Well, there it is... I remember having this discussion six months ago with my grand-father who is an eminent economics professor at LSE and former big CEO, in which I argued that the U.S. was edging closer to a 1929-style credit meltdown. He, being an optimist, wouldn't believe me but it now looks like my worries about the insanity of the economic policies of the U.S. government are turning into a true disaster in reality.
As if the fallout from the Enron scandal had not gone far enough to convince the American people that regulating financial markets, as both Warren Buffett and George Soros have been emphatically advocating for years, might be a good idea, the Bush administration is now intent on doing exactly the opposite: making the U.S. government liable for the hubris of Wall Street.
Frankly, I think the Paulson plan to rescue the American banking system could have been a relatively sound idea had the U.S. government not been so heavily in debt to begin with and the dollar not been so weak already. There is, it seems to me, a non-negligible chance that piling so much deficit so suddenly onto the U.S. budget will cause a further slide of the dollar, since it amounts to printing money. This might scare off foreign investors, particularly the Chinese, and drive them to divest from the U.S. market, which could in turn significantly aggravate the liquidity problem that the U.S. financial system is currently experiencing. In that sense the remedy might just kill the patient in the end.
Then there is also the problem of spending priorities: were the U.S. federal government to face some other costly emergency in the coming year, such as another disastrous hurricane, Katrina-style, a bird flu pandemic, or even the inevitable war with Iran (why not!), it would find itself hard-pressed to come up with large amounts of cash in a short period of time to take care of such eventuality.
Crucially the profitability of this bailout plan to U.S. tax payers is relying on both the U.S. real estate market recovering in the near term but also on future willingness from banking institutions to buy back all those credit derivatives from the Treasury once they have supposedly regained their value. Unfortunately both are likely a long shot, to say the least. It is indeed hard to imagine all the large banks such at Merrill Lynch and Citi, who've been seriously burned by this crisis, coming back to their customers in six months' time and explaining to them they are back into the credit derivatives business. Mortgage securities now have such a serious image problem with the American public that will simply prevent banking institutions from ever doing this kind of trading again. So now the U.S. treasury will be stuck with $700bn worth of insurance contracts on mortage loans that will probably keep on defaulting for a long while until the U.S. economy recovers. This, I think, will be very costly any way you look at it.
The truth is, there are still banks out there that are actually very well-managed. I could definitely mention Wells-Fargo (where yours truly has his checking account), BofA, JP Morgan Chase, and countless others, that still have plenty of cash to lend their customers. Instead of bailing out banks that did not exemplify good financial practice, I think a better idea would be for the Federal Reserve to loan large amounts of money at a low rate to financially sound banking institutions. These would in turn be most qualified to inject the cash back into the American economy through properly vetted mortgage loans, business loans, etc...
In fact, if the rationale for the Paulson plan is to jump-start the sagging U.S. economy, another excellent idea would be for the Federal Reserve to loan lots of money to venture capitalists in the Silicon Valley. If you're going to give American tax payer's money away to restart the economy, at least give it to businesses that deserve it and will really help the U.S. economy. Don't give it to bankers who've been acting like total crooks and are by far the least productive sector of the economy.
As Jay Leno put it, this plan-here's how it works: you screw up, you pay; they screw up, you pay.
