Monday, September 22, 2008

The Big Lie Behind the Great Wall Street Bailout

At the heart of Treasury Secretary Hank Paulson's bailout plan is a Big Lie. The $700 billion plan is predicated on this Big Lie, concocted by financial firms holding a bunch of stinky investments. In brief, Wall Street claims they can't sell the investments (securities backed by deteriorating U.S. mortgages) because of the current upheaval in credit markets and nervousness about the U.S. housing market.

That's a lie. The truth is, the firms can’t sell the securities for nearly as much as they would like. So in other words, let's say they think they're holding investments worth 60 cents on the dollar, when a buyer right now might give them only 20 cents. Their argument: once the fear and panic abates in the financial markets, they'll be able to recoup the "fair value,” or the 60 cents on the dollar. But they need money now. So they're looking for a chump with deep pockets.

Enter the U.S. taxpayer, stage right. Paulson's plan would have the government snapping up armloads of lousy investments in order to bail out Wall Street. If you wonder, how do we figure out how much to pay, go to the head of the class. That’s the $700 billion question. Paulson's line is essentially, “Trust me, I'll take care of it.” In private, he has essentially conceded that the government will pay too much for what are bad assets. (See this excellent blog entry by naked capitalism for the inside scoop.)

With Lehman Brothers recently going bankrupt and mammoth insurer AIG getting $85 billion of cash, the U.S. government is rightly resolved to do something about the financial crisis, and sooner rather than later. That's commendable. But the Big Lie makes this Paulson plan rotten at its core, especially considering the irresponsible behavior of Wall Street's financial firms over the last few years.

When your drunken uncle Hal staggers in from a two-week bender, should you write him a blank check to cover his expenses, buy him a jug of moonshine, and send him back out the door?