The Bankrupting of Henry Paulson

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‘while nationalization has enabled some industries to postpone job losses for a time, the resulting overmanning has usually proved unsustainable and the eventual job losses consequentially greater.’ – Nigel Lawson, The View From No. 11

Nigel Lawson served as Margaret Thatcher’s chancellor of the exchequer, and as the Thatcher and Reagan eras in England and the U.S. were most notable for governments removing themselves from the doings of private enterprise, it’s passing strange that politicians in the U.S. and around the world would take their hysterics to such astonishing levels. It’s as though the capitalistic economic revival of the last twenty-five years didn’t happen, and that the denationalization of industry was irrelevant to our subsequent good fortune.

Indeed, this week’s announcement that Henry Paulson’s Treasury will buy stakes in U.S. banks regardless of their health, and regardless of their desire for government funds would be truly shocking if we hadn’t already been conditioned to a resurgent federal government under the alleged heirs of Reagan conservatism. Sure enough, if there previously existed any uncertainty about the level of policy principle within today’s GOP, those questions were answered this week.

There is none. The very leaders voters sent to Washington based on their stated belief in small, non-intrusive government have betrayed those same voters on a stratospheric scale. What’s remarkable is that GOP partisans still comfort themselves with knowing references to the “socialist” instincts of Barack Obama; these comments made despite a growing level of federal intrusion by card-carrying Republicans into the workings of private markets that would make the few remaining New Dealers in our midst blush.

The Paulson plan to force formerly private money into banks was attempted once before; on President Herbert Hoover’s watch. Apparently untroubled by the past result, Paulson will try again. So if we’re willing to ignore the unfortunate history when it comes to a government-owned banking sector, it’s at least worthwhile to discuss the various holes and contradictions that are part of the Paulson plan.

First up, the federal government will now “guarantee new debt issued by banks for three years” as a way of encouraging interbank and customer lending. What’s impressive here is the very arrogance of such a proclamation. Last this writer heard, the federal government creates no wealth; meaning those in America who pay taxes will guarantee all government debt. The plan also presumes that the very kind of careful money that was not being lent in the private sector can somehow be taken from that same private sector, shoved into banks by bureaucrats, and then be lent out profitably despite market signals suggesting the opposite.

From an economic perspective, the above becomes even scarier due to the basic truth that capitalism is reliant on the efficient deployment of capital. But with the federal government as backstop, the need to be prudent when it comes to lending will become less pressing. Not only is Paulson seemingly unaware of Hoover’s mistakes, but he’s also unaware of what happened the last time Congress effectively told the S&Ls to go hog-wild with the funds entrusted to them.

Furthermore, it’s quite simply naïve to assume that in return for debt guarantees, the federal government won’t require new forms of non-economic lending. Many have made lots of noise about the Community Reinvestment Act, but with the federal government a preferred shareholder of the banking system, won’t the CRA become a minor nuisance relative to “soft” requests made to banks for loans to other politically preferred entities? As it is, Neel Kashkari, Paulson’s young lieutenant charged with oversight of the unfortunate plan, has made plain that a bank’s minority and/or gender status will be carefully considered when the money is passed around.

Treasury officials will of course protest that new federal oversight means more prudent lending, but even if this were somehow a good thing (the U.S. economy in the ‘80s was largely built on loans to firms whose debt was referred to as “junk”), the certain emasculation of our banking system by our federal minders promises to be bad for the innovation that will be lost.

For those who doubt the above, they need only reference the curtailment of executive pay that is part and parcel of the nationalization plan. And there lies the contradiction: Paulson et al ask us to have faith in their activities out of one side of the mouth, then they expect us to believe this will work alongside compensation rules that will surely drive the best-and-brightest away from the banking sector. Taxpayers beware.

Lastly, as Lawson noted in The View From No. 11, what “public ownership does is to eliminate the threat of takeover and ultimately of bankruptcy, and the need, which all private undertakings have from time to time, to raise money from the market.” Exactly. It is the fear of takeover, and the fear that markets will ignore capital requests that drives banks and companies of all stripes to be more efficient. With one fell swoop whereby Paulson is forcing all banks to take government money, the total sector’s future strength is understandably a major question mark.

Establishment economist Joseph Stiglitz has said in response to recent market troubles that “those who believe in free markets have received another rude shock.” But he mistakes the process in which markets correct for Washington mistakes with actual mistakes of capitalism. In short, Stiglitz misses the point.

What we’re experiencing is the correct market response to a collectivist ideology that has infected the political class. The weak-dollar policies of the Bush administration meant to redistribute wealth to the manufacturing and commodity sectors were surely the match that lit the property fire given the “money illusion” that made home purchases more and more profitable in terms of weakening dollars. Added to that, both parties to varying degrees endorsed all manner of lending practices given Washington’s politically correct, but ultimately impoverishing view that homeownership is something good.

So while Paulson and politicians generally will say bank bailouts are a necessity, be very wary. If you didn’t like the end result of government subsidization of the housing sector, just think how you’ll feel once the preferred owner of banking shares imposes its “compassionate” ideology on other parts of the economy.

Lawson concluded that the dangers of state ownership were “greater than even the Thatcher government realized.” But in a blast to the past, one that will bring us less economic vibrancy alongside rising unemployment, the very GOP operatives who would publicly refer to Thatcher and Ronald Reagan as the 20th century’s greatest leaders are seeking to undo all that they accomplished. So this is why we elect Republicans?

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