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Fear peddling can't save Paulson plan

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Paulson's bailout plan is in shambles. On Friday, House Republican Boehner of Ohio muttered an angry comment about not "getting rolled" by unnamed others at theWhite House meeting Thursday afternoon.

Republicans in the House have emerged as major opponents of the plan. True conservatives are inherently anti-interventionist, and the Paulson bailout epitomizes big government.

House Republicans appear to be sensitive to a potential backlash from voters about the size of the bailout package. The coming elections have led Republicans back to their anti-interventionist roots. Until recently, Republicans have all but discarded their watchdog role in the Bush-led run on bigger government. Now, with the election just days away, aligning themselves with a bailout authorized by the White House and Democrats may not make political sense.

Also noxious is the now-infamous Section 8 of the bailout plan, which grants Paulson unlimited and un-reviewable authority to spend the funds any way he so desires. Anyone suspicious of government conduct and motives has a reason to oppose the bailout based on the opague manner of applying the funds.

Paulson is the former CEO of Goldman Sachs, a company in the center of the credit crisis who stands to see considerable federal assistance under the plan. Populist Republicans are leery of associating themselves with over-paid executives who most Americans blame for the scandal. (Far easier it is to associate the crisis with greedy CEOs than it is with our personal over-consumption and debt-ridden lifestyles.)

Out of that tension-filled room in the West Wing also emerged Richard Shelby--a critic of Paulson's package--who told waiting reporters that no deal had been reached, as he held up five pages of opinions against the plan he said were from leading economists. Shelby has done a great job--perhaps too good of one--in shredding the bailout plan. I don't know if Shelby is up for re-election this year, but his railing about the size and lack of accountability in the Paulson Plan sure makes it sound like he's on the campaign trail.

Adding still more to the dramatics was a back room appeal to Nancy Pelosi by Secretary Paulson not to savage his plan in front of the press. Emphatically, Paulson dropped to a knee to beg Pelosi, an act that might actually have saved the bailout from immediate extinction.

Paulson had spoken at length in testimony before Congressional committees earlier in the week, crackling about the need to get his bailout passed this week. So awkward was Paulson's appeal that Fed Chairman Bernanke seemed almost smooth. Both were convinced that the credit crisis would consume the economy if the bailout weren't passed, and passed now.

I guess most of the reaction to Paulson's plan reflects the basic distrust with which most of the public deals with a Wall Street insider, one affiliated with an unpopular White House. Many equivocate White House's management of previous crises with cronyism and inside dealings in the mold of Naomi Klein's Shock Doctrine (see Real Time with Bill Maher video clip.) The bailout suggests that the private sector losses would be subsidized by the Treasury even as CEOs and other fat cats walk away with millions. Under the plan, bankers could theoretically sell their worst debt securities to the government, while keeping the best of what they have. This temptation makes the suggestion that Paulson's plan will pay for itself doubtful, and the notion that profits could emerge, ludicrous.

Even if the contagion effect does impact jobs--it already has, at least within the financial services industry--Paulson's plan assumes the best way to prevent a broader crisis is for him to save the banks. Ultimately it's been those same banks who've contributed to the crisis, through the failure of government to regulate their activities, coupled with a nod and a wink from the Congress and White House, that whatever made the investment banks more money was good for the economy. Trying to play regulator now, Paulson and the Treasury are compensating for what were clearly huge mistakes that gutted the regulatory environment.

While the GOP was in charge of Congress for the de-regulatory charge led by Phil Gramm, the Democrats clearly want to go along with the bailout. Senator Schumer of New York did throw a serious obstacle in the way by suggesting that a lower amount of money would suffice; Paulson and Bernanke appeared to be insistent on delivering a larger dose to reassure confidence in the markets.

It remains unknown just how much effect $700 billion could have in a credit crisis. Investor psychology does play a huge role in handling investment crises, so a big number could do more to help. The Fed has been addding liquidity--a euphanism for making money available--which doesn't mean that lenders will necessarily lend. As I said in my last article on OpEdNews, the interest rate at which banks lend banks has increased dramatically--would the addition of more capital change that? In an atmosphere of reckless borrowing, losing the second billion is probably easier than losing the first.

Presenting the bailout as a one-shot deal might convince newly re-minted conservatives that no more interventions might be needed. Also, if enhancing confidence is the goal, potential acquirers of debt need to know that sufficient government funds will be available to help mitigate their risk.

Another potential reason for urgency is the fact that Bush, Paulson, and Bernanke will be reduced to mere figureheads in 39 days or so, once a new administration is elected. Suspiciously, calls for urgency might be the last gasps of an administration losing its grip on power, one which will be unable to impact much of anything come November.

The timing of the bailout package suffers from nearness to the upcoming election. John McCain's supposed suspension of his campaign appears to have been little more than a publicity stunt as the Senator appears willing to go to the debates in Mississippi. McCain was in the infamous White House meeting, far down the table from Obama. McCain was said to have been unsupportive of the package.

McCain's not going along has been interpreted as an attempt to politicize the response to the crisis. McCain did bring a campaign staffer into the meeting, which was interpreted as a sign that not only was his campaign un-suspended (if it had ever been truly suspended), but that his reaction to the bailout package was a calculated part of his political campaign. McCain's may have been looking to disassociate with Bush and whatever his administration was trying to do, regardless of how vital the need to build consensus to resolve the crisis.

Obama appeared to have been supportive of the bailout, and his brief speech at the Mayflower Hotel near the White House (choosing not to speak before the White House pool reporters) was succinct, summarized the financial problems facing the country.

Ruling by fear

If American political candidates could be judged based on reason alone--exclusive of more emotional afflictions like how well voters identify with the candidate, or how patriotic they feel they are--Obama would seem the victor in dealing with the crisis. Yet we've seen in the past two Presidential elections the role that emotions play. Fear has been at the center of the last few federal elections--fear about terrorism largely contrived and diminishing in relevance as other issues like the economy grow in significance.

Fear about economic collapse is a card that chief players in the Administration have played. In a speech Wednesday, Bush talked about the possibility of financial panic in the event a bailout wasn't arranged.

Fear was the chief method by which Bush enticed Congress and the American people into attacking Iraq. I've gone on at length over the past two years on this blog about how the administration has been "calling wolf" from the watchtower. Americans have seemed highly susceptible to terror dogma, and more than willing to lay down their civil liberties at the slightest mention of the bad wolf Osama (never mind that at least two prominent Middle Eastern newspapers issued obituaries for bin Laden in December, 2001.)

Can the Bush administration play the fear card one more time, in this case to help protect the economy from a perceived threat? Funded through the CIA in the guerilla war against the Soviets in Afghanistan, al Qaeda and bin Laden are the creation of western intelligence agencies, just as the crisis we now face was produced from our own regulatory recklessness and cronyism between Washington insiders and the financial institutions. Despite the negligence of our own government in mismanaging both these threats--economic and terrorist--the reaction has seen the US launch two wars and spend over a trillion dollars so far. With the bailouts of Bear Stearns and Freddie/Fannie, alongside the massive AIG loan fest, the combined cost of resolving these manufactured and preventable crises could well exceed two trillion dollars.

Fears over what a credit crisis could do have convinced our politicians that something needs to be done. Yet when Congress is convinced they need to do something, we should hardly be relieved. With the pattern of gross mismanagement by our government in the recent past, the Washington consensus should now be seen as the threat it really is: an unabated trend towards increasing the size of government, restricting civil liberties, and transfering huge sums to private sector. Whether the funds flow to military contractors or banks doesn't alter the fundamental model of a larger and increasingly ineffective government.

Some have said that by spending the Treasury into bankruptcy, social programs that are at the heart of Democratic electoral popularity will fall on hard times. Unable to bribe the voter, this theory, called "starving the beast," supposes that the Democrats will lose their chief source of political strength: "social programs".

I don't know if the Republicans intend to bankrupt us, or whether or not they see some future political benefit in it, but becoming bankrupt we are. I've seen the signs myself, so I know, in the same way a junkie can pick out another junkie in a room no matter how straight they might appear. My conviction that we're heading for bankruptcy is more a feeling, knowing what I do about how much is going out to pay for our war machine and all the Medicare and other expenses. We simply won't be able to pay for both.

One major sign of impending failure is the amount of reserves set aside to pay for bank failure. Just last night, Washington Mutual had its deposits seized by federal regulators, and sold off to JPMorgan, the company who ended up buying Bear Stearns earlier this summer. Capital reserves at the FDIC, which is responsible for bailing out any failed banks, have fallen dramatically (Today I saw that Wachovia, another bank embroiled in mortgage-backed securities, is teetering.). I'd read that the IndyMac failure had drained one quarter of all funds available to that federal agency; WaMu , the largest bank to fail in American history, could easily drain most of what's left.

Should more bank failures occur, the FDIC would need to secure additional funding. These monies would come directly from Congress and be in addition to any bailouts enacted through the Treasury. In this regard the $700 billion might forestall even greater bailouts of failed banks. Or not. The credit default swaps and derivates market in the US is about $140 trillion (and dropping fast).

Martin Weiss explains what derivates are:
"Derivatives are essentially bets on interest rates, foreign currencies, stocks or specific events like the bankruptcy of a particular company. The interest rate-related bets are by far the biggest. But the bets on bankruptcies "" called credit default swaps "" are the fastest growing and the most volatile.
These derivatives were originally designed to help hedge investments reduce risk "" like insurance policies. But in practice, they've been increasingly used to leverage investments, increasing the risks of participants."

Weiss has criticized the bailout, along with Peter Schiff and a host of good economists who were ignored by Washington and the banks as derivatives trading expanded. These pillars of wisdon are entitled to an audience based on their previous predictions of a crisis ahead, so we should ignore them at our great peril. Not seeing the threat has led to the realization of fears. Politicians were basically being bribed with campaign donations from financial firms, who were seeing massive increases in profits created by the trading of credit defaults swaps and other derivatives. Like ostrichs, our representatives simply stuck their heads in the sand, pretended the problem didn't exist, and let it fester.

If Washington wasn't listening then, it probably isn't listening now. I suppose if we weren't having an election, the bailout would have long since been passed. But the Republicans have dusted off the old cloak of true fiscal conservatism, an inherently anti-Establishment role they played so well when they weren't in control of the Presidency. Perhaps they sense that they'll lose the White House, and understand the need to return to the role of spoiler, one that they played so well in the past by limiting the size of government--or at least trying. This reawakening might be what the nation needs to prevent ever more bailouts, which appear to be completely acceptable to the Democratic leadership, as long as they bring mortgage reform and benefits for mortgage-holders facing foreclosure. While I doubt that segment of the population is a good source of campaign donations, servicing them does give a more human face to the Democrats as they head into the Fall elections.

Both sides are politicizing any solution paths that could mitigate the credit crisis. The Washington consensus is simply to throw money at the problem. I hardly see Pelosi, who took impeachment off the table, as the person who can confront the White House or negotiate a more effective solution. Nor could the perennial sellouts on Iraq war funding--Steny Hoyer and Harry Reid--offer much resistance or negotiate from a position of strength, despite the fact the White House needs them badly in light of the House defections within the GOP.

At this point I have to support the efforts of Republicans to stop the bailout, largely on the grounds I don't think the proposal will work. I do think a constructive dialogue will need to take place, but in the current election climate, I think partisanship will hinder the effectiveness of any response. The lack of leadership is I think the product of eight years or more of extreme partisanship in Washington, typified by the dastardly deeds of a corrupt and malignant White House.

While neither Presidential candidate appears to offer an adequate response to the crisis, I do think Obama will be more willing to cross the aisle and work to resolve any crisis, should he be elected or before. McCain appears unwilling to work with Bush and his administration, which is a vital next step regardless of how flawed Paulson's plan is.

 

www.jbpeebles.blogspot.com

The author lives in small-town Indiana and is a Web-based writer and analyst covering economics, politics, and international affairs.

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