Economics, Zen

Give Hank The Boot

Hindsight is 20/20, but it’s high time that Hank Paulson gets his act together or steps aside before the next administration chooses his successor. The US markets are gyrating wildly to the hastily cobbled together ‘bailout’ that was supposed to dampen things down.

Kudos to Paulson for proposing something, but now it’s clear that his proposal amounted to, “give me unlimited power to act until I figure something out, and in the mean time I’m going to bail out my buddies in the business sector I worked in all my life by buying all their junk assetts.”

The original Treasury plan — which called for the transfer of virtually unlimited taxpayer dollars and unlimited spending discretion to Treasury with no judicial or congressional oversight — sent a very bad signal to the markets. Instead of restoring confidence, this approach to the crisis instilled more fear and panic in the markets.

Because of the complexity of the derivatives market, and all the abstractions of the modern financial sectors, banks are dealing with too many known unknowns. The banks themselves are not sure of their own balance sheets, so they are unwilling to trust other banks, which is the very foundation of the way that banks operate through a system of overnight loans. This is the underlying problem of the credit freeze…

As Barry Riholtz points out:

“Under these circumstances, the original Paulson rescue plan is unlikely to accomplish much. Buying up risky assets from the banks, which is what Troubled Asset Relief Program (TARP) is set to do, is like slapping a coat of paint on a house infested with termites. It may pretty up the banks for a short period of time, but it is unlikely to solve the underlying problem.”

Every economist in the world right now seems to be calling for the same prescription, but not Paulson’s: capitalize the banking system directly and do it yesterday. Their are numerous methods of doing this, ranging from the effective european model of outright nationalization, to government matching private investment dollar for dollar for preferred stock, where the government owns a non-voting stake in the company. This keeps the private sector in control of the market, while amplifying the purchasing power of private capital.

To put it bluntly, we need a no-holds barred approach to restore liquidity. If capitalization of banks doesn’t work, then the government needs to provide, not free money, but loans loans loans to every public and private institution that wants them immediately. Everybody needs money. So give it to them. As far-fetched as this sounds, this idea is already in the play: the government is lending money directly.

We CAN stop the feedback loop from taking hold of the world economy, but it’s going to take a bold and dramatic move sooner than later. Most importantly, we need some positive headlines from the Chicken Little Media.