Paulson The Junk Dealer

The Executive Branch wants it all and it wants it right now. But representatives in Congress are resisting. As representatives of the people, they’re right.

The $700 billion package with which Secretary of the Treasury Henry Paulson and Chairman of the Federal Reserve Ben Bernanke want to save world financial markets from ruin is simply too huge and too half-baked to get swift and uncritical approval.

The planned bailout move will determine America’s financial standing and future financial policy maneuvering room for years to come. Even though Paulson and Bernanke warn of an imminent catastrophe, it would be irresponsible to simply overlook the apparent weaknesses of their plan.

It’s true that financial and credit markets, shaken by panic, need to be quickly calmed at any cost. It’s also true that this can only succeed if considerable government help is forthcoming.

But meantime, it’s also clear that even if government help is forthcoming, that’s still no reason to hand the Treasury Secretary a blank check.

Paulson plans to indirectly support financial institutions by having the government spend hundreds of billions of dollars for mortgage-based securities the real value of which is unknown and which is still declining. The write-offs generated will threaten the equity base and with it the stability of the financial system.

Clueless Wholesalers

Under Paulson’s plan, the government would take on the role of a gigantic junk dealer who doesn’t even know anything about the junk it’s buying. Critics ridicule it as “cash for trash.” If the government pays little, it could end up being profitable but wouldn’t be helpful to financial markets right now. It’s likely the government will end up paying inflated prices, in which case the only winners will be stockholders and financial institution creditors.

Such a system is neither carefully targeted nor fair. Much can be said for injecting needed capital directly into needy institutions. If the government temporarily participates as a preferred stockholder with its own capital, than it can profit directly if the situation improves. At the same time, it can also assure that no more money will be lost in the form of undeserved bonuses or dividends.

Of course this would come very close to nationalization. But the Paulson plan amounts to a completely opaque mega-subsidy for a portfolio of problem loans with which the government will saddle itself. Congressional representatives who hesitate to go along with that have very good arguments.