The Mother of All Bailouts
Shortly after the stock market opened Friday morning, Treasury Secretary Henry Paulson told the world that he and important members of Congress would be meeting over the weekend to perfect a piece of legislation which will execute decisive action to fundamentally and comprehensively address the root cause of our financial system's stresses.
Paulson has been functioning as the nation's first emergency finance commissar. It is a new role for an American public official, and as such he may want to reach out to Moscow to tap the experience of one or two ancient apparatchiks who once labored in the Gosplan building. Gosplanners are remembered for their fundamental and comprehensive plans for the Soviet economy.
The center of Mr. Root Cause's proposals is the Big Bailout. The government will buy the worthless bonds owned by Wall Street. Paulson explained that the federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy.
As for costs, he said no more than that it will involve a significant investment of taxpayer dollars. A better adjective than "significant" might be "staggering." The economic tar pit is so deep and so sticky it may be necessary to sacrifice wildlife programs, preschool education and scientific research. Even without knowing the numbers, we can kiss health insurance goodbye. If and when Obama gets in, he will discover the cupboard is bare.
Paulson's hope is that by relieving the foolish financial institutions of the bad loans they should not have made in the first place, money will flow into real estate again and prices will rise. If prices rise on housing, prices will rise on mortgage-backed bonds and our leaky ship of finance will be refloated.
Boiled his plan down to its essentials, Paulson is hoping these manipulations will put a floor on the real estate and bond markets. The other name for what he is attempting is price controls.
Price controls are usually thought of as an attempt to prevent prices from going up, but controls can work the other way, too. In the early years of the New Deal, President Franklin Roosevelt tried to drive prices up by various schemes, which did not work. Similar efforts over the last 2,000 years have had a dismal record.
Real estate prices will start rising when people have the income to buy houses again. So far, Paulson has not addressed how individual homeowners are going to make enough money to meet their mortgage obligations. The Secretary's approach is top-down, although the housing market, upon which all depends, is a bottom-up activity.
Paulson is concentrating his rescue efforts on saving Wall Street's wooly-mammoth institutions. That they may be too big, too expensive, too cumbersome and too out-of-date are topics for another time.
Regardless, the men and women who are designing the bailout to end all bailouts have economic interests in how it is done. Paulson is a former head of Goldman Sachs, which is under the gun; Democrats, too, have more than a buck at stake. Nancy Pelosi has a quarter-of-a-million-dollars' worth of AIG stock. John Kerry's wife has more than $2 million.
Officials made two other announcements Friday. The government would guarantee deposits in money market accounts. From 1911 to 1966, the US government ran a money market fund through the Post Office, in which people could keep their savings and sleep at night. US Postal Savings was closed because the private sector did not want the competition. Ah, well.
The second announcement was the suspension of short sales on 799 financial stocks. (A short sale is a hedge against the price of a stock going down--put another way, a bet that it will.) Whenever things go bad in high finance, short sellers are blamed. It's the business equivalent of finding an innocent old lady and burning her as a witch. The auto-da-fe makes those wielding the flaming brands feel better, but will not necessarily improve the situation.
Paulson's moves sent the stock market into delirium, but delirium is a form of hysteria. In the present climate of despair alternating with crazed joy, the market will continue to behave as though stricken with St. Vitus dance.
John Bogle, the well-regarded Wall Streeter who founded the Vanguard Fund, may have had it right when he said, "The government seems punch drunk. It doesn't seem systematic.... We're playing a game of casino capitalism. "