manhattan like an attacking spaceship because of Bear Stearns, it's been downhill.
A little over a week ago, the Men in Black made a fatal mistake. They allowed the aliens to vaporize the proud old firm of Lehman Brothers. Whole fleets of spaceships then immediately began attacking AIG, Wachovia, Washington Mutual, even Morgan Stanley and Goldman, Sachs. Now desperate, the Men in Black switched back to their old tactics and rescued AIG, but the damage had been done. The aliens had learned from Lehman and AIG how vulnerable Wall Street really was. Soon inter-bank markets everywhere in the world locked up. With financiers preferring treasuries that paid essentially nothing to every other asset in the world, huge runs started on money market funds.
In response, the Men in Black have now gone to Congress. They have put a check for $700 billion and a loaded gun on the table. Sign the check, they insist, and give us unreviewable power to buy bad assets, or take responsibility for the collapse of the whole financial system and, likely, the world economy.
In America's money-driven political system, leaders of both parties love to pretend that the sound of money talking is the voice of the people. Both presidential candidates and Democratic Congressional leaders are mostly nodding, with the Democrats adding trademarked noises about balancing off gifts to Wall Street with mortgage relief, another small economic stimulus program and perhaps some curbs on executive pay. Meantime, save for a handful of splendid exceptions, notably Gretchen Morgenson of the New York Times, American newspapers just keep giving their readers more reasons to keep deserting them.
Actually, there are one or two things to like in the Men in Black's latest scheme for the Mother of All Bailouts. The economic case for single-payer insurance has always been overwhelming. With all the new precedents--Bear Stearns, Fannie, Freddie, AIG, and one, two, three, many more coming-- who would now dare deny the American people a chance for similar efficiencies in health insurance?
We also confess to having a soft spot for the New Deal--that remarkable moment that gives the lie to all of today's fashionable sneers about the impossibility of effective financial regulation. We just wish that the Men in Black would draw inspiration from something besides the anachronistic language of the Gold Reserve Act of 1934, which tried to make Treasury's decisions about the Exchange Stabilization Fund unreviewable by anyone else. (See the new plan's incredible Section 8, something you would think only Dick Cheney could love.)
And who can deny it? All the "Comrade Paulson" jokes should at least be good for a decent respite from Market Fundamentalism--the notion that unregulated markets automatically give you full employment and economic stability. Right now every individual financial institution is deleveraging--that is, reducing its use of borrowed money--at a terrifying pace. Financial houses are trying to recapitalize themselves by gouging depositors, borrowers, investors and credit card holders. As a group, they cannot succeed. They are collectively digging themselves into a black hole in which the gain of one is the loss of another, unless somebody from outside puts in new money.
Paulson does not exaggerate when he implies that just soldiering on and letting markets work will trigger a depression and collapse of the currency. But if it's high time for some Big Government, the Men in Black's plan is not the way to go, unless you work on Wall Street. And even if you do, there are compelling reasons to fear it.
The plan's belated focus on a systemic solution designed to reopen money and financial markets to normal transactions is exactly right. Currently there is simply too much junk out there for anyone in money markets to be sure of getting repaid if they loan to anyone else, even overnight. Everyone knows that other institutions are full of bad assets that are hugely depressed; but each sees for sure only their own desperate condition. So nobody trusts anybody.
But there is more than one way to restore trust and restart markets. Alas, not only is the plan the Men in Black are pushing the most expensive and likely to soak average Americans the most, but it is also the most likely to fail.
What Might Work
You could simply take a leaf from the New Deal and do a bank holiday. That is, send bank examiners into all the institutions-- investment houses, and insurance companies and the other major players, as well as banks--to assess them. Insolvent ones are simply closed; everyone knows then that those that survive are solvent. Economic life restarts. The total cost is minimal. In the nineties, under Greenspan, the Fed ran away from its duty to oversee primary dealers in government securities. Voting it sufficient authority to do the job not just on Wall Street and the banks, but in any part of the system not covered by effective regulators would be far less expensive than the Men in Black's scheme.
Guess why Wall Street hates this one and why Bernanke (whose work on the New Deal is indeed distinguished, though many of his hypotheses have since been refuted ) and Paulson do not even consider it. In all likelihood much of the Street is insolvent, which is why short-sellers were going wild until the SEC banned restricted them.
The government could inject capital directly into financial institutions with a reasonable prospect of survival in the long run. This was the essence of Senator Schumer's proposal that surfaced just ahead of Paulson's announcement and that triggered the rally in world financial markets. The New Deal did this, too. It used the Reconstruction Finance Corporation, which put severe terms on the banks receiving the aid. Wall Street, of course, would love the money, but not the terms. Somebody to inspect and certify the solvency of financial houses is also a requisite for this option, which, as already noted, is anathema to the Street.
The Men in Black's choice: just have the government buy the junk, giving Wall Street real money--our money--in exchange for it. Notice three points about this one: First, the lucky firms continue merrily in business. Thus far Paulson and Bernanke's plan does not even pay lip service to reforms. It is also well to remember that as the crisis hit, Paulson was at work on a preposterous scheme calling for more deregulation on grounds that New York faced competition from foreign financial markets. It is obvious where the former Goldman Sachs CEO's heart lies.