Aaron's Real Opinions:

Take a Deep Breath and Count to Three
by Aaron Harber
September 23, 2008- Print Article

Part 11: How To Protect The Taxpayer

By making only collateralized loans to financial institutions which hold toxic assets, the Federal Government greatly would lower the risk of substantial losses of taxpayer funds. It also would encourage troubled institutions to cut excessive executive pay and even slash shareholder dividends. It also would eliminate the incentive of investment bankers to game the system by buying assets from foreigners and then selling these assets at a profit to the Federal Government.

Finally, consider that large amounts of the equity of many of our financial institutions are now owned by foreign investors --- in fact, sometimes by the “sovereign” investment funds of foreign governments. By buying risky assets from financial institutions, the Federal Government will assume the risk of loss from these foreign investors and probably even enable them to receive dividends that otherwise would not be available.

Is the benefit of buying risky assets from financial institutions more than the benefit of a massive infrastructure program to the American economy? This is just one trade-off that Congress should be considering before passing its unprecedented bailout plan.

Part 12: The Somber Truth About The Nation’s Financial Obligations

Before undertaking the proposed bailout plan, Congress finally should face up to the dire fiscal condition of the Federal Government that Congress has created in recent decades.

If the bailout plan is approved, official Federal Debt quickly will soar to $11 trillion. Consider if the Federal Government was forced to pay an average interest rate of just five percent on these borrowings, the annual cost to the taxpayers would be $550 billion. At 10%, the annual interest tab would soar to over $1 trillion. Countries such as Brazil currently pay well over 10% on their current borrowings.

Yet official debt is only the tip of the iceberg. As David Walker, until earlier this year, Comptroller General of the United States, the nation’s top auditor, wrote in the United Kingdom’s Financial Times:

“Washington has charged everything to the nation's credit card -- engaging in tax cuts and spending increases without paying for them. Washington's imprudent, unethical and even immoral behavior is facilitated by a lack of transparency. For example, as of September 30, 2007, the Federal Government was in a $53 trillion fiscal hole, equal to $455,000 per household and $175,000 per person. This burden is rising every year by $6,600-$9,900 per American. Medicare represents $34 trillion of this deficit and the related Medicare trust fund is set to run dry within 10 years. The Social Security program is projected to have negative cash flow within about 10 years.”

Walker’s succinct comments make it clear Congress does not recognize the wisdom of the old joke, “When you’re stuck deep in a hole, what’s the first thing you do? Stop digging.”

Part 13: Would It Be Dangerous To Let The Markets Achieve Equilibrium?

Financial shock maven Jim Cramer on his CNBC program “Mad Money” said if Congress doesn’t pass the bailout program quickly, the U.S. may endure another deflationary Great Depression II. Of course, he said, if Congress does pass the plan, there is a risk the dollar will sink in value and plunge the nation into a mild version of the hyperinflationary depression suffered by Germany’s Weimar Republic after World War I, when a wheelbarrow full of paper money famously was needed to buy a loaf of bread. Both possibilities are not unfathomable.

The point is Congress and the current Administration have allowed the nation’s finances to deteriorate to a dangerous level, where the failure to act prudently can cause painful economic ramifications --- often after a period of time rather than immediately.

Part 14: The Stock Market’s Decline Is A Matter of “When” And Not “If”

If the Congress not does bail out financial institutions by buying toxic assets, would the stock market go down? Perhaps, but that might happen irrespective of the bailout which, at best, might only delay an inevitable decline. A correction on the order of 20% (e.g., a +2,000 point drop in the current Dow Jones Average), might cost investors --- many of them foreigners --- $2 trillion dollars on paper (a number which eerily parallels what a bailout eventually may cost taxpayers).

But keep in mind the Dow Jones Index hit a low of under 8,000 in 2003 --- only five years ago --- about the same level where the market would land after a 20 percent slump today. And who is to say the stock market must be propped up artificially if it may have risen, in the first place, due to unfounded speculation? In such an instance, wouldn’t a correction be the appropriate course anyway? Isn’t that what should happen in a Free Market?

While these are astronomical numbers, the appropriate question is, “So what?” 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? Why should the Federal Government guarantee investors’ success? Won’t investors ultimately prosper the most if Congress uses scarce taxpayer resources in the most prudent, stingy and economically beneficial manner possible?

Part 15: Who Picks The Winners And Losers?

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 no one is focused on who the actual winners and loser are. When Lehman Brothers failed, who was hurt the most --- the owners of Lehman Brothers or the average American family?

As financial markets began their death spiral and those begging for government intervention screamed for help, no one asked, “So what happened to the ‘Invisible Hand’ of the Free Market?” In reality, the Invisible Hand actually was working. It just happened to be in the process of slapping around those enterprises whose managers had grossly mismanaged their assets and who had taken unreasonable risk.

While Main Street businesses may suffer collateral damage, there is no guarantee financial institutions will lessen their credit grip on Main Street if bailed out. If this is true, a bailout may make little sense because it won’t help as many businesses and investors as projected --- only a select few will reap the benefits of such a bailout.

Part 16: What Happened To The “Invisible Hand” Of The Free Market?

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 much tighter regulation certainly is needed, there is no concomitant need to save those who gamed the system and already made billions. They don’t need more, especially if it is in the form of taxpayer dollars.

By potentially pumping $1 trillion or more into bad investments as part of a bailout, the Federal Government would be rewarding bad behavior. That is diametrically opposed to Free Market theories or the role the Government should play.

Part 17: Conflicts Of Interest Abound

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. At times, these people may be looking out for their personal financial interests and the interests of their friends before worrying about the average American taxpayer --- who is distant from both Wall Street and even Capitol Hill, and certainly not often a source of significant campaign contributions and personal favors.

After all, there are millions of taxpayers and a $1 trillion bailout only amounts to $3,300 in additional debt per person (on top of the already-existing per capita liabilities of $175,000 calculated by Walker for every man, woman, and child in America). That’s chump change to big-time money managers. They can spend that much on a single dinner in New York City, so what’s the big deal?

Part 18: Why Paulson & Rubin Should Not Be At The Helm

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. Paulson not only is not the best choice to look out for the interests of the American people, he may be one of the worst.

In fact, speaking of conflicts of interest, one could argue Paulson did not act even as he watched his old competitors fall --- including Lehman Brothers. Rather, he sprang into action only when his old firm, Goldman Sachs, where he earned hundreds of millions of dollars over a long career, was threatened. As the former Chairman and CEO of Goldman Sachs, Paulson’s personal ties to the firm remain strong.

At the same time, Democrats have been seeking guidance from financial experts such as former Treasury Secretary and recently CitiGroup Executive Committee Chairman (and former Goldman Sachs Co-Chair) Robert Rubin, whose recent compensation totaled $150 million over the past decade, even as CitiGroup shareholders have suffered staggering losses.

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.

And savvy financial managers, such as Paulson and Rubin, know they can use their knowledge and experience to pressure unwitting legislators into making a deal Paulson and Rubin want. That, alone, is reason to not be hasty. Let the light of day shine on bailout proposals so the true impacts can be measured before any taxpayer dollars are spent.

Part 19: We May Get More [Bad Outcomes] Than We Bargained For

Although all the Wall Street Chicken Littles seemed to have convinced most politicians the Financial Sky is falling, before any action is taken, the Federal Government should be wary of the Theory of Unintended Consequences and its corollary --- the Magnification of Unintended Consequences.

In the case of the former, the argument is Government intervention can have ramifications which ultimately make a situation worse rather than better. In the case of the latter theory, when even greater actions are taken without appropriate consideration, unforeseen small problems which can be easily addressed or overlooked expand to the point where the unintended consequences increase in both number and size.

The Federal Government’s contemplation of borrowing $1 trillion for a bailout likely will have ramifications which ultimately could negate and even exceed the benefits of any bailout. In addition, it could represent an extraordinary transfer of wealth from average American citizens to the financial elite of the U.S. and to other countries.

Part 20: Accelerating The Demise Of The Dollar

For example, the sinking of the dollar due to the borrowing of an additional $1 trillion and the resulting increase in prices and concomitant reduction in the U.S. standard of living will impact average Americans far more than the wealthy --- who can afford $7 per gallon gasoline anyway. The multi-decade burden of paying back the $1 trillion and annual interest will be shouldered by the masses. Skyrocketing interest rates will severely impact Americans in multiple ways that the wealthy can arbitrage and exploit.

The list of potential impacts is seemingly endless and not beneficial to U.S. taxpayers. Perhaps it is better to take our medicine now and swallow hard than become chained to a system which may be headed downward anyway.

Part 21: Sometimes Doing Nothing Is The Best Solution

In conclusion, the best policy may be for the Government to take its time to study the situation and be open to doing nothing. If it decides to act as a market participant, however, 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 could create a win/win situation for the financial markets and for American taxpayers by doing nothing until all the facts are in, the research has been done, and all the alternatives have been vetted. And if it is to use taxpayer dollars, the Government should enter the marketplace as any smart investor would --- i.e., cautiously and with the intent of making a return on its investment rather than giving away billions to the financial elite.

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