In the past 24 hours, Henry Paulson effectively committed up to a trillion dollars of tax payer money to bail out bankers and investors, and locked in fiscal policies of his choosing for the next several years. To try to understand the full implications of this, I asked Max Fraad Wolff for an email interview. Max's work regularly appears in the Asia Times, The Prudent Bear and many other international outlets. His work can also been seen regularly on his site GlobalMacroScope.com. Based in NYC, he does contract research on international financial risks and opportunities while teaching in the New School University's Graduate Program in International Affairs. Max is an unorthodox economist--just the kind we need right now.
ZE: Wow. What just happened?
MFW: We just went from Free Fall to Free Lunch. It turns out free markets are the greatest system on earth, but only when they go up. Market discipline is for low income people and homeowners. Short selling must stop only when it laps up on Goldman's shores. Today, the government deploys hundreds of billions, maybe more than a thousand billion dollars to bail out banks and owners, insurers and traders of mortgage backed securities. Wave after wave of cash infusions didn't work, Thursday morning's $183 billion did not work. So here come new rules and whole lots more money. The government will insure money markets, the government will buy between $800 billion to $1.2 trillion in distressed securities to sure up balance sheets. If this had been done last week, then Lehman, AIG and Merrill would still be out there with ALL their employees. If it had been done in March, Bear Stearns would be with us. This financial run just got more expensive than Iraq. Where will the money come from? Who gains and who loses? Is this the largest economic intervention in at least several decades?
ZE: So let me make sure I understand this. Big investors made trillions in bad loans over the past couple decades. Everyone just realized it and now markets are flipping into turmoil. Treasury Secretary Paulson and other financial big wigs decided that without intervention, we'd get into a 1929 free fall. And so they stepped in and said, "Everyone can stop panicking, because we'll insure all your bad loans." Is that right?
MFW: Basically, yeah. The crash is 13 months old. The pain is real and it is really slamming into employees, home owners and the global economy. Many of us have been warning of this for years. Federal regulators have lied and done day-late, dollar-short failed interventions for 14 months. After another round of false promises, they last night gave in and finally decided to admit that the financial sector was leading us into a global recession. So we just pledged years of tax revenues upfront to buy bad mortgage-backed securities. We still don't know the all important details. At what price is the U.S. tax payer picking up the tab? We have been told "market prices" but, what does that mean? Not the market prices before this announcement. Those prices were killing firms and spreading massive losses throughout the world economy. We still don't have congressional approval either. I have no doubt those dead fish will float with the tide. Congress will back the action. Action is needed. We were sliding off the edge. It is just a question of which actions and who benefits.
ZE: What should the American people be saying right now? Should home owners be saying: "Instead of helping some investor who bought my mortgage from my bank, just help me pay my mortgage!" In America we don't like handouts, right? But if we're handing out a trillion dollars to irresponsible lenders and investors, why not hand that money out to the borrowers instead? Shouldn't they be forgiven for taking out "irresponsible" loans before high-finance lenders are forgiven for making -- and aggressively marketing -- such bad loans?
MFW: Over the next few days every financial institution in America will be grappling with congressional staff for a piece of this bail out. It's a huge fight going on right now. People like to think of Wall Street as a monolith, but there are many competing factions. The bond market folks are not too excited by this. The shorts are told their life work is illegal -- at least for a while. Many hedge funds must be getting shredded by the new rules and regulations. The government waited until two of the five investment banks were destroyed and two others were in varying depths of shotgun weddings.
The big banks that wrote all those bad mortgages may well be the biggest beneficiaries of the whole shebang. Investors, especially those who were betting on financials are very happy. Many will be hoping that this works to jump start the heart of the US economy -- credit provision. And the American people have no direct say in this at all. So yes, those who claim to represent the interests of the American people -- Congress? -- should be asking what the people get in this deal. The banks and insurers are fully engaged. The American people are totally left out. There will be some provisions to keep some people in still-overvalued homes that they still can't afford. It is not clear that will do much other than buy time and transfer losses from asset holders to the already near-bankrupt government. That has been true all along and remains part of the problem. And in the end, will these newly helped banks loan again as they did before? I doubt it!
ZE: If their representatives did stand up for them, what should the American people be looking to get in this deal?
MFW: Firstly, they should have a say. They are missing the size and profundity of what is happening. We are selecting our national priorities and committing our tax dollars -- for years -- right now. What is on offer to distressed homeowners, struggling college students, unemployed Americans, pension and 401K accounts hammered by what has already happened? What is being done to address the core mismatch that created this problem? People can't substitute loans for wages and savings! They still can't after this deal goes through! Until and unless we fix that problem, all solutions are temporary and we fix one problem by creating the next problem.
By the way, the US Dollar is now the world's first currency backed by home mortgages!
ZE: And let's say the government did work to help ordinary Americans in addition to bankers at this moment. Would that fix the whole problem?
MFW: There is no easy fix here. It's crucial to understand the underlying problem. Over the past few decades, Americans' wages did not rise and government taxes did not rise overall. But, people and the government massively increased their spending. Thus, the vast debts and our addiction to foreign capital -- much worse and more pressing than the addiction to foreign oil! Now it's finally become clear that America can't pay back all the money -- and that is the source of all the pain. It is rippling through the system and slamming owners investors, traders. As long as the problem was just people losing their homes, there was no sense of urgency. But when it hits the people who really count, it is a crisis and they get help.
ZE: What I'm having trouble grasping, why is bad debt is such a huge problem for the economy as a whole. Can we boil it down? Let's say I bought a house for $500,000 and that you lent me the money to buy it. But I can't pay back the loan. And it turns out my house was only worth $500,000 at the height of the bubble and no one will buy it now. So even if you repo my house, you'll still lose half your money. That in itself doesn't seem like a huge problem for the economy. I lose my house, and you lose some money. Maybe you buy the house and rent it to me (as is happening often in real life). What's the big deal?
MFW: The problem is our economy runs an credit. When creditors take losses -- and these losses are global -- they can not and will not lend as much in the future. This creates shock wave after shock wave that slams into banks, investors, markets, pensions and confidence. By last Friday it became clear that the entire global financial system and the US macroeconomy were on the brink. In other words all those assurances and past solutions had definitely and totally failed. Thus, we confront the next round.
ZE: OK. Hopefully when we get to that next round you'll have time for another Q&A like this! Thanks.
Follow Zack Exley on Twitter: www.twitter.com/zackexley