Paulson Plan Is Still a Pig, Even With Lipstick: Caroline Baum

Commentary by Caroline Baum

Sept. 29 (Bloomberg) — If Treasury Secretary Hank Paulson thought he could cram a $700 billion plan to buy financial institutions’ toxic mortgage-backed waste through Congress with no questions asked, he got a rude awakening last week.

Paulson and Federal Reserve Chairman Ben Bernanke were grilled by Senate and House committees on the plan. Those same lawmakers were inundated with calls and e-mails from constituents expressing outrage at what they saw as a bailout of Wall Street for a problem of Wall Street’s own making. It took them all weekend to hammer out something they could sign off on.

Why was it so hard for Paulson to close the deal after laying the blame at Congress’ feet should a failure to act result in a collapse of the financial system? Maybe his report card holds the key.

Communication Skills: C-

Teacher comment: Student tries hard but finds the subject difficult.

It was a testy Paulson who showed up at the Senate Banking Committee on Sept. 23 to address lawmakers’ concerns about the holes in his proposal. He could have used his predecessor’s skills.

When President George W. Bush needed to sell his economic stimulus plan, heavy on tax cuts, in 2002, he turned to former railroad executive John Snow.

Snow was universally hailed as “a good salesman,” as if we, the people, were looking for a Willy Loman-type minding the Mint.

Without Snow’s much-touted sales-and-marketing skills, Paulson can put lipstick on his plan, but it’s still a pig.

Analytical Ability: C

Teacher comment: Student manifests some trouble connecting the dots.

Paulson has said repeatedly that the “root cause” of the problem is “the housing correction, which has resulted in illiquid mortgage-related assets that are choking off the flow of credit.”

“The root cause of the problem is that we don’t have any homebuyers,” Edward Leamer, an economist at the University of California, Los Angeles, told the Associated Press.

The “root cause of this crisis” is “the lack of capital in the banking system,” said Paul Ashworth of London’s Capital Economics. “The only way the Treasury’s plan would have any meaningful impact on banks’ capital ratio is if it vastly overpaid for the securities it is buying.”

The problem with the assets is “a lack of transparency,” said Josh Rosner, a managing director at Graham Fisher & Co. in New York. “The assets aren’t illiquid. The seller is unwilling to sell them at market prices.”

If you don’t diagnose the problem correctly, the odds are you won’t prescribe the right medicine. The troubled assets are the result, not the cause, of loose lending practices, a housing bubble that burst, a glut of unsold homes and home prices that are still too high relative to incomes and rental costs, according to many economists.

The government’s acquisition of underwater assets may give banks the wherewithal to lend. It’s no guarantee that they will.

Credibility: C+

Teacher comment: Student relies too heavily on Goldman Sachs credentials.

When Paulson went up to Capitol Hill last week, he and Federal Reserve Chairman Ben Bernanke warned of dire consequences to the financial system if Congress failed to pass a bill quickly.

This is the same Paulson who assured Congress that the subprime crisis was contained, that Fannie Mae and Freddie Mac — now wards of the state — were well-capitalized, that he needed a bazooka in order not to fire it, and that the banking system was “safe and sound.”

None of these assertions turned out to be accurate.

While public servants tend to present crises in the most favorable light, at some point the messenger starts to lose credibility.

Paulson to Congress: Trust me.

Congress to Paulson: Fool us twice, shame on us.

Class Preparation: D

Teacher comment: Student comes to class unprepared.

Paulson delivered a three-page legislative proposal requesting $700 billion from Congress. A year-end spending bill now before Congress providing more than $600 billion for three federal agencies runs more than 1,000 pages.

Granted, time was of the essence but that’s no excuse for poor preparation.

Social Skills: D

Teacher comment: Student relates poorly to those around him.

Even as Paulson was presenting a government rescue as the only option, the private sector somehow was finding alternative solutions.

Warren Buffett invested $5 billion in Goldman Sachs Group Inc., Mitsubishi UFJ Financial Group Inc. formed a strategic alliance with Morgan Stanley, JPMorgan Chase & Co. acquired the assets of failed Washington Mutual Inc., Barclays picked Lehman Brothers’ carcass clean, and Merrill Lynch & Co. saddled up with Bank of America Corp.

While it’s true banks are reluctant to lend to one another for a period longer than overnight, “the Fed will lend,” said Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. “That’s what the Fed was created to do.”

The Fed has loaned so much money through its various lending facilities that its Treasury holdings are down to 42 percent of its balance sheet compared with a pre-crisis 90 percent.

The Paulson plan, as originally presented on Sept. 20, would have bailed out the institutions holding mortgage derivatives without doing anything about the underlying homes or adequately protecting the taxpayer, who would have been taking the risk without potential for reward. Congressional negotiators addressed those glaring omissions in ’round-the-clock weekend negotiations and announced yesterday they had reached an agreement. Both the House and Senate plan to vote on the proposal this week.

We will never know what would have happened without the largest government bailout in history. And it’s far from clear this new New Deal will be the end. Surely there is a better way to dispose of bad assets.

“If you need money, sell assets,” Rosner said. “Excess inventory is liquidated at 99-Cent Stores every day, and it doesn’t require the government to get involved.”

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