The Paulson And Bernanke Follies

October 21, 2008 by Douglas A. McIntyre

FedA cabinet secretary is a person who has taken a job which they believe is the crowning honor of their career until they realize that they cannot do it and will never be what they able to. They continue in their work because they are a slave to their pride and their misplaced loyalty. They have been played for a fool, but cannot admit that to their friends or to the public.

The Secretary of the Treasury, Henry Paulson, is one of the most wealthy men in America,  like most of the men who ran Goldman Sachs. He could have bought the mayorship of some large city, the governor’s mansion , or a senate seat like his peers Michael Bloomberg and Jon Corzine.  Instead he followed other men from private finance who went into government. An equally large number of the people who run agencies and departments of the federal administration came from academia. Ben Bernanke could have remained the chairman of the economics department at Princeton. He might well have become an Ivy League president, which primarily involves fund raising and gives the personal access to the private homes and jets of immodestly wealthy alumni.

Bernanke and Paulson both came to government not to take a break, but to do make a difference to their country and their world. They were ready to do something other than make money or read graduate student dissertations.  In the best of times, being head of the Treasury is a leisurely job. While Alexander Hamilton did a great deal with the job, Paulson’s immediate predecessors were an aluminum executive and a railroad CEO. Almost no living American outside a history department can name more than four or five of the seventy-four men who have held this job.

The Fed chief and Treasury Secretary ran into the one thing that no appointed official wants on his watch—a full-blown disaster. Whether either man is treated well in the press or in future analysis, it certainly cannot be argued that they addressed the disaster too slowly, once they understood the acute and severe nature of the problem. There will always be lots of blame to go around for the three years of home price inflation and creation and multiplication of complex financial instruments. When matters became acute, Bernanke began the process of cutting rates and lobbying for more action from the Congress. Paulson even had the gall to walk up Capitol Hill with a three page piece of legislation asking for $700 billion to bail out the financial systems with virtually no strings attached. The astonishing thing is that he got 99% of what he asked for.

The first revision that Paulson made to his own plan was to put $150 billion into the stocks of nine financial firms and suspend GAAP so that they could accept the money without taking losses. He then got in front of TV cameras and told the world that the money he was shoveling into the banks better be loaned out "or else". His comments did not carry the weight of law, but perhaps they were  enough to shame executives at the banking  institutions into calling their mortgage departments to tell them to spread around some cash. Most analysts think that home prices have another 10% to 15% to fall. Modest lending into that market is extremely good PR.

Congress, responding to Bernanke’s testimony about the need for further economic stimulation, has already begun to undermine Paulson’s and the Fed chief’s original plan. Bernanke told the legislators, most of whom are still anxious to spend more money in their districts, that a second bailout would be needed. It would have to be larger than the first and directed more at the poor taxpayers. Bernanke’s mistake was that he let legislators who know almost nothing about the economy think that they could move onto a bigger rescue package without seeing whether the first one worked and why.

Paulson will leave office in ninety days and his role in the catastrophe will be over. Bernanke may well allow the next round of tests on the guinea pig of the economy to be done by the new Secretary of the Treasury and incoming Congress. He may cut rates another half a point, but in a storm of this magnitude that will probably make little difference. The value of the next version of saving the taxpayer using his own money will probably go well above a trillion dollars.

What will almost certainly happen is that the fire drill will have ended, and the day-to-day activity of making and carrying out the work of the financial arm of the US government will be handed back to a monkey with an abacus.

Douglas A. McIntyre