Curses! Foiled Again!
on October 1st, 2008 at 12:44 am
You all know the movie plot: the Evil Scientist has laced the town’s water supply with a poison. All will die unless The Antidote is added, and he holds the city to Ransom. All seems lost until the Hero rides to the Rescue with The Antidote. The Hero puts the Evil Scientist behind bars, and all is well (until The Sequel anyway).
Are there any parallels here with Paulson’s currently terminated Wall Street bailout?
Well, score one for the Evil Scientist. Henry Paulson, the architect of this Plan, was until 2006 the Chief Executive of Goldman Sachs, one of the Wall Street merchant banks that profited from Subprime lending when it was in full swing—and, tellingly, also profited on the way down by correctly guessing that the bonds that financed the lending would tank (along with American house prices).
The Ransom was certainly there—US$700 billion is a pretty cool sum of money. And a lot of it would have gone to Paulson’s old firm, which stood to make money by disposing of its holdings of toxic bonds for more than their current book value—as Michael West explained in yesterday’s SMH.
But what about Paulson also being The Hero? Here he was, riding into the distressed town, with The Antidote in his saddle.
But wait a minute… Paulson as The Hero, when he was also The Evil Scientist? Then wouldn’t he have known about the Poison when he was The Evil Scientist?…
Yes, unfortunately, the real world is even stranger than fiction. At least in the movies, the Evil Scientist knows what he is doing. In the Subprime crisis, while there were certainly some who knew it was a scam from the outset, the majority conformed to what Charles Mackay so well described long ago as “Popular Delusion and the Madness of Crowds”. Paulson, like his many buddies in Wall Street who also paid themselves enormous “wages” (Paulson paid himself US$37 million in 2005 as CEO of Goldman Sachs), deluded himself into believing that Subprime lending made economic sense.
So if he didn’t understand that it was in fact a disaster waiting to happen, why on earth should anyone think that he now knows what The Antidote to The Poison is?
Certainly, buying the bonds off financiers would have enabled them to replace their essentially worthless “assets” with real money—and they could then get back into the lending game. Without The Antidote, then sooner rather than later, they would be soon forced to record those bonds, not at “book” value, but at market value—and they could become technically insolvent and unable to lend. The world financial system could have come to a halt.
But how long would The Antidote have worked anyway? Even in the weekend that it was worked out, five major financiers failed—Wachovia in the USA, Bradford and Bingley in the UK, Fortis NV in Belgium, Hypo Real Estate in Germany, and even Iceland’s major bank Glitnir—leading to state takeovers costing well over US$100 billion. How long would a US$700 billion Antidote lasted in today’s climate?
Not long, because the root problem is not the banks’ holdings of toxic bonds, but the public’s holdings of unnecessary debt. A vast proportion of the US$41 trillion debt that America’s private sector has (almost 3 times the size of the US economy) was used to finance gambling on shares and house prices in the biggest speculative bubble in global history. That debt, ultimately, is what is driving the US economy into Depression. Unless that is attacked, then a Depression will follow, whether or not Wall Street is bailed out.
Tellingly, Paulson’s original plan made no provision to reduce mortgage debt. So Paulson wasn’t being a Hero for Main Street—though I expect he believed he was. He was instead attempting to save Wall Street from itself, as Greenspan did so many times when he was Fed Chairman—but each “save” only worked because it revived the frenzy of irresponsible lending that has defined Wall Street and American banking in general.
This time, nothing can save Wall Street. There is, after all, no-one to lend to below the Subprimes, apart from those who are already in gaol. But I have the feeling that some time in the future, many of Wall Street’s current lenders will indeed find themselves doing business behind bars.
Ken,
The government guarantees up to $20 000 per bank per person. Unbelievably, this was only the case after June this year; before that zip.
byrd62au,
Interesting article. The connection between breast augmentation and credit bubbles, although understated in the article, pretty well sums up the whole social mood really.
Indeed Keith!
Michael Moore (I know I know) seems to see the bailout as Bush and his cronies making a last raid on the US treasury before they have to give the keys back. Wall St opportunists are queuing up at the trough to “earn” management fees for brokering the $700Bil.
Why has there not been more talk about maybe saving a few trillion by pulling out of Iraq?
Sk,
I think henry paulson is one of the smartest individual. and with out bail out bill US stock market will collapse like russia.
Austerity, agreed, I forgot about the $20,000. Time to split up some investments.
My impression of the bailout is that America thinks, almost certainly correctly, that it needs to do something. I don’t think a bailout is the best option, if the Government is going to give them money, then it should obtain some equity in return.
Ken, Austerity,
There is no $20,000 guarantee at the moment. The government is only considering it, which means they might make a decision about it sometime in the future. The current status is no guarantee, although it is thought by some opinionated journalists that a troubled bank would be taken over by the government, along the lines of the recent Fortis takeover.
Ken, Austerity & Keith, thank you for your responses.
Keith, you’re right about no guarantee – when I phoned APRA last week they said the $20k guarantee was being considered by the treasury but for now it doesn’t exist.
Ken, where can an ordinary private investor buy government bonds? Incidentally, why would the government issue bonds if its in surplus?
Mattress Filler, at http://www.rba.gov.au/FinancialServices/CGBondFacility/index.html I think the state governments have something similar.
Splitting between the big 4 banks may be another strategy, as the government would have difficulty not bailing them out. One of the problems with not bailing out Lehmans was that various companies have money stuck there that can’t be accessed until the receivers can evaluate the value.
Some of the smaller banks have very good capitalisation but are more likely to face a run, but would then be bought by one of the larger banks.
Answer to, why they are issuing bonds is that they decided it was a good idea even though they have no debt. It seems a proportion of investors want that type of investment.
Brightspark:) re Q&A…I sent, somewhat with a heavy hand on the phone keys. a question re the CAD under Costello. Needless to say i was ignored!
Michael West at SMH is putting up a bit of a fight on behalf of the rational…which i’m not surte includes you and me! It must be a bit difficult writing for a media outlet that depends on ads from RE, lawyers, Govts etc. The systerm is corrutpted right through…not neceesarily anything directly criminal.
Cheers
G’day Outback Oracle
The system sure is corrupted and in these cases by monsterous conflicts of interest.
However, I think the day of rekoning is fast approaching:).
As for supercilious Costalot GRRRRRRRR.
Cheers.
LMAO Costalot…love it!!
I had another crack on ABC radio but they just think one is some kind of crank…I suppose i am