Catholic Citizen

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Where Are We Going with this Bailout?

I’m not an economist, but I have been paying attention. Here are the sequence of events as I saw them happen:

At some point, by some means, Secretary of the Treasury Paulson and Chairman of the Federal Reserve

Board Bernanke, became aware that AIG – the largest insurance company in the world – was floundering financially. In fact, I understand that AIG approached treasury because they said they could not raise enough capital privately.

Now it should be noted here that, at least to my understanding, one division of AIG had a “liquidity” problem, and that other divisions were, in fact, profitable, and could have “bailed out” the division in trouble without bothering the US taxpayers and their money at all.

Enormous assets are held around the world by this conglomerate of many different companies, and if the cash wasn’t readily available, assets could have no doubt been liquidated to cover the “temporary shortfall.”Additionally, there are the protections offered for companies in bankruptcy of which I understand AIG is well aware, having been there before. So why was this time different? I don’t know and can’t find out anywhere any particular situation being different that would have necessitated the federal government to step in this time. In fact, from what I can see, it is probably true that AIG could loan the federal government money rather than the other way around. This country is technically financially “bankrupt” in the sense that the only “product” the government produces, our currency, is valued as less every day by traders around the world. It is, after all, the primary task of the Fed and Treasury to ensure that American dollar value remains high.

But here comes AIG asking for a handout, and since they received that handout, they continue to send their employees on expensive junkets, at taxpayer expense, instead of taking seriously the fact that, partly due to them, the public deficit has now doubled in the last few weeks!

Nevertheless, as I understand it, Paulson and Bernanke and perhaps Cox, Chairman of SEC, decided to make available $85 billion in loans at a rate of over 11%. I can understand why the President would tell them to go ahead with what needed to be done – that’s why a President has advisors and department heads, to be experts in their field.

According to Paulson and Bernanke, they watched as the credit markets froze after making this deal with AIG and as they allowed Lehman Brothers, the oldest investment bank in Wall Street, to be liquidated. Why didn’t Lehman Brothers go into bankruptcy protection instead of immediately falling like a corpse picked apart by vultures?  I can’t find an answer for that either.

So now we have the situation where a few investment banks have gone belly up because they were gambling with other peoples money and got caught short. To me and I suspect the general public, it looks like the federal government has chosen to front some money to each of these “for profit” corporations so they could belly back up to the table and keep gambling so they can try to recoup their losses. This is the behavior of someone who is addicted to gambling, just before they blow their brains out in their unpaid for motel room.

Has the so-called “credit crisis” eased since the actions of Treasury and the Fed?  Not that I have heard. The stock market continues to tumble, which was not what the government was attempting to address, as I understand it. Are the billions that were added to the public debt being used to buy up the “toxic debt” which originally was said to be causing this problem?  No, it has been funneled to very wealthy banks and they have been told to start lending to corporations and the public. I have not heard that that is happening yet, at least.

Like many, I am trying to determine in my own mind whether we just have an awful example of rank incompetence on the part of those who have engineered this fiasco so far, or if there is something systemically failing in our system of government and economic practice. If, as some say, the market got the way it is through “capitalistic free-market” principles, why isn’t the solution free market and capitalistic as well?  When the government starts acting as instigated by corporations, or acting “in partnership” with corporations, are we not far afield from capitalistic principles?  I have heard some say that it is “socialism.”

Actually, from what I can see, it is by definition “fascist” according to the definitions I have included below.

“A philosophy or system of government that is marked by stringent social and economic control, a strong, centralized government usually headed by a dictator, and often a policy of belligerent nationalism.” (From The American Heritage Dictionary)
An “economic, social and political doctrine which expresses the struggle for the equal distribution of wealth by eliminating private property and the exploitative ruling class. In practice, such a distribution of wealth is achieved by social ownership of the means of production, exchange and diffusion.” (Rius, Marx for Beginners (New York: Pantheon Books, 1976), 152.)
Capitalism is an economic theory which stresses that control of the means of producing economic goods in a society should reside in the hands of those who invest the capital for production. It is a system based on the production of goods and services for exchange rather than use. Private ownership and free enterprise supposedly leads to more efficiency, lower prices, better products. Adam Smith popularized this theory in his 1776 book The Wealth of Nations.

As far as rank incompetence on the part of Paulson and Bernanke, I believe they are both rather new in their positions. Bernanke, I understand, is a professor with zero experience in business, and Paulson was CEO of Goldman-Sachs, one of the investment banks involved in this who have now changed to a “regular” bank, now insured by the FDIC (which is us). I am under the impression that he is not an economist but a trader and business man whose focus has always been on making money, not understanding the economy from a theoretical standpoint.

So if a Democrat administration had been in charge, what would have been different?  Would Bernanke still be in charge of the Fed?  We know Paulson will leave with the outgoing administration, so we can assume he would not be appointed by a Democratic President. Perhaps former Secretary of the Treasury Robert E. Rubin or Larry Sumner would be in Treasury. Perhaps former Fed Chair Volker would be in the Fed. (I’m ignoring Greenspan because he was in for so long before Bernanke that it is likely that Greenspan’s policies have much to do with the present situation.)

So what do Rubin and Volker say about the present situation? I can’t really find anything indicating a policy statement by Rubin, but an article from Financial Post is instructional:

Rubin Sees End to Crisis

Eoin Callan, Financial Post Published: Tuesday, September 30, 2008

It takes a brave soul to call the bottom in the depths of a global financial crisis, but yesterday Citigroup Inc.’ s Robert Rubin ventured a cautious prediction the end was in sight after his institution agreed to buy Wachovia Corp.’ s banking operations in a government-backed rescue.

As shock waves from the financial implosion on Wall Street continued to topple institutions around the world, the former U. S. Treasury secretary said governments had the power to “stem the immediate crisis of confidence” in world markets.

Speaking as the future of a US$700-billion bailout package was cast into doubt, the Citigroup director said it was within the gift of policymakers to restore stability, predicting the U. S. banking system would “weather” the turmoil.

“If we don’t, we are all in a new world,” said the Citigroup director.

The view from the boardroom underlines the pivotal role bank executives expect world leaders to play in halting the worsening credit crisis, and came after George W. Bush, the U. S. President, approved an emergency rescue of Wachovia, the sixth-largest U. S. lender.

The rescue follows a dramatic wave of consolidation in the global banking industry brought on by an unprecedented seizure in credit markets and concentrates control of more than a third of the U. S. retail branch system in the hands of three banks: Bank of America Corp., JP Morgan Chase & Co. and Citigroup.

The deal protects depositors but decimates Wachovia shareholders, setting a fresh precedent that spooked investors in financial stocks who see the terms as a model for how authorities will handle failing banks in the absence of a comprehensive bailout scheme.

As high-political drama yesterday on Capitol Hill gave way to in-fighting, shares in Citigroup fell 12% as the wider U. S. financial sector dropped 11% and Canadian financials slid 5.6%. While heavyweights Royal Bank of Canada, Toronto-Dominion Bank and Bank of Nova Scotia were the biggest contributors to the decline in Canadian financials, Canadian Imperial Bank of Commerce and Bank of Montreal shares were the worst performing big banks, dumping 8.5% and 9.4% respectively.

The rescue of Wachovia will land a direct hit on Toronto-based financial institutions such as Manulife Financial Corp., which has $600-million in exposures to the bank.

The terms of the takeover allow the branches and deposits of Wachovia to be picked up at a fire-sale price of US$1 a share, or about US$2.2-billion, but mean Citigroup will absorb up to US$42-billion in losses on a US$312-billion pool of tainted loans, with the Federal Deposit Insurance Corp. assuming losses beyond that point.

“I think it was the right decision,” Mr. Rubin, the Citigroup director, told the Financial Post after a 6.30 a.m. board meeting yesterday to approve the deal.

Outlining the tense 48 hours leading up to the agreement, Mr. Rubin said the Citigroup board had met twice on Saturday to assess the situation and again on Sunday to strategize before a marathon negotiating session that continued until just before dawn yesterday morning.

With minimal time to assess the risks lurking in Wachovia’s books, the Citigroup board appears to have been guided in part by confidence that credit markets would start to stabilize in six to 12 months.

Mr. Rubin said that as former U. S. Treasury secretary he had witnessed first-hand crises when markets enter “a state of deep psychological duress and at some point begin to heal themselves.”

“I think public policy should be able to stem the immediate crisis of confidence,” he said after flying to Toronto to address an industry conference hosted by the Financial Times.

An article in MarketWatch gives us a sense of Volker’s opinion of government bailouts. Former Treasury Secretary Sumner seems to share Volker’s philosophical bent in the same article.

Volcker: Fed’s role should be above politics of whether to support markets

By Kate Gibson, MarketWatch 5:13 p.m. EDT April 9, 2008

NEW YORK (MarketWatch) — Former Federal Reserve Chairman Paul Volcker on Wednesday challenged recent moves by the central bank, including its $29 billion bailout of Bear Stearns Cos. and interest rate cuts, saying both could create more problems than solutions.

Last month’s rescue of Bear Stearns and the subprime mortgage mess that led up to it illustrate sharp differences between investment and commercial banks, with the latter better capitalized and regulated, and therefore better able “to protect against these crises,” said Volcker, speaking at the Harvard Club of New York City.

The Fed intervention also calls into question what role the central bank might be expected to play if and when other such scenarios arise, said Volcker, who chaired the Fed from 1979 to 1987.

“Taking this kind of action in an emergency does create a precedent in people’s minds… the more you support the market, the more political concerns arise. The Federal Reserve is supposed to be above all that,” said Volcker.

“Financial crises don’t come along unless there are underlying problems,” said Volker, who pointed to years of the U.S. consuming more than it produces, with U.S. debt financed by money from abroad and Americans buying cheap goods from overseas.

“The only trouble is you can’t go on forever spending more than you’re producing,” he said.

Volcker, whose Fed is credited for halting the stagflation crisis of the 1970s, also maintained the central bank’s interest rate cuts won’t be an easy fix to current financial problems. “The history of markets is littered with the idea you can solve problems by raising inflation,” he said.

Addressing the same audience, former Treasury Secretary Lawrence Summers said the U.S. economy is “currently in recession,” but the next administration would likely inherit an economy on the cusp of recovery.

“In a technical sense the recession will have ended when the next president takes office,” although the climate may not feel much improved, said Summers, a Harvard University professor who led the U.S. Treasury during the Clinton Administration.

David Walker, up until recent weeks the country’s comptroller general, lashed out at the “imprudent and immoral practices of the Federal government,” saying the current policy of low taxes and high government spending means “tomorrow’s taxpayers will pay the bill, (including) those too young to vote and some of them not born yet.”

For a financial system to work, it needs to have incentives “for people to behave the right way,” adequate transparency, and individual and institutional accountability when things go wrong, said Walker, who for a decade headed the Government Accountability Office.

So what do Rubin, Sumner and Volker say about the present situation?  Note that this instruction came clear back in April, but certainly applies to what has occurred in August and September and continues on into October.

It seems clear that a Democratic administration would not have intervened in the troubles of Wall Street, which has now spread to the global markets. Barack Obama, who voted for the bailout, has said that if and when elected, he will be reviewing every line of this bailout, and may change the rules once able to do so.

from MIKE ALLEN, Politico 9/28/08 7:59 AM EDT
Hours after a tentative congressional agreement on a mortgage bailout program, Sen. Barack Obama (D-Ill.) said Sunday morning that he is likely to support it but might seek changes in the program if he is elected.

“If elected President, I will order a thorough review of this plan to make sure that it fully lives up to the principles I’ve laid out,” Obama said. “And I will also move quickly to upgrade our financial regulations for the 21st century, establishing new rules of the road and tougher oversight to ensure that the American taxpayers are never again forced to put their money and their futures at risk because of bad decisions in Washington and on Wall Street.”

Suggesting he will support the plan, Obama said: “While I look forward to reviewing the language of the legislation, it appears that the tentative deal embraces [four] principles [he had advocated].”

Obama’s statement began: “The breakthrough between Congress and the Administration is the culmination of a sorry period in our history, in which reckless speculation and greed on Wall Street and lax oversight from Washington led to a meltdown of our financial markets. But regardless of how we got here, a failure to deal with the current crisis would have devastating consequences for our economy, costing millions of Americans their jobs and retirement security.

“To understand how this tentative deal was reached, it’s important to remember how this all began. The Bush Administration initially asked for a blank check to respond to this problem, which I strongly opposed. It would have been unconscionable to expect the American people to hand this Administration or any Administration a $700 billion check with no conditions and no oversight when a lack of oversight in Washington and on Wall Street is exactly what got us into this mess. If the American people are being asked to pay for the solution to this crisis, their tax dollars must be protected.

“That is why over the past ten days, in conversations with the President, Secretary of Treasury and leaders of Congress, I laid out the four core principles I believed had to guide any solution: oversight by an independent board; protections for taxpayers to ensure that they are treated like investors and that they receive any profits – and recoup any losses – from this plan; measures to help homeowners stay in their homes; and rules to make sure CEOs are not being rewarded at taxpayers’ expense. While I look forward to reviewing the language of the legislation, it appears that the tentative deal embraces these principles.

“When taxpayers are asked to take such an extraordinary step because of the irresponsibility of a relative few, it is not a cause for celebration. But this step is necessary. Now Washington has to show the same sense of urgency in dealing with the crisis facing Main Street and the middle class by passing an emergency economic stimulus plan that would create jobs by rebuilding our crumbing roads; shore up flagging state budgets to prevent drastic cuts in education and health care; and extend expiring unemployment insurance benefits for those who’ve lost their jobs in this downturn and cannot find new ones.”


October 16, 2008 Posted by | Uncategorized | Leave a comment