Paulson’s Plan: Who is Bailing Who?
By: Guest Authors
By C. Edmund Wright
The term bail out has been all over the media in light of the extraordinary rescue efforts the Federal Reserve and Treasury are hoping to take relative to Fannie, Freddie, AIG et al on Wall Street. Backed up by the “balance sheet” of the government, the Fed is using it’s “unlimited ability to tax” as collateral to take on the mortgage debt these companies have as a result of plummeting real estate values and aggressive leveraging.
Few phrases send a chill up the spine of conservatives like that of the “unlimited ability to tax.” As well it should. Having said that, as a tax payer suffering from that chill, I think it’s important to figure out just who is bailing out who here. The answers are not all that simple. A quick analogy might be that of a life boat on the Titanic. If the boat will save your life, are you going to turn down the offer because the dude who rammed the iceberg will also get a seat on your boat?
And speaking of the Titanic, this is an analogy of pertinence according to many for our macro-economy if the “Paulson Plan” does not pass. CNBC’s Jim Cramer, who has been ahead of the curve on almost every step of the economic slowdown for a couple of years, agrees that we are looking at another “depression” if the Paulson plan does not pass and spent time on his show discussing the “five lies” about the Paulson plan circulating among the naysasyers.
Cramer’s conservative alter-ego, Larry Kudlow, is also strongly in agreement with the Paulson plan though in his mind it is an unhappy solution to prevent catastrophe. As Kudlow puts it, this is a “bail out of main street America” by underpinning home values and therefore mortgage paper. (And for good measure, registered Socialist Bernie Sanders of Vermont is against it, which almost always means thinking people should be for it.)
Personally the tax payer in me is not at all thrilled about this 700 billion plus plan to which I am a co-signor. However, existence as a tax payer is not some kind of single dimension in which people can dwell. Most taxpayers are also some combination of home owner, Wall Street investor, real estate investor, private sector employee and/or business owner. Many families fit into all categories.
So for proper perspective, we all should analyze our own personal balance sheets with respects to this deal. To boil the financial crisis down to its simplest form, the root cancer is the destruction of underlying real estate values that have allowed the over leveraging of, well, almost everything on Wall and Main Street. (I would argue that the energy shock has caused the destruction of those real values, but that’s another story). This started with the sub prime crisis months ago which bled into the standard market and thus unravelled real estate prices throughout the system. When the cash dried up for mortgages and tons of repo houses were for sale, all real estate lost value. Thus the tsuanami was launched on the financial system.
The Fed, in an attempt to clip the rogue thread that is unwinding the entire garmet, is taking on all of the bad debt to put a floor under real estate values by “re-liquifying” the system and taking on the upside-down mortgage paper much like the Resolution Trust Corporation did in the 80s and early 90′s. The “re-liquifying” is inflationary to be sure. But if this plan works, every piece of real estate in the country will become more valuable than it would be without the plan and all the bad real estate will be sold off over a period of years. It might happen at a profit in fact. But the key is, it will arrest the rampant foreclosure rate which is the death knell of property values.
It’s kind of like putting all of the financial gangrene – the bad mortgage loans — into one limb and them amputating it. It hurts like hell and reduces some future activities, but it saves your life.
This stabilizing of real estate values will by “trickle up” stabilize the financial markets and stock markets overall. Sure, the markets were over-leveraged on the impossible dream of perpetually rising real estate and many Wall Streeters got rich as a result. Many average tax payers were complicit in this by taking on 125% mortgages and other fools gold simply to live above their means. Wall Street execs were fools to think home prices would always rise, but so were folks on main street. For every “predatory lender,” there had to be a “predatory borrower” on the other end. This plan will help both ends of that equation. Can you say “Main street?”
And speaking of Main street, folks with mutual funds and other investments will all reap returns of this bail-out by avoiding a total stock market meltdown. The fact that one’s 401K gets significant protection should blunt the pain of potential future tax increases as a result.
Then there is the little “Main street” thing known as the overall economy. A crashing of real values and stock prices would have inevitably led to more slowdowns in spending by the consumer and more lay-offs by businesses and failures of businesses. This is the “abyss” that Secretary Henry Paulson and Chairman Ben Bernanke are saying they were staring down; the total collapse of the economy. All of the arguments about “moral hazard” and “tax payer protection” and “creeping socialism” and so on are indeed valid, but the decision from Paulson’s standpoint was do we have those arguments with a somewhat stablized economy — or do we have them in the soup line? In his mind, better to be half right than all wrong.
In the long run, the Chrysler loan guarantee and the Resolution Trust Corporation were not at all disasters for the tax payers. Chrysler, in fact, was a win. Having said that, there is much here as a free marketeer to abhor. This is acknowledged by Paulson himself. However, most of these problems were brought on not by capitalist greed, but by regulatory greed, cronysim and obfuscation. And most of that by Democrats now blaming Bush and capitalism for the problems. It is not “unfettered capitalism” that is the problem, it is “unfettered government” corrupting capitalism that is the problem.
And yes, it is a sad and scary irony that it is taking government action here to avoid a disaster brought on by earlier government actions. This will no doubt mal-inform the debate in fact, which is a painful irony for all conservatives who support it. In the meantime, as tax payers, we should ease our pain by realizing that the homeowner, investor and stockholder in us desparately needed this to take place. Then we must vigorously debate the issues of government interference and demonstrate how it was the central problem here and do all we can to prevent more of this in the future.
Sometimes, you have to fight the battle in front of you, regardless of what future battles it might set up.
The author has been involved in 27 business ventures in the past 25 years, including Real Estate, Insurance and Contracting.