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Wall Street bailout and the need for reform

10/09/2008

 By Matthew Jarosinski

There is much to be said about the design of the bailout plan. The poorly designed Paulson plan has been pushed with the same urgency as the invasion of Iraq, and it may become a weapon of mass destruction. But the fact that our financial system has been on a brink of collapse overshadowed that concern. The bailout plan was passed. The rescue was necessary but insufficient and there is no guarantee that the bailout will work.

There are two problems Paulson wants to address. The first problem has to do with the fake financial assets which Wall Street has created -- perhaps trillions of dollars. No one knows for sure. The second problem is the debt. These financial institutions are deeply in debt and now have serious liquidity problem while their fake assets prevent them from raising new capital.

Time is a factor. The growing economy badly needs new capital and the financial institutions are the main source of new capital for the economy. Now the financial sector itself needs new money just to operate. It has itself become a drag on the economy. Meanwhile the economy has already been in sharp decline. The Paulson plan was generated under such impossible conditions.

The Paulson plan will provide new liquidity immediately, no strings attached. But the best that could be expected under such plan is a slow revival of the credit system. With new money some financial institutions might be able to stabilize their loan portfolios and start lending on a regular basis. If not they will be back for additional bailout. To hope for more is sheer folly.

The proponents, Paulson, Bush and McCain, have not expressed any concern about the limited nature of their quick-fix "plan." They are simply trying to start an emergency rescue, without a plan, for a financial sector whose structure is highly unstable at the time when we need strong financial industry for the nation and for the world. They could and should start reforming the highly unstable financial industry now. Without such reform our nation remains in grave danger.

Importantly they have not expressed slightest concern with economic instability. They claim that the "fundamentals of economy are strong" and that we are having a temporary financial problem of technical nature. In their opinion this "rescue" will restart the muscular economic engine. They have not mentioned growing national debt, growing household debt, growing credit card debt, growing car loan debt, growing student loan debt, growing federal debt and growing unfunded government spending. They have not mentioned that the economic engine has been running for years on fictitious money and on borrowed foreign capital. It has been fake-money-driven growth and debt-driven growth and it has drained the nation's financial resources. It brought our economy, and with it our financial system, to the brink of collapse.

Clearly the economy cannot stand on fake assets and huge debt. Putting billions of taxpayer dollars into such a contaminated system will not restart the gravely worn-out engine. The economy and financial markets, relative to the government, have become so monstrously huge that the government cannot restore a market balance through Keynesian measures. The government has to immediately scrap toxic assets and stop overspending. It will strengthen the currency, restore consumer confidence and bring the market power to do heavy lifting. The Paulson plan, or lack of a plan, postpones a funeral.

Meanwhile Wall Street has not been getting ready for a decent burial. With the bailout, Wall Street wants to utilize the false financial assets! They want us to believe that the entire crisis will disappear if these trillions in fake assets are mixed with billions of real money. They call it an "economic stabilization plan" and promise that "if run properly, it might even make the taxpayers some money." Meanwhile they would not allow an independent accounting assessment. They simply say that their problem requires massive amounts of "patient, long-term money" to solve the problem. No preconditions, no oversight and no legal responsibility. Trust us.

Meanwhile these institutions cannot just sell all toxic assets to the government at current market value. Any sales at market value would inflict unsustainable losses on them. The government cannot grossly overpay for these assets because the American taxpayers don't have trillions of dollars to spare. No profit-sharing structure and no mortgage bonds would work because there is simply not enough money to buy them. The only hope is that the banks will have time to slowly work their way out of the crisis they created.

Recapitalizing the banks should be the heart of a policy; but it should be selective. There are only few institutions with hope for revival. A targeted relief for debtors should be part of a plan. But this is not enough. There can be little doubt that the Wall Street that exists is no longer the industry that Congress should be seeking to rescue. We need reform. The systemic restructuring of the reformed financial system using public money is badly needed.

The scale of the current crisis signals again that the U.S. has more to deal with than just resolving a banking crisis and reforming the financial sector. The complete reversal of the current failed economic policies is the precondition for success of any financial reforms. The deepening of the crisis cannot be avoided, but the situation can still be managed if we wake up. Meanwhile the Paulson plan simply increases government spending and decreases consumer spending without addressing the failed economic policy. Clearly the current American leadership has limited capacity when it comes to reversing the disastrous guiding principles.

Matthew Jarosinski lives in Waitsfield.

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