Page 1 of 2 The mother of all golden parachutes
By Hossein Askari and Noureddine Krichene
Conventional wisdom in Washington believes that a slightly modified version of
Treasury Secretary Henry Paulson's initially US$700 billion bank bailout plan
will pass the House of Representatives on Friday following the Senate's
approval on Wednesday.
Conventional wisdom fails to see that Paulson's "Troubled Asset Relieve
Program" (TARP), now an $810 billion measure thanks to an increase in the cap
on federal deposit insurance and tax breaks, will do little to alleviate the
ominous financial and economic clouds hanging over the United States and the
rest of the world.
The initial defeat of the plan hatched by Paulson and Federal Reserve chairman
Ben Bernanke in the House of Representatives at the start of the week should
have ushered in the end of the
George W Bush's administration disorderly financial policies, lax financial
supervision and the irresponsible expansionary monetary policy of the Federal
Reserve Board era under former chairman Alan Greenspan and Bernanke, his
successor.
It was a setback to the inflationist forces that wanted to put the burden of
the speculative bank losses on the American workers based on the thesis that
the Paulson-Bernanke plan is better for American families and their children
than any other economic stabilization plan, plans which were not presented and
debated. Bankers wanted to get rid of their speculative impaired assets by
exchanging trash for cash, with an attendant cost to the economy of
hyperinflation, in turn exacerbating food and energy price inflation and
eroding family real incomes.
TARP has been a coordinated ploy to dump troubled assets onto the government in
a "quick and clean" way. If the plan is approved by the US Congress, Paulson
would immediately issue Treasury bills that would be bought by banks, the
proceeds from the sale of Treasury bills would in turn finance the purchase
troubled assets. At the same time, remember that Bernanke has already injected
over $630 billion of liquidity into the banking system.
Throughout their history, US banks have never been so flush with liquidity that
is remunerated by the Fed. By getting money at very low rates from the Fed and
making profits in purchasing Treasury bills, banks will make huge riskless
profits, and the financing of the TARP will be fully guaranteed without
requiring financing from sovereign wealth funds. Paulson and Bernanke have
failed since August 2007 to re-inflate unworthy (housing) assets, despite the
Fed's extremely low interest rates and aggressive monetary policy. It would
appear that they found out that, only by combing fiscal and monetary policies
and forcing unusual expansion of both, can they remove "clogging" troubled
assets and achieve their re-inflationary objective.
The battle between the supporters of the Paulson-Bernanke plan and its
opponents has been a battle between debtors and bankers and those who would
like to safeguard American public finance, equity among the various segments of
society, and seek to restore orderly adjustment of the financial system and
asset prices.
Debtors and bankers would like to protect their acquired wealth, walk free from
debt and dump unworthy financial assets onto the government budget. By inducing
hyperinflation, they will be able to extinguish real value of their
liabilities. The bankers' group maintains that only the government can
recapitalize the banking sector; they claim that rejection of bank
recapitalization by the government would be fatal for the economy, and
policymakers would live to regret the rebuttal of the TARP.
TARP's opponents, wary of the maneuvers of its supporters and observing that
the sky has not or is not falling, see clearly the dangers for the economy, its
inequity, the long economic decline that will ensue, and their constituency's
discontent.
The proponents of TARP have maintained that the US Treasury will make money
buying worthless paper. At one point, the paper will become valuable, the
Treasury will resell at much higher prices than it paid and will make money;
hence, the Paulson-Bernanke plan will end up making profits for taxpayers! Some
dubbed the TARP as a genius deal by the two men. If proponents of this argument
are certain that worthless financial paper will become very valuable in the
future, why then do financial institutions not keep this paper, sell it later
and reap profits? Why don't speculators grab the stuff?
Unfortunately, bad debt rarely becomes good debt. Throwing good money after bad
money is not a sound business practice. If a modified TARP is adopted, an
additional exposure for taxpayers is that the Treasury may keep coming back for
additional amounts of financing, with no end in sight, and lawmakers will be
hard-pressed not to give in, as they would have already invested so much in the
plan.
TARP's proponents have forcefully argued that without a massive bailout, the
economy would literally collapse. Banks will fail, retirement savings will
disappear, no more credit will flow to the economy and the economy will shed
jobs. If bailed out, banks will resume lending, and the economy will continue
to grow. Unfortunately, their arguments are not supported by actual data.
The US economy has shown remarkable resilience so far since August 2007; it has
continued to grow, albeit at slower rate, at 2% a year in 2008. Credit to the
economy has continued to grow at a high rate of 9% so far in 2008. The banking
system has never been so flush with liquidity as it has been now, not only in
the US, but also in Europe and Asia.
Not all the US economy is a speculative economy. The non-speculative components
- agriculture, industry and services - continue to have access to credit at
very low interest rates both domestically and in the international markets.
While there has been no credit squeeze for the productive sectors of the
economy, as clearly supported by the Fed's data, the US economy, and even the
world economy, have been undeniably affected by extremely high price inflation
in the essential components of consumer spending, namely energy, food, rent,
mortgage payments and health. Price inflation deflates real quantities. Real
consumption of high marginal propensity consumer groups (wage earners) has
declined under the effect of exorbitant energy and food price inflation,
leading to a reverse income multiplier effect. In addition, national savings
have turned negative leading to a decline in real investment. Accordingly,
unemployment rose to 6.1% in 2008.
Bernanke and Paulson appear blind to the underlying reason for the financial
crisis. It is a housing bubble that has not completely burst. Prices are still
inflated relative to indicators such as disposable income. Price declines still
have some way to go. Banks do have the money to lend but are unwilling to do so
at these inflated prices unless the borrower puts down a much higher down
payment than that required in normal times. This would appear to be good
banking practice and will not be altered by the TARP.
The uneven-handedness of the TARP is obvious. It purports to protect one group
(bankers) at the expense of another group (workers, pensioners) arguing that
the gains of the former serve the economy while the losses of the latter have
no incidence on the economy.
Unprecedented action
Such a massive bailout of the whole banking system has never been adopted in
any country before. Banking bailouts should not fall under the jurisdiction of
the Treasury, and should remain confined to the jurisdiction of the central
bank. Ailing banks should be treated on a case-by-case basis, and not in a
systemic way. Solutions have to be addressed at each ailing bank level.
Recapitalization has always been the responsibility of shareholders. They have
enjoyed profits during fat years. If they
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
