Sunday, November 16, 2008

Treasury bailout - Paulson's failure

Henry Paulson became Treasury secretary 28 months ago, when he was at the top of the financial world: Wall Street’s best-paid chief executive officer,capping his career with a high-profile sojourn in public service.

Today, two months before he leaves office, some say Paulson is a reduced figure, damaged by the financial-market meltdown that happened on his watch and by the government’s struggles to respond to it.

Like many others who have served in President George W. Bush’s administration — among them former Secretary of State Colin Powell and former Treasury chief Paul O’Neill — Paulson, 62, will leave office casting a smaller shadow than when he arrived.

“Paulson’s credibility has certainly been substantially diminished,” said Peter Wallison, who was general counsel at the Treasury under former President Ronald Reagan and is now a fellow at the American Enterprise Institute in Washington. “There has been a lot of shifting back and forth and he clearly hasn’t thought through much of these policies. He has lost a lot of confidence from the market from all of this.”

The latest blow was his announcement last week that the Treasury is abandoning his plan to buy devalued mortgage assets — the one he unveiled dramatically just eight weeks ago, and defended against congressional and market skeptics.

“This is a flip-flop, but on the other hand, when they first proposed the thing,they didn’t really know what they were doing,” said Bill Fleckenstein,president of Fleckenstein Capital in Seattle and author of the book Greenspan’s Bubbles. Paulson has pushed some “cockamamie schemes,” he said. “So one has to ask, does he have any clue?”

“This is not something he’s going to be proud to put on his résumé,” said James Cox,a law professor at Duke University in Durham, N.C., who has testified on securities regulation before Congress and served on legal advisory panels for the New York Stock Exchange and National Association of Securities Dealers. “It does tarnish Paulson’s image, because it shows that a lot of political capital was spent on something that most of us thought was not a good idea to begin with.”

Only history will render a final verdict on Paulson’s handling of this year’s cascading economic crises. But he surely couldn’t have wanted to spend his final days in office this way: spearheading the massive government intervention in the banking, insurance and mortgage industries;fielding requests to bail out automakers and even heating-oil retailers.

“He’s ended up really in kind of a hair-on-fire thing,” said Stephen Stanley, chief economist at RBS Greenwich Capital. “Particularly in his position, of somebody who was going to be a government official for a very short time and then ride off into the sunset, it’s been very different from what he had in mind.”

The Treasury chief last week said he had no regrets over reversing his plans for the bailout program. “I will never apologize for changing a strategy or an approach if the facts change,” Paulson said at a press briefing.

In an interview with Bloomberg Television, he said “the original plan was a good plan. What changed was our understanding of the magnitude of the problem.”[...]


  1. This article is full of criticisms of Henry Paulson and his policies as Secretary of the Treasury, but contained therein are no constructive suggestions for bailing out the world economy.

    At least Pres. elect Obama seems to have a working knowledge of Macro-economics which we should all find encouraging.

    Obama says aiding economy trumps budget deficit
    Sun Nov 16, 2008 7:15pm EST
    By Jeff Mason

    CHICAGO, Nov 16 (Reuters) - The United States government should not worry about deficits over the next two years while spending money to jumpstart the ailing economy, President-elect Barack Obama said in a television interview that aired on Sunday.

    Obama, a Democrat who takes over from President George W. Bush, a Republican, on Jan. 20, said consensus had emerged between economists in both major U.S. political parties that expensive measures were necessary to avoid a deep recession.

    "The consensus is this, that we have to do whatever it takes to get this economy moving again, that we have to -- we're going to have to spend money now to stimulate the economy," he told the CBS television network's 60 Minutes news program.

    "And (consensus is) that we shouldn't worry about the deficit next year or even the year after; that short term, the most important thing is that we avoid a deepening recession."

    During his presidential campaign Obama pledged to fund all of his policy proposals, but the severity of the economic downturn has made balancing the budget a low priority as the government takes measures to stimulate economic growth.

    Obama said the $700 billion bailout bill passed by the U.S. Congress had helped stem the financial crisis, even though the $300 billion already spent may not have had visibly positive effects.

    "I think ... part of the way to think about it is things could be worse. I mean, we could have seen a lot more bank failures over the last several months," he said.

    "We could have seen an even more rapid deterioration of the economy-- even a bigger drop in the stock market. So part of what we have to measure against is what didn't happen and not just what has happened."

    Obama, who has made revamping U.S. energy policy a key goal once he's in the White House, said falling gasoline prices did not make the issue any less critical.

    "Gas prices at the pump go up, everybody -- goes into a flurry of activity. And then the prices go back down and suddenly -- we act like it's not important," he said.

    "As a consequence, we never make any progress. It's part of the addiction, all right. That has to be broken. Now is the time to break it."

    (Additional reporting by Kim Dixon, Editing by Sandra Maler)

  2. I hope that this article, second page of the Wall Street Journal today, might explain a bit about some of the difficulties in trying to bailout the economy. It is far from simple.

    No one has "done" anything wrong and there is no one to "blame" for this crisis. It is an inevitable correction as so many have predicted for 20 years.

    Banks Keep Lending, but That Isn't Easing the Crisis

    All around Washington, policy makers are scrambling to figure out how to get banks lending again. Lawmakers have criticized banks for not using new federal money to make loans and have threatened to place conditions on additional money. Regulators last week sent out a directive, encouraging banks not to hold back on lending.

    But there's a flaw in that logic. Banks actually are lending at record levels. Their commercial and industrial loans, at $1.6 trillion in early November, were up 15% from a year earlier and grew at a 25% annual rate during the past three months, according to weekly Federal Reserve data. Home-equity loans, at $578 billion, were up 21% from a year ago and grew at a 48% annual rate in three months.

    The numbers point to one of the great challenges of the crisis. The credit crunch is surely real, but it is complex and not easily managed. Banks are lending, but they're also under serious strain as they act as backstops to a larger problem -- the breakdown of securities markets.

    The worst of the credit crisis is being felt not in banks but in financial markets. Loans from a bank might stay on its books. Increasingly in the past decade, loans were packaged into securities and sold to investors around the world -- pension funds, endowments, mutual funds, hedge funds and others. Institutional investors gobbled up this and other kinds of credit that didn't come via traditional commercial banks, such as junk bonds or commercial paper.

    To get credit flowing, policy makers need to repair financial markets as well as banks. But investor confidence in credit markets has been shattered, in part because many debt securities performed so much worse than their credit ratings suggested they would.

    Issuance of asset-backed securities -- instruments used to package credit-card and auto-loan debt during the boom -- was down 79% in the year through October from last year, to $142 billion, according to Dealogic data. In 2005 and 2006, investors snapped up more than a trillion dollars of these instruments. Junk-bond issuance was down 66% in the first 10 months of the year from the same period in 2007.

    A new paper by Harvard Business School economists David Scharfstein and Victoria Ivashina sheds light on how the recent rise in bank lending plays into this. Bank loans are rising, the economists say, because companies -- from General Motors to Tribune -- have turned to banks for precautionary cash. With markets shut down, they're drawing on existing credit lines to meet financing needs or simply to have money in reserve in case they need it later.

    Neel Kashkari, Interim Assistant Treasury Secretary for Financial Stability, speaks during a hearing of the House Oversight and Government Reform Committee subcommittee on domestic policy on Capitol Hill, Nov. 14, 2008, in Washington, D.C. The subcommittee called Kashkari and others to testify on the status of the $700 billion bailout plan.

    Many of these firms lined up credit facilities during the boom, when terms on loans were forgiving. Between April 2006 and April 2008, bank rainy-day credit lines, known as revolving credit facilities, increased by 36% to $3.5 trillion, the professors show. Individuals might be using home-equity lines in the same way, tapping them for cash while the lines are still open.

    The point is that banks are being forced to act as backstops to a reeling financial system just as the banks, too, are vulnerable. Simply demanding they lend more misses the broader point of the role they're playing in the crisis, and how to manage it.

    "They provide a measure of protection to vulnerable firms, helping them forestall financial distress," the Harvard professors argue. But there is a dangerous downside. During the boom, many of these credit lines were extended to firms with shaky prospects, like GM. Now, banks are on the hook to lend to them, often even if they don't want to. This is likely crowding out making new loans to healthier firms, the professors say.

    Crowding out is one problem. Another is the markets. During the boom, many bank loans were packaged into securities. With markets for those securities shut down, banks have lost this important escape valve for making new loans.

    Using a different database called DealScan, the professors looked at new bank loans to large corporate borrowers -- the kinds of loans that typically get resold and packaged into securities. While overall banks' loan books are growing, this kind of lending, which used to get distributed among banks and other investors, fell by 46% in the August-to-October period from the same period a year earlier.

    Add in the fact that many banks are short of capital because they have been forced to write off a rising tide of bad loans on their books. Mr. Scharfstein concludes in an interview, "It may be unrealistic to expect them to lend more aggressively."

    Some Federal Reserve policy makers are worried about expectations in Washington. The government has effectively been pumping air into lifeboats. The U.S. Treasury has invested $250 billion of new capital into banks. Fed officials believe bank lending would be much tighter now if that money hadn't been pumped into the system.

    But lawmakers reconvening for a lame-duck session this week are impatient for bigger results. They're also unhappy with banks that take public money with one hand and pay out dividends to investors with the other.

    The next batch of money may come with strings attached. But that could be a dangerous game. Can banks be expected to lend much more when they're short of capital and are waiting on the edge of their seats to see if GM pays back the last $3 billion it took down?

    Mr. Scharfstein says the most important step is to get banks a lot more capital, a critical buffer to losses on loans.

    If there is to be one condition on pumping additional public money into them, he says, it should be this: Insist the banks don't stop there. Insist they raise money from private investors, too. The Treasury Department said last week it wanted to take that step.

    Write to Jon Hilsenrath at


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