Thursday, September 25, 2008

THE BIG LIE: The Supposed Paulson 'Bailout' Plan

By Robert Wenzel

Treasury Secretary Paulson's "bailout" plan has little to do with bailing out banks in trouble. In fact, if his plan is approved by Congress, it is likely the number of banks that will be in trouble will hardly decrease. Billions more in real bailout money will be needed to bail these banks out.

By the end of 2009, about 100 U.S. banks with collective assets of more than $800 billion will fail, predicts Christopher Whalen, managing director of Institutional Risk Analytics, a firm that sells its analysis of FDIC data to investors.

Emergency federal funding of the FDIC could swell the cost of government rescues of failed financial institutions to more than $400 billion -- not including the $700 billion general Wall Street bailout now under discussion in Congress, says Bloomberg.

Pimco founder Bill Gross told CNBC that the banking system needs another $500 billion to survive beyond the $700 billion rescue plan being contemplated by Congress..

So what gives?

First, it doesn't appear that insiders really want a bailout of the banking system right now. They want the banks back on their heels sweating survival.

Keep in mind that Henry Paulson's old firm Goldman Sachs just got approval to become a bank holding company. They will be aggressively buying banks. They want those banks sweating when they are in negotiations.

Keep in mind that the Fed just raised what it considers a minority stake in a bank to 33%. This has been something that Papa Bush's Carlyle Group has been aggressively seeking since the beginning of the crisis. Banking point man at Carlyle, Randal Quarles, even penned a Wall Street Journal Op-Ed calling for the Fed move. Thus, Carlyle also want banks sweating when they are in buying negotiations.

This $700 billion may end up in many places, but it doesn't appear it is going to bail out many troubled banks. This could be news to many Americans, since it also appeared to be news to Fed Chairman Ben Bernanke, who is something of Paulson's lapdog. Bernanke tends to follow Paulson's lead and doesn't generally get out of order, but he even barked as he was figuring out what Paulson was up to.

You see, Paulson wants to buy the mortgages on the cheap, at their "real" value. But the bad stuff, the sub-primes, and the like, are worth at best 50 cents on the dollar. For banks that are insolvent because they own this paper, a Treasury purchase of 50 cents or less on the dollar isn't going to help things, indeed, it may make it clear to even more that these banks' liabilities far exceed their assets. The only way a Treasury purchase of these mortgages would help is if they were bought closer to face value, boosting the value of the banks assets. Apparently as late as this Tuesday, that is what Bernanke thought the bailout was all about, since he told Congress that:

Accounting rules require banks to value many assets at something close to a very low fire-sale price rather than the hold-to-maturity price.If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits.

By Wednesday, probably after getting a good talking to from Paulson, he was back on script testifying that that the mortgages should be bought on the cheap.

Since this $700 billion in money will not be helping banks in trouble, Paulson had to come up with a new reason for why the money was needed. His justification is that it will unfreeze the credit markets by adding huge amounts of new liquidity to the system. This is an odd justification, since it is the very role of the Fed to add liquidity to the system, when it is needed, that is at the very heart of why Fed was founded and continues to exist--wrongheaded as this Keynesian method of dealing with the economy may be.

But, the current crisis is, indeed, the result of the Fed not adding liquidity to the system in recent months. Just over a month ago, we wrote:

Fed chairman Bernanke believes the Fed is currently conducting an easy money policy.This despite the fact that as recently as Mar.2008 three month annualized money growth (M2) was climbing at annualized rate of 12.6%, but has since collapsed to the point where as of Aug. 21 three month annualized money growth (M2) is increasing at only a 2.5% annualized rate.

This is simply a remarkable drop in money growth that will lead to a depression, if not reversed...

[T]he clueless nature of the current slowdown in money growth could lead to a depression whereby radical government policies are adopted to "cure" the recession. Such new polices are apt to further stifle the economy and prolong any downturn by years.Thus, Bernanke's misunderstanding of current money supply policy is shocking. More shocking is that many other economists, if not most, hold this inaccurate belief...If this policy is not soon reversed, we repeat, we are headed for a depression.

In a follow up piece, we reported what Bernanke was doing wrong and how to fix it:

The boom was fueled by the Fed's money printing under Alan Greenspan and the early Ben Bernanke. As we have been emphasizing in lone wolf fashion--with no regulator or other commentator coming close to mentioning this most important event of the current crisis environment--the Fed over the recent months has for all practical purposes stopped printing money. That's why the market continues to struggle. The Fed has turned this from just a mortgage crisis, to the beginnings of a major full-fledged economic crisis...

A lot of headline watching commentators are even reporting that the Fed is adding gobs of liquidity through their bailout operations, when in fact the Fed has been sterilizing its bailout operations, including the Term Auction Facilities, by either liquidating or loaning out the Treasury securities already in their portfolio....

At this point we must add that ideally the Fed shouldn't be monkeying and manipulating the money supply at all, but in realworld economik if the Fed is going to be messing with the money supply, they should be good at it. This means reverting back to Volcker's rejection of targeting interest rates, and instead targeting money supply. In Volcker's case, he targeted money supply to fight inflation, in Bernanke's case, money supply targeting is required to battle economic crisis.This economy isn't going anywhere until Bernanke gets Volcker "Target The Money Supply" Religion. Failure to do so will lead to an enormous economic crisis which in one sense can be viewed as a cleansing of the mal-investments caused by the money manipulations of Greenspan and Bernanke. However, in the land of realworld economik, the crisis is likely to lead to untold suffocating new regulations, restrictions etc....

Thus, what Paulson really needs to fix the liquidity crisis is not $700 billion dollars, but $72 to buy Paul Volcker a train ticket from New York to Washington DC to explain to Bernanke how to target money supply instead of interest rates.

As best that can be determined, since Paulson likes to keep everything vague, it appears the $700 billion will act as a feeding trough for all sorts of insiders and wannabes.

NYT reports:

Financial firms were lobbying to have all manner of troubled investments covered, not just those related to mortgages.

At the same time, investment firms were jockeying to oversee all the assets that Treasury plans to take off the books of financial institutions, a role that could earn them hundreds of millions of dollars a year in fees. Nobody wants to be left out of Treasury’s proposal to buy up bad assets of financial institutions. “The definition of Financial Institution should be as broad as possible,” the Financial Services Roundtable, which represents big financial services companies, wrote in an e-mail message to members on Sunday...

The lobbying became particularly intense because Congress plans to approve a package within just two weeks, without the traditional hearings and committee process.

“Of course there will be fierce lobbying,” said Bert Ely, a financial services industry consultant in Alexandria, Va. “The real question is, Who wouldn’t want to be included in the package?”

Mr. Ely said the open-ended nature of the Treasury’s plan could be interpreted to mean that the government was open to acquiring “any asset, anywhere in the world.”“The question that I am raising — is there any limit?” Mr. Ely said...

William H. Gross, chief investment officer of Pimco, which manages about $830 billion in assets, would like to be an asset manager for the government, he said.

Carlyle Group, in addition to buying banks, wants to get in on the asset grab also:

The Carlyle Group is interested in buying some of what the government takes over in a planned $700 billion rescue of the financial markets. Speaking on CNBC, Carlyle Group co-founder David Rubenstein said the D.C-based private equity firm may be interested in acquiring some mortgage-backed securities and other assets. "Private equity can help by buying these assets," he said. "Private equity can be among the most significant buyers of assets." Rubenstein said he hopes Congress will move quickly to approve the rescue of the U.S. financial system.

Timing on Treasury purchases of mortgage backed securities will also be instructive. Will Goldman and Carlyle have a chance to buy up banks before the mortgage securities are bought by the Treasury, which would suggest that, to help out insiders, the mortgages will be bought at higher prices (in effect from Goldman and Carlyle). Or will the purchases be made before Goldman and Carlyle buy into banks, which suggests the securities will be purchased at a lower price and give Goldman and Carlyle the opportunity to then buy the securities on the cheap from the Treasury.

In either case its a win-win for Goldman and Carlyle. Is it any wonder then why Warren Buffett has bought into Goldman Sachs with a $5 billion purchase?

Is it any wonder why PEU in a post titled, Welcome To Disaster Capitalism, writes:

Carlyle grew from $5.8 billion to some $90 billion during the George W. years. It looks like that trend will continue....

In summary, there is nothing "bailout" about this $700 billion Paulson plan. It would be more aptly called, Feeding Pigs At The $700 Billion Trough.

The public uproar over this $700 billion money grab is completely justified. One question remains. Does Congress have the balls to resist their insider masters and do something noble for a change, and kill the Big Lie?

UPDATE: Dallas Fed President Richard Fisher is one of the most astute officials in the entire Federal Reserve Syatem. However, even he must be scratching his head as to what Paulson is up to, since on Thursday he gave a speech where even he appears to believe that the bailout is about helping banks and that mortgage backed securities purchased will be purchased near yield to maturity versus what it now seems clear Paulson wants, purchases at deep discounts that won't help any bank. Here is Fisher, Thursday, in his own words:

As you heard Chairman Bernanke testify, the key strategy in the Treasury proposal is that by gathering these distressed assets under the TARP and auctioning them off in a prudent manner, something closer to a “hold to maturity” price, rather than a panic-based “fire sale” price, can be determined. This process would give banks a basis for marking their portfolios to a more realistic level, allowing them to clear the air and stabilize their capital base.

Robert Wenzel is an economic consultant and Editor & Publisher of He can be reached at


  1. What’s happening now isn’t socialism, but feudalism.

    It appears that they are nationalizing the financial system. We're not. Without the plan, there would be massive unemployment, loss of 401(k) and pensions, and loss of student loans— which means increased welfare and universal healthcare (no jobs-no insurance); more social security expenditures (both for retirees and those who are suddenly “disabled”)— and government subsidized education.

    Regardless of whether our ideological reasoning is correct, the fact is that a lot of people in this country are going to be very angry when they lose their jobs or their savings, and they will inevitably turn to the Democrats— or outright riot. They won’t care about ideology.

    The Paulson plan breaks the government hold over the nation. It takes considerable power away from Congress and puts it in the hands of the Treasury. No one even notices the absence of the President— we just assume Treasury’s got this one. I’m not saying any of this is a good thing, I’m merely observing that far from centralizing the power, it breaks government into sharply competing... fiefdoms.

    And no, there won’t be inflation. Europe is worse off than we are. There’s a massive global recession coming/here, and we may be the only ones that come out of it, or the first, anyway. Japan in the 80s is Europe now. Right now, if the plan is approved, we are the U.S in 1978. And Russia is Russia, 1978.

    The Speech President Bush Should Have Given

    Oct 2 will be a market crash. Whether we get out of it or not depends on this plan.

  2. Bernanke knows exactly what he's doing. Paulson has _nothing_ over Bernanke. Your misunderstanding of the purpose of the Fed is common, and that was on purpose--part of their deception. Watch "The Money Masters" sometime to get a full understanding.