Thursday,
September 25, 2008
"Those who cannot remember the past are
condemned to repeat it."
George Santayana
"The bill
gives [Sec.] Paulson
the ability to nationalize an unlimited amount of private debt and force you
and your children to pay for it.... I predict that if this passes it will
precipitate the mother and father of all financial panics."
Karl Denninger
(Market Ticker)
“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.”
Section 8, Bush's
administration proposed legislation to bailout U.S. banks [Legislative Proposal
for Treasury Authority to Purchase Mortgage-Related Assets].
"The Fed
is merely trying to inject money to keep prices not supported by fundamentals
from falling. It is a prescription for hyperinflation. The only way to keep
prices of worthless assets high is to lower the value of money. And that
appears to be the Fed unspoken strategy."
Henry Liu,
economist
If I may simplify somewhat the situation,
(but only slightly) we can say that over the last quarter of century, Wall
Street firms bought out Congress and the White House (and paid
at wholesale prices). Now, they want the U.S.
government to buy them back (and they want to sell at retail
prices).
Over the years,
indeed, Wall Street firms have lavished hundreds of millions of dollars in
lobbying Washington D.C. so that their more and more complicated financial
businesses would be less and less regulated. During the 1980s, the Savings &
Loans industry (S&Ls) was the recipient of Washington
largesse. The epitome was the lobbying by five prominent U.S. senators, one of
them Sen. John McCain,
to deregulate the borrowing and lending practices of savings and loans banks.
During the Reagan-Bush era of the 1980's, such deregulation encouraged unsound
real estate lending by Savings & Loans financial institutions and this led to the
1986-1995 Savings and Loans
crisis. Some 747 savings and loans banks failed and about $160
billion was lost, most of it through a $124.6 billion bailout by the U.S.
Government.
During the Clinton
and Bush-Cheney eras, large banks were allowed to buy relatively long term
subprime home mortgages from regional banks and other mortgage lending firms
and repackage them, “securitize”
them and resell them as
sliced mortgage-backed
securities. The
banks sold them as short term-like commercial paper, but without guaranteeing
them. In 1999, for example, the banking industry spent more than $300 million
in lobbying Congress and the White House to repeal the 1933 Glass-Steagall Act
that closely regulated
banking activities. In November 1999, the Glass-Steagall Act was eviscerated
after many years of lobbying efforts. It was replaced by the Gramm-Leach-Bliley
Act which
established the new market-driven unregulated system for many financial
institutions, the largest ones being the New York-based investment
banks.
With scant regulation,
banks could engage in highly leveraged new banking practices, in violation of
sound banking practices. For example, regulated commercial banks normally keep
a 1:10 ratio between reserves and loans.
But U.S. unregulated entities embarked upon highly leveraged finance,
keeping a 1:30, 1:40 or even 1:50 ratio between reserves and risky loans. In so
doing, the unregulated banks raked in huge fees at what (they thought) was very
little risk for them, because they had hoped to transfer the inherent risk to
the buyers of their repackaged securities.
However, when some
of the original mortgages downstream became delinquent as the housing price
bubble burst, in the spring of 2005, and home foreclosures began to rise, more
than $1 trillion of the artificial mortgage-backed securities previously
created thus became less secure and less liquid. As time went on, the market
for such artificial securities de facto dried up. As a consequence, the issuing banks were
left with a large inventory of now toxic securities that nobody wanted to buy.
Huge permanent losses replaced huge but illusory short-term profits, although
banking CEOs kept receiving large (some would say obscene) total corporate
compensations.
The incestuous
relationship between unregulated high finance and Washington politics is coming
to a climax with the U.S. Treasury Secretary, a former Wall Street CEO of one
of the Wall Street banks in relative distress, being declared by legislation
a de facto economic
tsar and a public Santa Claus. According to proposed
legislation, indeed, Mr. Henry Paulson, the former Chairman and Chief
Executive Officer (June 1998 – July 3, 2006) of Goldman
Sachs, would be entrusted with the power to buy from troubled
banks, at his discretion, the bad financial assets they now have on their
books. To accomplish that task, as much as $700 billion would be placed in his
hands. It is said that Congress, in this election period, does not have time to
create an independently-run Bank Resolution Trust under the model of the 1989 Resolution
Trust Corp, and all the power to intervene has to be
concentrated in the person of the Treasury Secretary.
There you have it.
—This is the overall feature of the Bush administration's plan to place
hundreds of billion dollars of public money at risk to shore up the U.S.
banking industry and prevent the unstable financial house of cards from
collapsing.
At the bottom of
the problem is the fact that American banks are presently very short of capital,
to the point of being insolvent, because of overleveraged investments in the
past and because of the huge losses they have suffered in illiquid
mortgage-backed securities. The purchase by government of the most illiquid
financial assets they have on their books could have the effect of providing
some badly needed capital to banks through some form of public subsidies,
provided it is done in a not too transparent way.
Indeed, the
government rescue of U.S. banks comes down to this: How many of the toxic
financial assets is Sec. Henry Paulson willing to buy from banks and at what
prices?
The “Paulson
put”
Henry Paulson is being placed in the role of a
government financial plumber who promises to unplug the pipes of finance and
cleanse them of the mortgage-backed sludge. He is asking taxpayers'
representatives for a blank check, to create a huge slush fund, $700 billion,
that he would be free to use to buy toxic depreciated securities from troubled
banks and relieve their balance sheets from this undesirable load.
If Sec. Paulson
were to pay a high price for the most illiquid bank-owned mortgage-backed
securities, this would amount to a “Paulson put”
because it would have the effect of guaranteeing the profitability of many
risky financial operations that otherwise would have failed. As a matter of
fact, at what price would Sec. Paulson buy the illiquid bank toxic assets? At
70 percent of initial book value, or at a price closer to market value which
may be 20 to 30 percent of face value. Who would know? When? Under what
guidance?
Answers to these questions
are crucial because they will help to calculate what could be the final cost to
the public purse of the bank bailout. But there is a fundamental dilemma here
for the government. If Sec. Paulson were to overpay for the banks' garbage
securities, the bailout would amount to a recapitalization
of the banks, with taxpayers' money. This would not be a popular move,
considering how much money the banks' CEOs made in driving their institutions
into the ground. On the other hand, if Sec. Paulson were to pay strictly fair
market value for those bad debts, priced at a substantial discount to reflect
their poor liquidity and marketability, then the troubled banks would have to
write down their losses
and would still remain weak and unstable.
There is something
surreal and profoundly immoral that the individuals who were front and center
in creating the subprime financial
meltdown are also those who have been entrusted by the
government to solve the mess they have created. Are there not independent
economic and financial experts in the United States who could have been
assigned this task?
Conclusion
Even though it is the
primary responsibility of a government to make sure that financial markets and
institutions function properly, the Bush administration's banking rescue plan
leaves a lot to be desired before being called economically efficient, and
socially and politically acceptable.
Rodrigue Tremblay is professor emeritus of economics at the University
of Montreal and can be reached at rodrigue.tremblay@ yahoo.com.
He is the author of the book 'The
New American Empire'.
Visit his blog site at www.thenewamericanempire.com/blog.
Author's Website: www.thenewamericanempire.com/
Check Dr. Tremblay's coming book "The
Code for Global Ethics"
at: www.TheCodeForGlobalEthics.com/
_____________________________________
Posted, Thursday, September
25, 2008, at 5:30 am
Email to a friend:
http://www.TheNewAmericanEmpire.com/tremblay=1097
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© 2008 by
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