I am still digesting the Paulson Plan, what everyone is calling the $700 billion bailout. So far, I have accepted what Mr. Paulson and Mr. Bernanke have done and the immediacy with which they have acted. But the 'bailout' currently being debated in Washington is another matter. I am stuck because it is unclear what is motivating Mr. Paulson. Some people say he is simply trying to protect his old bank Goldman Sachs, others say he is trying to throw them a tax-funded gift. In these two lines of thinking, Mr. Paulson is either destroying free-market ideology, or practicing crony capitalism.
But I'm not so sure. I can't shake the notion that Mr. Paulson (and Mr. Bernanke) knows something about the current economic conditions that his critics don't know. It strikes me that very few conversations are dealing with the massive concentration of wealth in the hands of hedge funds and soveriegn wealth funds. These kinds of organized money, as far as I can tell, have economic power unparalleled in the history of capitalism. And much of the wealth is located outside the US and is put to use with other than US interests front and center. For example, these funds are at present betting against the very assets that Mr. Paulson is saying the US government should buy. Is buying them a good thing? If Mr. Paulson and Mr. Bernanke are right, the answer to this question is yes, because the US government is the only organization with the creditworthiness to make a return on the bad assets. Not Goldman Sachs. Not Morgan Stanley. And we already know the answer about Merrill Lynch, Lehman Brothers, and Bear Stearns.
To me, the notion that the state must intervene or we will watch the American financial organizations collapse to nothing is evidence that hedge funds here and abroad, and sovereign wealth funds abroad, could be too big for free markets to absorb. Mr. Paulson is arguing that the US government is now an explicit economic player, and moreover the only one large enough to defend themselves from the organized money.
Some of the most important questions, then, center on the wealth funds. Why are they betting against American markets? Are they large enough to be determinative simply by themselves? What do their existence mean for the stability and growth of the American economy? And finally, is this $700 billion dollar bailout basically a way of self-refunding what the American economy lost to the funds? Or is this $700 billion bailout a way of protecting all of us from these funds?
While I am leaning toward supporting the plan on the basis it is the only way to compete with these massive wealth funds, a few critics of the plan make sense too. First, the Princeton economist and NY Times columnist Paul Krugman is making a lot of sense on the subject of a public stake. Read his blog here.
Today he wrote:
As I wrote earlier this morning, the whole “take these assets off the balance sheets” line is fundamentally disingenuous; the key question is what price Treasury pays for the assets. And here we have Bernanke effectively saying that it’s going to pay above-market prices — prices that allegedly reflect “hold-to-maturity” value, but still more than private investors are willing to pay.
This should be read in the context of Brad Setser’s calculations: he finds that if Treasury pays a price that seems appropriate given the poor quality of the assets, “The hit to the banks balance sheet might be too big” — the losses would be much larger than the amounts banks have already acknowledged, so that their capital position would be severely weakened.
So the plan only helps the financial situation if Treasury pays prices well above market — that is, if it is in effect injecting capital into financial firms, at taxpayers’ expense.
What possible justification can there be for doing this without acquiring an equity stake?
No equity stake, no deal.
And as for hedge funds? Barry Ritholtz has 14 questions for the Fed and Treasury. Two of them are at the front of my mind:
3. Are you now, or have you ever been a short seller? Do you think short selling ban is a smart move? What does this mean to our concept of free trading markets?
. . .
5. You have said that "The Housing correction is the root cause of market stability." What about leverage -- how significant was that as a root cause?