Well, you’ve probably heard the news by now. After a very rough week and the near collapse of many major wall street investment banks, the Federal reserve bank and the Department of the Treasury are planning on putting forward a major plan to attack the source of the nation’s economic troubles. This plan calls for the creation of a new Federal agency primarily to purchase all the bad loans from the nation’s banks.
Having spent some time over the weekend to absorb the news, I am urging our readers to reject the Paulson/Bernake Plan.
In took some time over the weekend to check with friends who work on Wall Street and in the financial industry, the general consensus is that Bernake and Paulson’s plan will help to stabilize the markets and keep credit flows liquid. So, simply put. It will probably work.
The Paulson/Bernake plan will probably work…but at what cost? When weighed against the long term consequences, the temporary benefits from stabilization seem to pale in contrast with the potential long term costs.
1) A PriceTag That Promotes Long Term Decline:
The Paulson/Bernake plan will require a titanic sum of money to buy up the bad debt. The Wall Street Journal is reporting that it formally calls for $700 billion, others like Congressman Richard Shelby are saying its cost at a minimum level could be at least a trillion dollars (1).
While this blogger does not know much about the federal deficit, it is a good bet that the treasury department does not have an extra $700 billion on hand. This money will have to be raised one of three ways. All have a detrimental effect on the economy. 1) taxation 2) Federal debt 3) issuing new money. Since the economy is effectively in a recession for many people, a tax increase would not help economic growth. Similarly, more debt would just strain the federal deficit and make it harder to fund sensible domestic spending. Finally, authorizing more money will decrease the value of the dollar via inflation. In short, none of the long term outcomes of the Paulson/Bernake plan will improve America’s long term financial health.
2) Moral Hazard:
The Paulson/Bernake plan will “bailout” many of Wall Streets largest investment banks. Much of the crisis was predicated on investments in “subprime” loans which have become worthless. In addition, many of these large banks borrowed against these loans for, many, many times the value of the underlying assets or built up complex investments called “derivatives” from them. Its reasonable to argue that people who borrow heavily or otherwise engage in unwise business practices should not be rewarded for engaging in misbehavior. In short, its unethical to bailout large companies who have acted imprudently with public money.
3) Leaves Average Citizens Holding the Bag:
The Paulson/Bernake plan leaves average citizens “holding the bag” in at least two ways. First, the average person has to bear the brunt of any potential long term fall out, whether higher taxes or increased inflation. Second, the plan does not help homeowners who are going to loose their homes or individual investors who bought bad shares – all the money goes to big institutions. In short, the average Jane and Joe get zero direct benefits and pay for everything.
4) Crisis Decision Making Is Problematic:
The current plan submitted to congress is currently 3 pages long. It would increase the debt limit to $11.3 trillion, establish a large new bureaucracy and give the treasury and the federal reserve bank unprecedented control over financial markets (1). Secretary Paulson is urging that congress quickly approve the plan to avoid financial disaster. Common sense would seem to suggest that this sort of decision should be made only after a long and careful debate. However, it appears that this debate may be prematurely cut off. Both parties appear willing to move forward within the week (1).
Just to wrap up, clearly the subprime mess impacting America’s financial markets is a tragedy, however America should not make the mistake of trading off a temporary current gain for long term economic disadvantage merely for the sake of defending corporate profits.
We are better than that.
Thank,
James
