Paul Craig Roberts
America has become a pretty
discouraging place. Americans, for the most part, will never know what
happened to them, because they no longer have a free and responsible
press. They have Big Brother's press. For example, on September 28,
2008, a New York Times editorial blamed the current financial crisis on
"antiregulation disciples of the Reagan Revolution."
What utter nonsense. Every
example of deregulation that the New York Times editorial provides is
located in the Clinton Administration and the George W. Bush
administration. I was a member of the Reagan administration. We most
certainly did not deregulate the financial system.
The repeal of the
Glass-Steagall Act, which separated commercial from investment banking,
was the achievement of the Democratic Clinton Administration. It
happened in 1999, over a decade after Reagan left office.
It was in 2000 that
derivatives and credit default swaps were excluded from regulation.
The greatest mistake was made
in 2004, the year that Reagan died. That year the current Secretary of
the Treasury, Henry M. Paulson Jr, was head of the investment bank
Goldman Sachs. In the spring of 2004, the investment banks, led by
Paulson, met with the Securities and Exchange Commission. At this
meeting with the New Deal regulatory agency tasked with regulating the
US financial system, Paulson convinced the SEC Commissioners to exempt
the investment banks from maintaining reserves to cover losses on
investments. The exemption granted by the SEC allowed the investment
banks to leverage financial instruments beyond any bounds of prudence.
In place of time-proven
standards of prudence, computer models engineered by hot shots
determined acceptable risk. As one result Bear Stearns, for example,
pushed its leverage ratio to 33 to 1. For every one dollar in equity,
the investment bank had $33 of debt!
It was computer models that
led to the failure of Long-Term Capital Management in 1998, the first
systemic threat to the financial system. Why the SEC went along with
Paulson and set aside capital requirements after the scare of Long-Term
Capital Management is inexplicable.
The blame is headed toward
SEC chairman Christopher Cox. This is more of Big Brother's
disinformation. Cox, like so many others, was a victim of a free market
ideology, itself a reaction to over-regulation, that was boosted by
academic economic opinion, rewarded with Nobel prizes, that the market
"always knows best."
The 20th century proves that
the market is likely to know better than a central planning bureau. It
was Soviet Communism that collapsed, not American capitalism. However,
the market has to be protected from greed. It was greed, not the
market, that was unleashed by deregulation during the Clinton and
George W. Bush regimes.
I remember when the
deregulation of the financial sector began. One of the first inroads
was the legislation, written by bankers, to permit national branch
banking. George Champion, former chairman of Chase Manhattan Bank,
testified against it. In columns I argued that national branch banking
would focus banks away from local business needs.
The deregulation of the
financial sector was achieved by the Democratic Clinton Administration
and by the current Secretary of the Treasury, Henry Paulson, with the
acquiescence of the Securities and Exchange Commission.
The Paulson bailout saves his
firm, Goldman Sachs. The Paulson bailout transfers the troubled
financial instruments that the financial sector created from the books
of the financial sector to the books of the taxpayers at the US
This is all the bailout does. It rescues the guilty.
The Paulson bailout does not
address the problem, which is the defaulting home mortgages.
The defaults will continue,
because the economy is sinking into recession. Homeowners are losing
their jobs, and homeowners are being hit with rising mortgage payments
resulting from adjustable rate mortgages and escalator interest rate
clauses in their mortgages that make homeowners unable to service their
Shifting the troubled assets
from the financial sectors' books to the taxpayers' books absolves the
people who caused the problem from responsibility. As the economy
declines and mortgage default rates rise, the US Treasury and the
American taxpayers could end up with a $700 billion loss.
Initially, the House, but not
the Senate, resisted the bailout of the financial institutions, whose
executives had received millions of dollars in bonuses for wrecking the
US financial system. However, the people's representatives could not
withstand the specter of martial law and Great Depression with which
Paulson and the Bush administration threatened them. The people's
representatives succumbed as they did during the New Deal.
The impotence of Congress
traces to the Great Depression. As Theodore Lowi in his classic book,
The End of Liberalism, makes clear, the New Deal stripped Congress of
its law-making power and gave it to the executive agencies. Prior to
the New Deal, Congress wrote the laws. After the New Deal a bill is
merely an authorization for executive agencies to create the law
through regulations. The Paulson bailout has further diminished the
legislative branch's power.
Since Paulson's bailout of
his firm and his financial friends does nothing to lessen the default
rate on mortgages, how will the bailout play out?
If the $700 billion bailout
is based on an estimate of the current amount of bad mortgages, as the
recession deepens and Americans lose their jobs, the default rate will
rise. The $700 billion might not suffice. The Treasury will have to go
hat in hand to its foreign creditors for more loans.
As the US Treasury has not
got $7, much less $700 billion, it must borrow the bailout money from
foreign creditors, already overloaded with US paper. At what point do
America's foreign bankers decide that the additions to US debt exceed
what can be repaid?
This question was ignored by
the bailout. There were no hearings. No one consulted China, America's
principal banker, or the Japanese, or the OPEC sovereign wealth funds,
Does the world have a blank check for America's mistakes?
This is the same world that
is faced with American demands that countries support with money and
lives America's quest for world hegemony. Europeans are dying in
Afghanistan for American hegemony. Do Europeans want their banks, which
hold US dollars as their reserves, to fail so that Paulson can bail out
his company and his friends?
The US dollar is the world's
reserve currency. It comprises the reserves of foreign central banks.
Bush's wars and economic policies are destroying the basis of the US
dollar as reserve currency. The day the dollar loses its reserve
currency role, the US government cannot pay its bills in its own
currency. The result will be a dramatic reduction in US living
Currently Treasuries are
boosted by the habitual "flight to quality," but as Treasury debt
deepens, will investors still see quality? At what point do America's
foreign creditors cease to lend? That is the point at which American
power ends. It might be close at hand.
The Paulson bailout is
predicated on cleaning up financial institutions' balance sheets and
restoring the flow of credit. The assumption is that once lending
resumes, the economy will pick up.
This assumption is
problematic. The expansion of consumer debt, which kept the economy
going in the 21st century, has reached its limit. There are no more
credit cards to max out, and no more home equity to refinance and
spend. The Paulson bailout might restore trust among financial
institutions and enable them to lend to one another, but it doesn't
provide a jolt to consumer demand.
Moreover, there may be more
shoes to drop. Credit card debt could be the next to threaten balance
sheets of financial institutions. Apparently, credit card debt has been
securitized and sold as well, and not all of the debt is good. In
addition, the leasing programs of the car manufacturers have turned
sour. As a result of high gasoline prices and absence of growth in
take-home pay, the residual values of big trucks and SUVs are less than
the leasing programs estimated them to be, thus creating more financial
problems. Car manufacturers are canceling their leasing programs, and
this will further cut into sales.
to statistician John Williams
who measures inflation, unemployment, and GDP according to the
methodology used prior to the Clinton regime's corruption of these
measures, the US unemployment rate is currently at 14.7 per cent and
the inflation rate is 13.2 per cent. Consequently, real US GDP growth
in the 21st century has been negative.
This is not a picture of an
economy that a bailout of financial institution balance sheets will
revive. As the Paulson bailout does not address the mortgage problem
per se, defaults and foreclosures are likely to rise, thus undermining
the Treasury's estimate that 90 per cent of the mortgages backing the
troubled instruments are good.
Moreover, one consequence of
the ongoing financial crisis is financial concentration. It is not
inconceivable that the US will end up with four giant banks: J.P.
Morgan Chase, Citicorp, Bank of America, and Wachovia Wells Fargo. If
defaulting credit card debt then assaults these banks' balance sheets,
who is there to take them over? Would the Treasury be able to borrow
the money for another Paulson bailout?
During the Great Depression
of the 1930s, the Home Owners' Loan Corporation refinanced one million
home mortgages in order to prevent foreclosures. The refinancing
apparently succeeded, and HOLC returned a profit. The problem then, as
now, was not "deadbeats" who wouldn't pay their mortgages, and the HOLC
refinancing did not discourage others from paying their mortgages.
Market purists who claim the only solution is for housing prices to
fall to prior levels overlook that rising inventories can push prices
below prior levels, thus causing more distress. They also overlook the
role of interest rates. If a worsening credit crisis dries up mortgage
lending and pushes mortgage interest rates higher, the rise in interest
rates could offset the fall in home prices, and mortgages would remain
unaffordable even in a falling housing market.
Some commentators are blaming
the current mortgage problem on the pressure that the US government put
on banks to lend to unqualified borrowers. However, whatever breaches
of prudence there may have been only affected the earnings of
individual institutions. They did not threaten the financial system.
The current crisis required more than bad loans. It required
securitization and its leverage. It required Fed chairman Alan
Greenspan's inappropriate low interest rates, which created a real
estate boom. Rapidly rising real estate prices quickly created home
equity to justify 100 percent mortgages. Wall Street analysts pushed
financial companies to improve their bottom lines, which they did by
An alternative to refinancing
troubled mortgages would be to attempt to separate the bad mortgages
from the good ones and revalue the mortgage-backed securities
accordingly. If there are no further defaults, this approach would not
require massive write-offs that threaten the solvency of financial
institutions. However, if defaults continue, write-downs would be an
Clearly, all Secretary
Paulson thought about was getting troubled assets off the books of
The same reckless leadership
that gave us expensive wars based on false premises has now concocted
an expensive bailout that does not address the problem, which will
fester and become worse.
Paul Craig Roberts was Assistant
Secretary of the Treasury in the Reagan administration. He was
Associate Editor of the Wall Street Journal editorial page and
Contributing Editor of National Review. He is coauthor of The Tyranny
of Good Intentions.
He can be reached at: [email protected]