THE BLOG
10/16/2008 05:12 am ET | Updated May 25, 2011

Sack Paulson

Current economic conditions are nothing if not complex. Investment banks are disappearing and merging; massive insurance companies are floundering, trillions of dollars of mortgage debt is in question (and it's not even held by American companies). It's tempting to think that economics is just an inherently complicated discipline, and that these kinds of shocking events were destined to take place at one point or another. Sadly, that's not the case. We were destined for a downturn eventually, but not this.

While it's true that economies go through cycles, bringing good times and bad, what makes this particular cycle different from many past ones is that this has been about more than just low stock prices, lost jobs, and negative GDP growth. Rather, this most recent crisis has resulted from systemic failures in the very institutions that we have relied on to keep our economy going.

For the big banks, weathering the technology bubble eight years ago was difficult, but possible, given how far removed most of the companies involved were from the day-to-day operations of buying and selling. When Enron began to slip, the lights went out in California, but New York hummed along relatively smoothly. In each instance, however, hindsight revealed massive fraud, whether it was on the part of get-rich-quick entrepreneurs and venture capitalists, or Andy Fastow and his acolytes, who manipulated energy prices for their own gain (among numerous other tricks).

This time is no different. Numerous investigations will eventually reveal that the downfall of Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, and an independent Merrill Lynch were completely preventable, mired in deception, and anything but pre-determined. The people who were directly responsible for the problems at each individual firm will eventually be exposed, shunned, and possibly incarcerated. But that won't make the world a better place. If Wall Street is daycare for quantitative wizards, then the traders, analysts, and even executives responsible for selling bad mortgage loans as top-grade securities were merely the two-year-olds stealing someone's toys (and then lying) while the adults in the room looked on and encouraged them to. After all, with free market policies, shouldn't one let the market do as it pleases?

The answer, which should be all too obvious now, is "no." At its extreme -- what we just witnessed -- laissez faire economic policies encourage the less ethical among us to exploit whatever loopholes can be found, with no fear of retribution. Those on Wall Street are probably just as ethical as any sample of the American population (meaning that there are some saints, some devils, and some in-between), but throw in some intense competition, huge yearly bonuses, a trading desk, and a set of laws that is rarely comprehensive or water-tight, and with only a few misguided souls you've got yourself the potential for a huge disaster. Now that the huge disaster has transpired -- again -- the need for better regulation should be topic number one in the presidential election, or at the very least, something the press starts asking questions about.

Meanwhile, we have a Secretary of the Treasury who apparently believes that, as Paul Krugman recently put it in The New York Times, the best way to handle the current economic conditions is by playing Russian roulette. At this point, options concerning the best way to proceed are definitely limited, but they weren't always. Paulson could have pressured the SEC to keep regulations restricting short sales on the books (in order to prevent traders from profiting on stocks going down, instead of up) long after Bear Stearns collapsed, and yet the emergency provisions were scheduled to be lifted on July 29. On September 12, the Friday before the collapse of Lehman Brothers, the short sale interest in its stock was 11.68% of outstanding shares, compared to 0.68% of outstanding shares for General Electric. It's impossible to say exactly which rumors or trades finally did Lehman Brothers in, but having seventeen times as much short selling taking place as an average Dow Jones component could not have helped.

So, if I were President, I would put a new Secretary of the Treasury in place who understood why it's a bad idea to let the market cure all ills. If humans were perfect, than our markets would be too -- but we're not, and as of today, our markets definitely aren't. Paulson failed to uphold his duty to effectively regulate our financial system, and his solutions thus far have placed an unbelievable burden on taxpayers. Thousands of Lehman Brothers employees are packing their desks today. Why isn't Paulson packing his?

Aaron Greenspan is the author of Authoritas: One Student's Harvard Admissions and the Founding of the Facebook Era.