The Bungled Bailout (Or the Perils of Paulson)

Somebody should compile an authoritative list of the foolish statements, Wall Street parochialisms and bungled bailouts racked up by Treasury Secretary Henry Paulson and his faithful Federal Reserve Board sidekick, Ben Bernanke, since the Great Credit Crash began in August 2007. Small wonder the global markets can't sustain any belief in the two men's tandem policies. Neither understands the cancer cells spreading in the corpus of the U.S. (and now world) economy.

First, we had Paulson's fatuous analysis that the summer 2007 spasms were just a real estate matter that would be easily contained. Tonto Bernanke agreed. Then came the Treasury Secretary's little remembered autumn proposal to set up a "SuperSIV" to handle the financial sludge that Citigroup and other big banks had parked in tricky off-the-books vehicles.

No sooner was the SuperSIV gambit ignominiously dropped than it was time for March's $29 billion Fed rescue of the investment firm of Bear Stearns. Although former Fed Chairman Paul Volcker called that one barely legal, Paulson and Bernanke said it would stem the tide. It didn't. Since then, we have seen the Washington-facilitated rescue of Merrill Lynch, the shrugged-off failure of Lehman Brothers, and the last minute bail-out of AIG, the too-cocky insurance giant. This regulatory triple-play failed to strengthen international confidence, and the Crash just kept on Crashing.

Eventually the towering T-Man and the bearded banker decided that perhaps skeptics were correct in surmising the world's biggest financial crisis since the 1930s. So during the week of September 15, they forswore the hapless doctrine of piecemeal bail-outs, assembled their crack staffs and consulted the memories of Herbert Hoover and J. P. Morgan. Then, in a mere three page emergency document approved by "President" Bush, they proposed that Paulson be made America's financial czar empowered to use $700 billion of the taxpayers' money to bail out Wall Street scofflaws by buying up the half-worthless or toxic financial products that other Wall Street geniuses -- all too many working in the same hotshot firms -- had pioneered.

The public, rightly perceiving a staggering ego trip and shameless bail-out, inundated Congress with a wave of letters, telephone calls and e.mails, and on September 22, the House of Representatives voted to reject the Treasury-Fed power grab. This stunned the financial community, which bathes 24/7 in the aura of its own importance, and global markets shuddered. Within ten days, the Senate had acted on a new rescue package -- loaded up with $100 billion of baubles, tax breaks and fresh pork to sway public opinion and bribe several dozen congresspersons. On October 3, the House accepted this version, but the global markets scoffed and sank for three straight days -- October 3, 6 and 7.

Here we must keep in mind that while Paulson and Bernanke got much of what they were looking for -- $700 billion and powers that verge on unconstitutionality -- some potentially important conditions were attached. To over-simplify somewhat, companies that turn in their junk paper to the Treasury's new subsidized rescue office can't have overcompensated top executives, and Paulson's Treasury has to make some details of the arrangements public within a few days. Meanwhile, the Secretary did not get the full immunity he sought -- above-the-law financial czar status -- and the Treasury still has a small degree of accountability. The upshot is that if Congressional committees, state attorneys general, consumer and civic groups, watchdog organizations and public interest law firms and research groups set up serious bailout monitoring and response mechanisms, they can quickly identify and publicize any improper pigs lining up at Washington's new public trough.

And hopefully they will.

But the largest reason to the doubt any major success of the just-enacted Washington bailout is that it does not go to the heart of the problem -- the gross excesses of the U.S. financial sector and the need for sweeping reforms and indictments, both ethical and legal. Or to put it differently, given the last decade's malignant transformation of U.S. finance, providing federal transfusions without needed corrective surgery is not medicine but unwise favoritism and cosseting.

Bad Money, my book published this Spring, detailed at length the recent rise of the U.S. financial sector. Over the last two decades, the financial sector has grown from 15-16% of U.S. Gross National Product in the mid-1980s to 20-21% of the current Gross Domestic Product calculus in 2006-2007. Manufacturing, meanwhile, has dropped to a mere 12% share. This upheaval is closely related to the ballooning of total public and private debt in the U.S. -- the great bulk of it is private -- from some $11 trillion in 1987 to some $47 trillion in 2007. Debt and credit, in all its new forms and mutations, from exotic mortgages to securitization and credit default swaps, has become one of this nation's top industries. Alas, the displacement by finance of manufacturing represents as far-reaching a changeover as manufacturing's displacement of agriculture did a century ago. However, the national media refuse any discussion, an information gap that cripples national policymaking.

Something similar, albeit milder, happened to the previous leading world economic powers -- most recently Britain and Holland (in the 17th century when New York was still New Amsterdam). I have described these prior financialization patterns in several previous books, and I will not repeat the discussion here. However, the recent transformation of the United States is a much deeper and more systemic development. In looking at Spain, Holland and Britain and their decline patterns, I described financialization as a late historical stage, a symptom of national aging, and an arteriosclerosis of sorts. Some others have made similar points.

But looking at the financial interactions, complications and surprises of 2007-2008, I think that we can usefully consider a further analogy - positing the U.S. variety of experimental mega-finance and "scientific" speculation as a kind of historical cancer, a dangerous stage in the historical biology of nations and economies.

Even the mainstream financial press has been using pop scientific terms to describe the new economic behaviors, miscalculations and hard-to-explain interactions. "Toxic" and "contagious" are two popular, if imprecise examples. Toxicity, for its part, leads to the subject of cancer, which science only really began to understand in the 20th century.

Interestingly, on the American Cancer Society's website, their short "History of Cancer" begins as follows: "Cancer develops when cells in a part of the body begin to grow out of control. Although there are many kinds of cancer, they all start because of out-of-control growth of abnormal cells." Such cells develop because of damage to DNA, usually among older adults. Then "cancer cells often travel to other parts of the body, where they begin to grow and replace normal tissue. This process, called metatastisis, occurs as cancer cells get into the bloodstream or lymph vessels of our body."

My thesis is that the Frankenstein finance of the last two decades -- the crazed borrowing, pseudo-science, frenetic growth, greed and gambling -- did something roughly similar to the once-normal cells of our American economic corpus. So we don't know exactly what is happening now, why, or with what kind of contagious complexity. Radiation and even surgery (cutting out institutional tumors) may be in order. Over to you, doctors Paulson and Bernanke.

Kevin Phillips' new book Bad Money: Reckless Finance, Failed Politics and the Global Crisis of American Capitalism, published by Viking in April, is now back on the New York Times non-fiction and business bestseller lists.

Comments

[Puller58]

Mr.Phillips, it is a pity you are shunned by the media. You've been a voice of reason for many years. But the MSM has masters to obey.

[Manelvagorio]

WOW, 1200 (mostly big) words and somehow the words "Fannie Mae" and "Freddie Mac" NEVER APPEAR EVEN ONCE.
How can one expect to have ones brilliant CANCER ANALOGY taken seriously without even a tip of the hat to the ORIGINAL CARCINOGENS involved.
Thanks to K. Phillips for leaving NO STONE UN-TURNED in your "insightful" analysis.

[corkonian]

Stop listening to the repugs and learn something:
http://www.mcclatchydc.com/251/story/53802.html

[corkonian]

http://www.mcclatchydc.com/251/story/53802.html

[Artos]

As I have said before in previous posts, the only reason that all this "High Finance" of credit and banking, has gotten complex is because just like in Magic acts you must use smoke and mirrors along with some slight of hand to hide the fact that underneath it's all just fakery. They do all this complication to hide the fact that most of it is marginally legal or flaunts the envelope of legality. They probably have hired lawyers who tell them on a regular basis what they can get away with. For example the lawyer might say," Well I do believe you can do this because as of yet they haven't made a law against it. They might later when they discover how corrupt it is, but they haven't done it yet so go ahead for now and don't worry about it." So perhaps later down the road when what they did has wrecked the economy and millions of dollars have been stolen from investors the idiots in Congress will deign to make an after the fact law covering it. By then it will have been too late for thousands, perhaps millions of average people who are now poverty stricken.

[schatsie]

KEVIN PHILLIPS for Secretary of Treasury!!! ANY ONE who has read either of his books BAD MONEY or The American Theocracy knows that this man has the overall expertise and will give due consideration to the pros and cons of any TAX Restructuring or Reform...

He is a man of great ethical and moral fiber and understands politics and our democracy over the last 40 years!!!

[Artos]

schatsie,

I might also suggest Nouriel Roubini. From what I have heard from him of late, he speaks straight and does know what he is talking about.

[veracity]

Right on, Mr. Phillips.

I'm a big fan of your "Wealth & Democracy in America", if I may distill your thesis, it is that every major fortune in America has been built in _close cooperation_ with the US government, and therefore there is a substantial undercurrent of SOCIALISM to those private fortunes (= corporations), using GOVERNMENT funds to protect & secure vast concentrations of wealth.

I learned a parrallel lesson independently, looking at the example of WWII, where PROFIT was _NOT_ the Alpha-&-Omega, the Holy Grail, of America's WWII production.

Quite the contrary: there were STRICT LIMITS on profits, Harry Truman came to America's attention (& was virtually drafted by FDR to be VP 1944) because Truman's Senate Committee hearings exposed War Profiteering. Despite all the rules, regulations, mandatory rationing, America produced more production in the war years than was imaginable during the depression, the "Miracle of Production" from the arsenal of democracy - at a time when a huge portion of manpower was taken OUT of the economy to supply armies overseas!

A perfect example of America's top-heavy, trickle-down, finance-as-god economy NOT producing what America needs, is the lack of high speed rail Boston-NY-Phila-DC-Richmond. America fully 20 years behind Europe & Japan, the NE air corridor overcrowded to point of hazardous. But communters FORCED to go out to airports, through security, fly gas-hog flights, then repeat commute back into town - because the Wealthy & financial community quite incapable of producing what America really needs.

[castlerider]

SO TRUE about the lack of proper rail service. All over the country!!!

It's one of the biggest issues that can be traced to greddy corporations that want to keep you burning oil, Keep you working the same worn-out infrastrucure, and politicians who are neck-deep in their pockets. It's disgraceful, cowardly, uncaring for our future, and downright un-American.

This is a change I feel very confident Obama will confront happily.

Obama/Biden 08!!!

[montemalone]

"It's disgraceful, cowardly, uncaring for our future, and downright un-American."

I'm afraid to say you're wrong. By all accounts, that's what we've become.

[Artos]

veracity,

In Truth, this country was founded on Socialism. Think about it, Men came from overseas and took land from others then they doled it out according to their own lights to those they wanted to give it to. None of that land belonged to them so by what authority did they have the right to give it to anyone or at a later date sell it to anyone else. By assuming ownership of that land they acted no different than the Communists of The Soviet Union or China. Then when they doled out lands to others it was with the addendum the they still had a Sovereign right to take all or a portion of it back to do with as they will ie Eminent Domain. So is that not the same as Socialism or isn't it. When the Railroads were created in the 1800s our government just gave them land in order to make it easier for them to create it. That land was stolen from the indians and just reallocated. Is that not Socialism. You don't see Corporations complaining about Socialism when it works in their favor.

[reunionpi]

Henry Paulson, 5 weeks before he became Treasury Secretary, got a FANNIE MAE/FREDDIE MAC 30 year fix mortgage/loan for his 82 year old mother in May 2005 for 5.37%, (below rate)

webofdeception.com

[Artos]

reunionpi,

Had the Government, both Congress and the President, taken the foreclosure problem seriously the first year rather than wait so long, they could easily have prevented it. Instead of this crazy idea of McCains in which the Government buys up all the foreclosures in order to rescue the loan institutions why didn't they just issue a Government order that made all of the Loan Organizations stay all of the loans at a reasonable fixed rate something like the 5.37% rate that Paulson got for his mom. Had they done this it would have prevented any further erosion in the economy and left thousands of families in their homes. The Loan Institutions might not have liked it initially since it would have left a dent in their overall profits and most certainly they wouldn't have been able to give their overpaid execs the huge bonuses they got, but in the long run these organizations would still have remained solvent. Where are they now. Fools and their money are soon parted.

[likeicare]

Dead on, again, Mr. P.

William Greiger (spelling?) has suggested that Congress re-instate the usury laws, which would do much to correct the problems in the financial industry, as well as going a long way in alleviating the crushing burden of debt which is crippling people and the country as a whole. He says this can be done in 3 days.

Your observation that the financial sector of the economy has grown too big and become too powerful and all-encompassing, gets to the very heart of the problem. We have an "economy" based on Monopoly money -- the guys on WS can say X is worth $XXXX, or whatever they want, b/c it's "too complicated" to explain to the brain dead great unwashed masses who're being ripped-off, and that's how they'd like it to stay.

The stock market is nothing more than a Las Vegas-gambling venue without the glitzy showgirls and the music. The self-important, overly-preened silver spoons who inhabit that theater of the absurd, sniff at the very notion that what they do -- bet on which stocks will rise and which will fall -- has been proven to require so little skilll and intelligence, that a chicken or a monkey can accomplish the same results as someone with a degree from Harvard, Princeton, or Yale.

The financial "geniuses" really believe the world in incapable of spinning on its axis without them.

It's the hubris, stupid!

[ylDave]

Another great post. The overdeveloped financial sector is in response to the excessive liquidity of the Greenspan years which juiced the economy and cushioned us from recession, but you don't get something for nothing and now we're seeing the hangover / aftereffects from that, first in a stock market bubble that burst in '99 now a housing market boom (rife with fraud and risky speculation) gone bust. So government is intervening to stop that natural correction in the markets - taking steps that will exacerbate rather than help the situation.

Dave
http://www.islandersoftware.com/weblog/2008/09/27/just-say-no-to-the-bailout-plan/
http://www.islandersoftware.com/weblog/2008/07/11/pollyanna-creep-economy-worse-than-we-know/

[cylindar]

No one has the answer. It was the same for the last great depression. All the economists were dumbfounded. People are going to lose their heads, their shirts and all their money on this one. You will suffer, your dog will suffer, your wife will suffer, and your kids will suffer. On the up side however, everything changes and sooner or later we will pull out of this. Yes there will be a lot of dead bodies but no one will be counting. They will just be glad that the plague is over.

[peterg76]

Just out of curiosity, did Paulson actually say at any point that he was going to solve the problem, or just that he was going to spend money?

[JBS]

It depends on how you define "problem" ... if all you're worried about is "saving" the Wall Street Wolves, he did.

[themodernleader]

Sposton and the London Sociologist. The Wall Street mechanism which allows the torpedoing of a competently run organization simply for short term profits is a Reagan era innovation. Such an innovation must be outlawed. Long term planning is an indispensible repertoire of leadership for directing any successful enterprise.

[GrainOSand]

...and keeping your manufacturing in-house as much as possible. When you do not make anything and everything you are is dependent upon complex financial instruments, something is wrong...but we knew this before we went down the road. Greed is not a wedge issue it is a catalyst or a magnet for self-destructive behavior.

[Artos]

themodernleader,
Torpedoing is a good way to describe it. I have this vision of two wealthy Corporate heads meeting for a game of golf, and one casually says to the other, " My Union is giving me a hard time. They want more benefits and a pay increase. I want to keep that profit and put it in my account in the Caymans. Are you interested in buying a manufacturing business (wink, wink)." the Other replies," Ya know, my lawyers have advised me that if I don't sink some of my liquid assets into some sort of investment soon I might have to pay an inordinate amount of taxes next year, How much are you asking?". Rich Guy #1," Oh, you can have it cheap, I am going to skim as much of the profit off of it this next 5 months and then file for chapter 11 or 12 or somesuch, then it's stock value will sink. . In the meantime I'll also tell the investors everything is peachy so they won't know what hit them when their investments disappear. After that you can have it for a song." Rich Guy #2," Yeah and isn't it great that our buddies in Congress made it legal to get rid of the Unions if a Corporation changes hands! Wow it great to be a Rich Guy!" And so it goes........ Thank god this was only a vision.

[MsYellowDog]

This whole thing is Reaganomics coming home to roost,after almost 30 years. Bush 41 called it "voodoo economics" when campaigning against Reagan,and that was about the only time any Bush got something right.

[WritusMaximus]

Too bad. Obama is on board the USS Paulson. Chances are Obama, once he becomes prez, will keep Paulson in charge, 'cuz the market hates unpredictability, don't you know! In addition, Obama voted Yes for the bailout, his political fortune is riding on the success or failure of the bailout. Obama is tied to the bailout just as McSame is tied to Bush.

Either Obama got fooled by Paulson or Obama and/or his team of advisers knows something that escapes the minds of those that opposed the bailout in favor of other plans. Mr. Phillips, Obama foolishly or rightly thinks you are wrong. I hope Obama is right, otherwise the worst is yet to come!

[rnadna]

Hate to tell you - it is!

Regardless of whether or not Obama gets elected, the genie is out of the box. It took 30 years of of reckless and foolish political and ecomomic leadership by the GOP to get us here - it isn't going to get fixed in 4 years, or 6, or maybe even 15!

Going to the Moon will prove to have been a lot easier to do than it will be to fix this mess!

[themodernleader]

Kevin Phillips. I am as appalled as you that our politicians and controlled media will not discuss the emasculation of manufacturing with the emergence of finance. Concomitantly, mercantelistic trade, especially, the Chinese, target one American industrial function after another and destroy it with cheap imports; then they buy up the idled machinery and technology at auctions. We are in the same position as the pre- revolutionary war colonies, both confronted with mercantelism. Indeed, we are losing control of our own affairs.

[kbunkboy]

I've not seen much mention of today's congressional hearings chaired by Rep. Waxman. Testimony shows American International Group AIG which received $85 in bailout money and another $37 billion today immediately held a party for its top executives to celebrate the bailout --- at the tune of a half-million in taxpayers money. What chutzpah! You gotta love 'em!

[politicky]

Your book is next up in my queue. Cancer seems like a great way to describe it. I have a feeling that the treatment is not going to be fun. Somehow I don' think the government is going to issue us stock certificates for all the homes we're now in the hole for OR barf bags.

[schatsie]

you need to stop reading whatever it is you are reading and pick up either Bad Money or the Theocracy book.... The Theocracy book is overwhelming in its theses and frankly I did not have the stomach to open up Bad Money because it would put me in a deep depression..

Kevin Phillips books are the best books erudite and thoughtful with due consideration of the facts and issues and subtexts of our culture... Once you have read either of them, it will make you sick because this mess we are in right now was predicted by Kevin and the Economist..
If people had done their due diligence before investing and these were sophisticated and educated investors, then we would not be in this position....