Big Bailout: Frantic Changes In Strategy

Can Government Fix the Crisis Government Caused?

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Sixty days ago Treasury Secretary Paulson and Federal Reserve Chairman Brenanke warned Congress and the public of imminent financial calamity that would engulf the entire economy.

According to the Paulson-Brenanke-government brain trust, the only thing that could save us from this fate was the immediate purchase, by the federal government, of “toxic” securities that were backed by mortgage loans of Indeterminate value and quality.   Congress was implored to authorize these purchases with the utmost urgency. After two weeks of politics Congress finally passed the famous $700 Billion bailout package.

That was sixty days ago.  This week the Treasury Secretary announced he has invested the first $190 Billion in stocks of banks and financial institutions, and that he will not be buying those mortgage backed securities after all.  Why not?  Here’s an excerpt from Secretary Paulson’s announcement:

As credit markets froze in mid-September, the Administration asked Congress for broad tools and flexibility to rescue the financial system. We asked for $700 billion to purchase troubled assets from financial institutions. At the time, we believed that would be the most effective means of getting credit flowing again.

During the two weeks that Congress considered the legislation, market conditions worsened considerably. It was clear to me by the time the bill was signed on October 3rd that we needed to act quickly and forcefully, and that purchasing troubled assets, our initial focus, would take time to implement and would not be sufficient given the severity of the problem. In consultation with the Federal Reserve, I determined that the most timely, effective step to improve credit market conditions was to strengthen bank balance sheets quickly through direct purchases of equity in banks.

Secretary Paulson’s actions and explanation does not inspire confidence.  Back in September when he asked for authority to buy mortgage backed securities he acknowledged that the process of pricing and buying the mortgage backed securities would be complicated and time consuming, taking many months.  Now he’s asking us to believe that a delay of only two weeks made the difference?  A better explanation is that he and his staff of smartest-people-on-earth don’t really know how to deal with this crisis.

In the six weeks since the President signed the bailout bill, the Dow has gone down 20% and the Nasdaq has declined 23%, both in very volatile trading.   These are staggering losses in a very short time, a vote of no confidence in the political establishment.

The best way to resolve this crisis and prepare for a new era of prosperity is for government to minimize its intervention, allowing markets to work.  There is more than ample proof in economic history that markets are smarter and more efficient than politicians and government officials, no matter how qualified.  And Secretary Paulson is certainly qualified.

Unfortunately, allowing markets to operate is only idea Congress is sure to reject.  Instead, we’ll see many more months, or maybe years, of frantic actions by government, diverting Trillions of Dollars from the productive private sector,  to back stop unproductive, financial institutions selected by political processes.

Fasten your seat belts.  As helpless citizens, at the mercy of politicians, we’re in for a long, bumpy ride.  And when it  gets really awful, look up the Constitution.   You’ll find that it doesn’t authorize the government actions and programs that got us into this mess.  Nor does it authorize Congress to seize resources from taxpayers to prop up businesses that should be allowed to fail due to their own mistakes.

2 Comments so far

  1. theclassiclib on November 14th, 2008

    Jim Rogers believes ultimately even the Fed will fail. He can’t understand why anybody would listen to Greenspan, Bernanke, or Paulson because they don’t know what they’re doing.

    It frustrates me that people don’t understand inflation, because there’s now a good chance of the US going into hyperinflation.

  2. aaa again on November 14th, 2008

    This change of strategy indeed does not inspire confidence. However, one should note that in a classic workout/financial restructuring a direct injection of equity is the standard procedure. Why? Fairness – The old equity, who basically, lost their bet, gets diluted or washed out, and the new equity gets the upside for their new investment. Further, liquidity is restored, just like with a “toxic” asset purchase. Said another way, with a direct equity injection the taxpayers get paid for their fresh money support if the company does well. Its based upon the performance of the enterprise, not the performance of some stinky assets.

    The old plan? Buying “toxic” assets is analagous to a troubled manufacturing company where fresh money is used to buy dilapidated or excess equipment. How does that fix things?

    All in all, I think the change in strategy is a good move. But one wonders what in the world they were thinking weeks ago. Just Resolution Trust Part II?