The Thinking Man's Fridge

My post below outlines why I think the Paulson Plan is an outright terrible idea. But just when you thought the idea to dump US$700b into the failing banks in the United States couldn’t get any worse… it has.

Recent insight from an interview by Rep Brad Sherman provides some further clarity on the plan:

"It (the bill) provides hundreds of billions of dollars of bailouts to foreign investors… The Bank of Shanghai can transfer all of its toxic assets to the Bank of Shanghai of Los Angeles which can then sell them the next day to the Treasury. It had a provision to say if it wasn't owned by an American… the Treasury can't buy it. It was rejected.

“The bill is very clear. Assets now held in China and London can be sold to US entities on Monday and then sold to the Treasury on Tuesday. Paulson has made it clear he will recommend a veto of any bill that contained a clear provision that said if Americans did not own the asset… that it can't be sold to the Treasury. Hundreds of billions of dollars are going to bail out foreign investors. They know it, they demanded it and the bill has been carefully written to make sure it can happen."

Hmmm. This helps to explain why, for nearly a year, investors and foreign banks have been buying up billions of dollars worth of debt from US banks. They’ve been able to buy up huge amounts of debt, at bargain basement prices, with the intention of selling it back to the United States Treasury, to be dumped on the tax-paying American public.

Now, here’s the real kicker…

On September 29, the Bloomberg News reported that "the Federal Reserve will pump an additional $630 billion into the global financial system, flooding banks with cash to alleviate the worst banking crisis since the Great Depression. The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide”.

What’s that? The Federal Reserve has ALREADY dumped close to US$650 billion into the failing banks to prop them up, and it HAS NOT WORKED. Why then, is Henry “no Plan B” Paulson’s suggestion to dump another US$700 billion of taxpayer money into the problem going to make any difference, particularly when most economists estimate the true damage to be between US$3-5 trillion?

Wouldn’t the tax-payer money be better spent on education, health care and infrastructure? What are the odds that Goldman Sachs (the bank where Paulson worked since 1974, and who paid him an estimated US$35 million in 1995 alone as the CEO) gets a good seat at the table when it comes to dividing up the US$700 billion amongst the banks?

“What we are witnessing today is how empires end” (Buchanan, 2008)

The United States’ Treasury Secretary Henry Paulson’s plan to pour US$700 billion into the failed banking system is possibly the worst idea hatched yet under the Bush administration.

Firstly, forget that since mid-2007 thousands of home ‘owners’ around the US have lost their properties under forced foreclosure (a search of any foreclosure website will list hundreds upon hundreds of listed properties over the past 12 months alone), and that throughout this time the US government has not been able to find a cent to help these people out. Also, forget that the CEO of one of these failed banks walked away with a US$10 million dollar bonus, as the bank he ran into the iceberg slipped below the waves. And now that it's the people at the top who are in trouble, the US government has US$700 million to throw into the fray?

As with so many disasters, the banks are crying ‘Government, save us!’, even though it was not the government that got them into trouble. It was the Federal Reserve and its cheap money, reckless ‘gambling’ and inflated valuations of assets which got the banks where they are.

The first sign that something is awry here is that Henry Paulson has openly admitted that “there is no Plan B”. The second is that he is the ex-CEO of Goldman Sachs, one of the very banks he is trying to help out, as he watched others like Lehman wipe themselves out.

Economist Nouriel Roubini notes that "the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer”.

In many ways the United States' economy needs the recession-come-depression that is coming. It is built on money that, quite simply, does not exist. One of the biggest rorts in the history of the Wall Street model is the mortgage-backed derivatives market which has got the US into the situation it is now.

Derivatives are essentially bets. The problem is, however, that unlike investing in a tactile commodity, derivatives actually create nothing. Worse still, you can gamble with things that you don’t even own. And herein lies the problem. This process was essentially made legitimate in the 90’s by the Federal Reserve Chairman and general dirty sh*t Alan Greenspan, when the process was challenged as an illegal form of gambling. Basically, derivatives have no value, but derive value from something else. This is very similar to the modus operandi that brought down Enron, regarded as the corporate scam of the century.

To outline how grossly inflated the situation has become, the Bank for International Settlements recently reported that total derivatives trades exceeded $1000 trillion, which is remarkable given that the GDP of all the countries in the world combined is only around $60 trillion. The bankers have been free to bet as much as they want, even with money they don’t have (or doesn’t even exist). Warren Buffett refers to derivatives as "weapons of financial mass destruction". What we are seeing now is just the system starting to find its natural equilibrium.

Now, here’s the REAL catch. Why does this system need the US government to pour in US$700 billion? Because that’s a GUESS of the grossly-inflated value the banks put on their own assets.

The Bush administration AND the banks claim that the banks’ assets cannot be sold, but this in not true. These assets can be sold, but only for a fraction of the inflated value that the banks place on their OWN assets. Hence, to sell them at the real market price would leave the banks broke. And here’s the kicker – Paulson’s US$700 billion plan revolves around the US government buying these bank assets at the full inflated price. It’s really that simple. The banks then keep their grossly inflated value, but converted to cash instead of thin air, and the debt gets transferred to the taxpayer, through the hands of the US government.

The question that stands out is why should American households earning $50,000 a year subsidise the Goldman Sachs partners who earn $5 million a year, and who have been gambling at this insane rate for years, and bringing the current situation upon us?

And for those that still don’t feel that something fishy is going on, prior to their bankruptcy, 14% of Lehman Brothers’ assets fell into the 'imaginary' category described above, yet Goldman Sachs is still in business despite the fact that 13% of their assets are in the same boat. Perhaps if the Treasury Secretary claiming that Congress needs to endorse this plan immediately, and that there is no Plan B, wasn’t once the CEO of this bank, they would have succumbed to their own fraud long ago.

So why do I care what happens with this latest Wall Street collapse? I care because the media, particularly in Australia, is mindlessly spouting the virtues of this bailout plan without understanding what it’s all about. Just this morning, the presenter on Channel 9’s morning program dropped into an interview that “the US Congress need to consider this plan again, and we’re praying they accept it”. How did the media lose the ability to scrutinise what they spew forth? I’m not praying that Congress accept it. Maybe their initial decision to knock back the disgraceful Paulson Plan is the first step in restoring sense and order to an economic system built on thin air?