Aaron's Real Opinions:

Let's Do Nothing!
by Aaron Harber
September 21, 2008 - Print Article

Part 1: The Bush Administration & the Democratic Congress Have It All Wrong Again

As financial markets headed downward, the Bush Administration and the Democratic-controlled Congress decided they needed to "save" those markets by promising to intervene with up to $700 billion of taxpayer dollars. This is in addition to the $200 billion already committed to date prior to the $700 billion bailout. And there is nothing which prevents them from borrowing even more at a future date to increase this new debt-load to $2 trillion. After all, they don't have to pay for it today, right?

With a National Debt of $10 trillion already crushing the U.S. Economy and sending the dollar into a gradual decline which, in turn, negatively impacts most Americans by making goods and services more expensive, the idea of adding another $1 trillion almost overnight seems irrational, despite the pleas of sinking financial titans.

The Government's "solution" could be the end of the U.S. dollar as we know it today. It also will accelerate the sale of interests in U.S. companies to foreign investors - who already own a sizable percentage of the United States.

Just as the Patriot Act had serious flaws because it was rushed through and the war against Iraq was equally defective from a policy-making perspective due to the hurried nature of its approval by Congress, we should recognize that barreling through major decisions usually is not the best route to go. Congressional Democrats should have learned from these lessons and not be rushed to judgment.

Why not simply say the Government is committed to helping find a solution but is going to take its time figuring out the best course of action? Then let's truly take our time and properly vet all the proposals being made to save the financial world.

Keep in mind the War in Iraq may have an ultimate cost to taxpayers of $3 trillion. One of the key concepts in Economics is Opportunity Cost. It simply means if you spend $3 trillion on one endeavor, you won't have that $3 trillion to meet other needs.

If the Congress authorizes $700 billion today, it could easily evolve into $2 trillion, especially once a commitment was made to save private financial markets with public dollars.

If those dollars are used for a bailout, those funds will not be available to help solve the health care crisis, repair aged transportation systems, educate children, head our foreign policy in a new direction, or revitalize our military. Rather than bailout those who already have a lot of money, perhaps we should direct the funds to those who truly need help. At the minimum, we should take our time and carefully consider all of the options and tradeoffs before making such a momentous decision.

Part 2: What's The Big Rush?

Sometimes doing nothing is better than acting impetuously. There is no real need for Congress to authorize the spending of almost $1 trillion today to bail out the financial markets.

The Bush Administration is trying to rush this through because its term is coming to an end. If action is not taken before the upcoming Election Recess, the Administration knows it will become increasingly unlikely to get its way because the added time will (a) result in greater scrutiny of any proposals and (b) allow Democrats, if they win the White House, to wait so they can unilaterally shape their own solution.

Democrats in the House and Senate want to appear they are addressing the crisis so, unfortunately, they are almost as eager to act as the Bush Administration. Cooler heads not only are failing to prevail - they're not even in the discussion. This is illustrated by both presidential candidates failing to rein in their respective party's enthusiasm for spending more taxpayer dollars. Contrary to their own advertising, both Barack Obama and John McCain are more than willing to go to the public trough once again.

If the Federal Government today simply announced it definitely would commit $700 billion to the marketplace, that announcement alone - as already was proven - would restore confidence to financial markets. What the Government does with that $700 billion is the next question and how it is answered will determine how the financial markets will continue to respond.

One question to ask is, "If the Government takes its time - over a period of several months - to determine exactly what to do and how to invest - why would that be a good or bad idea?" Perhaps an even more important question to first ask is, "If the Government does nothing, what will happen and who gets hurt the most?"

If the Government did not intervene in the financial markets any more than it has to date, a number of financial institutions would falter. They then would have to find buyers for their depressed stock or assets. Those who failed to find buyers would declare bankruptcy. Their shareholders would suffer considerable losses. New investors would come in, they would value assets appropriately, and then they would pick up the pieces.

That is exactly how the Free Market is supposed to work. Those who are successful are rewarded by the Market and those who fail are punished. Why should the rules be changed now by the Federal Government? Why should failure on such a large scale suddenly be rewarded?

Part 3: What Would Happen If We Did Nothing?

If the Government stopped bailing out failing companies, most firms who were irresponsible would be punished and most who were responsible would survive. That is exactly how the Free Market is supposed to work. There would be collateral damage - in which some good companies would be forced out of business due to the bad decisions of their brethren - but the American Economy would survive.

Would stock markets go down? Absolutely. There probably would be a correction on the order of 20% (e.g., a +2,000 point drop in the current Dow Jones Average). Stock Market investors around the world would lose up to 10 trillion dollars on paper if such an event occurred and if it had the same effect on all stock markets (i.e., they all went down 20%).

But keep in mind the Dow Jones Index hit a low of under 8,000 in 2003 - only five years ago - the exact same spot it might slump to today. And who is to say the stock market must be propped up artificially if it may have risen due to unfounded speculation in the first place? In such an instance, wouldn't a correction be the appropriate course anyway?

If the same loss calculation principles were applied to the derivatives market (derivatives are financial instruments usually tied to stocks or bonds), the losses could be ten times greater - i.e., $100 trillion rather than $10 trillion.

While these are astronomical numbers, the appropriate question is, "So what?" Stocks and derivatives go up and down. One assumes that, if he or she is an investor for the long term, a market which falls 20% or more ultimately will recover. Isn't that what every investment advisor and stock broker has argued for decades?

One of the key issues not being discussed is distributional in nature. That is, the financial losses are being talked about in general terms but we're not examining who the winners and loser are. When Lehman Brothers failed, who was hurt the most - the owners of Lehman Brothers or the average American family?

The same applies to AIG. If AIG had been allowed to file bankruptcy, the world would not have come to an end. In fact, the Federal Government could have guaranteed that by saying it stood ready to compete in the Free Market for AIG's assets.

So, spending $1 trillion to protect $100 trillion may seem like a wise move but if that protection is extended primarily to the country's or the world's richest investors, it may not be in the best interest of taxpayers.

Part 4: What happened to the "Invisible Hand" of the Free Market?

So what happened to the "Invisible Hand" of the Free Market? It actually was working and was in the process of slapping around the money managers and investors who tried to make something out of nothing.

Free Market capitalists who believe the Market rewards and punishes people appropriately, are in favor of letting financial markets work. Give the Free Market a chance to function properly and it will sort out the winners and losers - just as it was intended. While tighter regulation certainly is needed, there is no concomitant need to save those who gamed the system.

By pumping $1 trillion or more into bad investments, the Federal Government is rewarding bad behavior. That is diametrically opposed to Free Market theories or the role the Government should play.

One of the problems both Democrats and Republicans face is the inherent conflicts of interest of their top advisers - many of whom come from and still are on Wall Street. These people will have a tendency to look out for their personal financial interests and the interests of their friends before worrying about the amorphous American taxpayer.

After all, there are millions of taxpayers and a $1 trillion bailout only amounts to $3,400 in additional debt per person (on top of the already-existing per capita debt of $35,000 per man, woman, and child in America). That's chump change to big-time money managers. They can spend that much on a single dinner so what's the big deal?

Treasury Secretary Henry "Hank" Paulson is lionized by many as the best possible person to be in charge of resolving the crisis but people quickly forget Paulson and his predecessors at Treasury totally failed to address the crisis in a timely manner.

In fact, speaking of conflicts of interest, one could argue Paulson did not act as he watched his old competitors fall - including Lehman Brothers - but sprang into action only when his old firm, Goldman Sachs, was threatened. As the former Chairman and CEO of Goldman Sachs, Paulson's ties to the firm remain strong. He knows that without a Government bailout, Goldman Sachs - the company which made him the wealthiest Treasury Secretary in the history of the United States - could fall by the wayside.

At the same time, Democrats have been seeking guidance from CitiGroup Executive Committee Chairman and former Goldman Sachs Co-Chair Robert Rubin. Conflicts of interest scream out when considering Rubin or Paulson. Both are far too close to the action and have too many Wall Street interests to be the ones the country looks to for help.

What the nation needs is a dispassionate view of the dilemma with recommendations coming from people with the American taxpayers' interests at heart - and not the interests of friends, associates, family, and colleagues who are depending on him or her to save their financial necks from an impending disaster. Ironically, even if the markets tanked, most of these people would not suffer. Having a portfolio reduced from $100 million to "just" $10 million, for example, should not exact much sympathy. It's the average American who needs someone to look out for him or her - not hedge fund investors.

Part 5: A Pragmatic Solution To The Crisis

With all the Wall Street Chicken Littles convincing politicians the Financial Sky is falling, the Federal Government is now ready to spring into action once more and spend taxpayers' money.

Nevertheless, what the Government should do is not spend $700 billion of taxpayer dollars to buy what may be only $200 billion of assets. You don't have to be "Smarter Than A Fifth Grader" to do that math. We all know who loses and who gains from this deal.

Rather, take the $700 billion and announce the Government will invest it in the financial markets. That would simultaneously accomplish three goals. First, having a player come in at that level could psychologically buoy the markets in the short-term even more than spending it on bad debt (i.e., flushing taxpayer dollars down the proverbial toilet). It is true some investors would prefer to be "taken out" by the Government, which would be seen as a sucker in the process, but that would be unfair to taxpayers.

Second it puts the Government in competition for asset purchases with other buyers over a longer-term period (e.g., two to four years). Assuming rudimentary laws of supply-and-demand apply, this can only help increase or at least stabilize prices in the near-term. This also moves the Government away from the ludicrous "reverse auction" philosophy espoused by those seeking more taxpayer subsidies.

Third, assuming some assets will be heavily discounted due to their true value, the Government many end up buying $3 trillion worth of paper assets for as little as $500 billion (their current, true value). Then, if the value of those assets does increase (don't hold your breath), taxpayers not only will get their $500 billion back but also will have the opportunity to profit.

The Government's purchases can be protected, to some extent, by getting appraisals on assets before making purchases. It can demand warrants which give it equity positions and an exit strategy should it make a stock investment which eventually recovers. As sophisticated investors know, there are a number of other ways the Government can protect taxpayers and minimize risk while still acquiring an upside opportunity.

In conclusion, if it is to use taxpayer dollars, the Government should enter the marketplace as any investor would - i.e., with the intent of making a return on its investment.

The good news is simply the Government's entry into markets, while bearing $1 trillion of cash, likely will accomplish the goal of restoring confidence in those markets. So, if this is the case, instead of giving taxpayer dollars away, the Government can create a win/win situation for the financial markets and for American taxpayers.

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