Paulson’s Plan B

Paulson’s Plan B

The Treasury Secretary’s decision to buy equity stakes in banks still fails to address the fundamental flaws in the system.


How do you stop a ship from sinking, and simultaneously rebuild it to prevent its future destruction? That was the question in the minds of the world’s central bankers as they sat down over the weekend to figure out how to right the global financial Titanic.

European leaders came up with a plan to inject “unlimited short-term funds” into the system in addition to $2.3 trillion of guarantees and various emergency measures (pledged by Germany, Britain, France, The Netherlands, Spain, Portugal and Austria). This could be like dumping money into a black hole, since most of these funds will be given in the form of loans, which means banks must come up with adequate collateral to back them, which is in short supply these days. But it’s more decisive than anything the Treasury or Federal Reserve has done so far.

Indeed, the coordinated efforts of the European central banks have had a more positive initial impact on the markets than the bipartisan passage of Treasury Secretary Henry Paulson’s $700 billion rescue fund did. That announcement preceded an eight-day market selloff and the global freezing of credit. This one sent the Dow zooming up 11.1 percent, its biggest percentage gain since 1933. But the week is young.

Meanwhile, the question addressed by Paulson Monday is what to do with that $700 billion? To answer this, he sat down with his friends, the leaders of the largest financial institutions in America that got us into this mess. Namely, Ken Lewis, CEO of Bank of America; Jamie Dimon, CEO of J.P. Morgan Chase; Lloyd Blankfein, Paulson’s successor at Goldman Sachs; John Mack, CEO of Morgan Stanley; and Vikram Pandit, CEO of Citigroup.

These men have shown themselves to be far more interested in preserving themselves than in stabilizing the general economy for American citizens. And it’s a safe bet (probably the safest out there) that their philosophy remains intact.

Economists and media pundits over the weekend optimistically hoped that Paulson might get a clue that his initial idea of purchasing $700 billion of toxic assets would not stabilize the financial system. Having worked on Wall Street, I remain cynical about the notion that purchasing assets was off the table.

And it turns out that Paulson’s Plan B is not to completely abandon plan A. So far, he has decided to spend $250 billion of that $700 billion to buy equity stakes in banks whose future losses are still unknown. The rest could conceivably be used to buy up toxic assets.

These, and other related decisions are to be made, in large part, by Paulson’s former protégé at Goldman Sachs (and now interim assistant treasury secretary) Neel Kashkari. Kashkari described the equity purchase program as “voluntary and designed with attractive terms to encourage participation from healthy institutions.”

But encouraging participation hardly seems an issue. There’s not a bank around that wouldn’t want its stock price boosted by a Treasury purchase of its bleeding shares. Equally, every bank has a bunch of toxic assets good to go.

There are equally eager participants running this plan, too. No fewer than seven policy teams and five veteran government officials have been culled to figure out which banks will receive the most help. (This comes as the leaders of the top five cozy up to Paulson.)

There’s also no shortage of firms wanting a piece of the action of the bright new Treasury hedge fund. Seventy financial firms have made bids (i.e., asked for money) to become master custodian of the fund, managing inflow and outflow.

One hundred firms have bid to become one of the five master program operators that will decide which assets to buy and how to manage them. Let’s see if Goldman Sachs makes the cut.

The outcome of Monday’s meeting included no request for more stringent banking regulations going forward. That would require a complete restructuring of the financial landscape into transparent, manageable parts à la the Glass Steagall Act of 1933, which separated commercial banks, investment banks, and insurance companies.

The meeting did not provide a much-needed disclosure of the dangers that still lurk on the books of these firms, in a painfully transparent manner that will illuminate future losses, a move that would help alleviate the uncertainty that has been dragging down the market and freezing corporate and consumer credit alike.

As Paulson waffles on action and plans, always weighing Wall Street demands first, European leaders are taking more decisive action with their coordinated capital-injection moves. But it remains to be seen whether these will work. Perhaps their actions are an admission of responsibility; British and European institutions also made reckless bets with inadequate capital backing them.

But they all of the world’s central bankers should really consider injecting more transparency and regulation, to restore international confidence, not just money. They must create a global financial structure that will both contain the fallout and avoid a repeat performance–one that never again will be so opaque, over-leveraged and dangerous.

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