US Backpedals on Bank Bailout

US Treasury Secretary Henry Paulson spoke for about an hour yesterday, claiming the situation in the financial markets is better than a few weeks ago. Then, he admitted that buying up the bad debts of US banks was a bad idea. He bought himself some wiggle room by adding that the Treasury and the Fed might revisit the idea in the future if bad-debt purchases could “play a useful part” later on. For now, the Treasury will simply buy a stake in some banks to improve the balance sheet.

The trouble with buying the “toxic” asset-backed securities and their derivatives was the difficulty of pricing. Effectively, the market had stopped trading the things, and therefore, there was no objective price set. The banks wanted them off their books at their maturity value. In other words, pretend these instruments would have performed as expected and pay the banks accordingly. Mr. Paulson knew that would have resulted in his own lynching by the torches and pitchforks crowd and rightly so. Yet, buying them for considerably less would have done little good for the banks. And each instrument was different, meaning that the negotiation on price would outlast the universe.

So, what will happen now is the government will partially own some of the US banks. The banks will take whatever losses they incur from the bad debt. Their shareholders will take a bath, and the market will eventually recover. Rudy Narvas, senior analyst at 4Cast, told the BBC, “The best bet is just to give them [the banks] the capital and to let them absorb the losses anyway. That is exactly what it looks like is happening.”

The stock market reacted to Mr. Paulson's words with typical panic. As he spoke, the Dow Jones Industrial Average fluctuated around a loss for the day of 250 and 300 points. When he had finished, and when the traders realized that there was no free money coming, they sold. The DJIA wound up 410 points lower. Asian markets overnight were hugely disappointed as well and dropped. By the time Europe opened for trading, everyone had had his fit. The European bourses are about flat as of this posting.

Despite the fact that about half the $700 billion in bailout money remains to be used, Secretary Paulson has decided not to use a penny of it to help America's auto makers. Jeff Sessions, Republican Senator for Alabama, pointed out, “Once we cross the divide from financial institutions to individual corporations, truly, where would you draw the line?" This journal is as troubled as he is. Yet, there are 3 million auto worker jobs in the US, and another 16 million tied to the industry. If the US car companies fail, the recession in which the world likely finds itself may be prolonged needlessly.

To answer Senator Sessions, the case for the car makers is simple – national security. If there is no Chrysler, Ford and GM, will America retain a sufficient vehicle manufacturing base to provide for an adequate national defense? Should Starbucks, Walgreen's and Piggly Wiggly ever need a handout, one would say “no” because the safety of Americans does not depend on them. Auto makers might just be different enough to warrant a government purchase of preferred stock to keep them afloat and to force them to build cars that are appropriate for the energy hungry world in which mankind now lives.

© Copyright 2008 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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