Additional Thoughts On The Bailout
By Paul Craig Roberts
17 October,
2008
Countercurrents.org
"We
hang the petty thieves and appoint the great ones to public office"
- Aesop
Just as the Bush regime’s
wars have been used to pour billions of dollars into the pockets of
its military-security donor base, the Paulson bailout looks like a
Bush regime scheme to incur $700 billion in new public debt in order
to transfer the money into the coffers of its financial donor base.
The US taxpayers will be left with the interest payments in perpetuity
(or inflation if the Fed monetizes the debt), and the number of Wall
Street billionaires will grow. As for the US and European governments’
purchases of bank shares, that is just a cover for funneling public
money into private hands.
The explanations that have been given for the crisis and its bailout
are opaque. The US Treasury estimates that as few as 7% of the mortgages
are bad. Why then do the US, UK, Germany, and France need to pour
more than $2.1 trillion of public money into private financial institutions?
If, as the government tells us, the crisis stems from subprime mortgage
defaults reducing the interest payments to the holders of mortgage
backed securities, thus driving down their values and threatening
the solvency of the institutions that hold them, why isn’t the
bailout money used to address the problem at its source? If the bailout
money was used to refinance troubled mortgages and to pay off foreclosed
mortgages, the mortgage backed securities would be made whole, and
it would be unnecessary to pour huge sums of public money into banks.
Instead, the bailout money is being used to inject capital into financial
institutions and to purchase from them troubled financial instruments.
It is a strange solution that does not address the problem. As the
US economy sinks deeper into recession, the mortgage defaults will
rise. Thus, the problem will intensify, necessitating the purchase
of yet more troubled instruments.
If credit card debt has also been securitized and sold as investments,
as the economy worsens defaults on credit card debt will be a replay
of the mortgage defaults. How much debt can the Treasury bail out
before its own credit rating sinks?
The contribution of credit default swaps to the financial crisis has
not been made clear. These swaps are bets that a designated financial
instrument will fail. In exchange for “premium” payments,
the seller of a swap protects the buyer of the swap from default by,
for example, a company’s bond that the swap buyer might not
even own. If these swaps are also securitized and sold as investments,
more nebulous assets appear on balance sheets.
Normally, if you and I make a bet, and I welsh on the bet, it doesn’t
threaten your solvency. If we place bets with a bookie and the odds
go against the bookie, the bookie will fail, as apparently happened
to AIG, necessitating an $85 billion bailout of the insurance company,
and to Bear Stearns resulting in the demise of the investment bank.
Credit default swaps are a form of unregulated insurance. One danger
of the swaps is that they allow speculators to purchase protection
against a company defaulting on its bonds, without the speculators
having to own the company’s bonds. Speculators can then short
the company’s stock, driving down its price and raising questions
about the viability of the company’s bonds. This raises the
value of the speculators’ swaps which can be sold to holders
of the company’s bonds. By ruining a company’s prospects,
the speculators make money.
Another danger is that swaps encourage investors to purchase riskier,
higher-yielding instruments in the belief that the instruments are
insured, but the sellers of swaps have not reserved against them.
Double-counting of assets is also possible if a bank purchases a company’s
bonds, for example, then purchases credit default swaps on the bonds,
and lists both as assets on its balance sheet.
The $85 billion Treasury bailout of AIG is small compared to the $700
billion for the banks, and the emphasis has been on banks, not insurance
companies. According to news reports, the sums associated with credit
default swaps are far larger than the subprime mortgage derivatives.
Have the swaps yet to become major players in the crisis?
The behavior of the stock market does not necessarily tell us anything
about the bailout. The financial crisis disrupted lending and thus
comprised a threat to non-financial firms. This threat would reflect
in the stock market. However, the stock market is also predicting
a recession and declining earnings. Thus, people sell stocks hoping
to get out before share prices adjust to the new lower earnings.
The bailout package is a result of panic and threats, not of analysis
and understanding. Neither Congress nor the public knows the full
story. If the problem is the mortgages, why does the bailout leave
the mortgages unaddressed and focus instead on pouring vast amount
of public money into private financial institutions?
The purpose of regulation is to restrain greed and to prevent leveraged
speculation from threatening the wider society. Congress needs to
restore financial regulation, not reward those who caused the crisis.