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Crony Communist or Businessman?

Is Henry Paulson a crony communist or a businessman? The answer could be the difference between economic disaster and recovery.

Understanding Paulson's role in stopping-or fueling-the credit
crisis requires a review of two axioms from Economics 101: 1) A credit
crisis occurs when banks stop lending and 2) The amount banks can lend
is a multiple of the capital in their vaults. Therefore, ending a
credit crisis means prompting new lending-and that means maximally
increasing bank capital.

Enter Paulson, the former Goldman Sachs executive and current
Treasury secretary. The bailout he fearmongered through Congress aims
to waste almost a trillion taxpayer dollars buying banks' bad
mortgages-a scheme all but ensuring a disastrous outcome.

If Paulson pays banks exactly what their mortgages are worth, he
will not increase banks' capital (or their lending ability)-he will
merely convert one asset (mortgages) into another (cash), making no
impact on the credit crisis. If, to protect taxpayers, he buys
mortgages at lower prices than banks list them, banks will have to
write down their capital and consequently contract lending-and the
credit crisis will worsen. If Paulson overpays for mortgages, he may
marginally augment bank capital, but also incur massive taxpayer losses
when he later resells the mortgages at their real price.

The silver lining is a little-noticed provision in the bailout bill
allowing Paulson-if he chooses-to buy ownership stakes in banks.
According to Robert Johnson, the Senate Banking Committee's former
chief economist, this would cost roughly $375 billion less than the
mortgage-buying plan-and, better yet, more aggressively attack the
credit crisis.

Mortgages may be underpriced today, but they retain some value on
banks' books. So rather than purchasing mortgages (a capital-neutral
transaction), Paulson could buy bank stock, infusing banks with new
capital on top of their mortgages. That would exponentially increase
lending capacity, prevent taxpayers from buying toxic assets, give the
public a share of future profits and grant regulators ownership
leverage to restructure bank management.

This is where Paulson's personal proclivities come in.

A crony communist looking to socialize risk and privatize gain
would consider these options and choose to buy mortgages-that is,
choose to ignore the credit crisis, reward discredited executives and
permit banks to keep any subsequent profits-all while inhibiting a
potential government-mandated housecleaning of Wall Street. Indeed, the
Financial Times' Wolfgang Munchau says Paulson's mortgage-buying
program is driven by "a wish to benefit the investment banks he once
chaired, and which stand to gain handsomely from such a package."

A businessman, by contrast, would limit taxpayers' exposure, give
us a stake in future gains and demand management control. He would, in
short, treat taxpayers like Warren Buffett treats his Berkshire
Hathaway shareholders when buying banks with their money.

This is how Sweden successfully confronted its banking crisis in
1992, and how England is addressing its own meltdown today. In fact,
world leaders are citing our crony communism as a cautionary tale.
"This is not the American plan," said British Prime Minister Gordon
Brown in announcing his bank rescue. "We will have a stake in the
banks-we are not simply giving money."

The bailout bill's failure to make this course of action mandatory
should have killed the legislation in Congress. But banking CEOs and
their lobbyists turned "should have" into "didn't." They love crony
communism and hate government ownership stakes because, as financial
analyst Luigi Zingales says, "Nobody likes to pay for their own
mistakes-it is much better to have the taxpayers pay."

Considering the opposition, then, it is a miracle any ownership
stake language slipped into law. Whether Paulson now uses that language
will signal how deep Washington corruption runs.

© 2023 TruthDig