Economist Kevin Phillips: The Bungled Bailout (Or the Perils of Paulson)

The Bungled Bailout (Or the Perils of Paulson)
by economist Kevin Phillips - Huffington Post
Posted October 8, 2008

Somebody should compile an authoritative list of the foolish statements, Wall Street parochialisms and bungled bailouts racked up by Treasury Secretary Henry Paulson and his faithful Federal Reserve Board sidekick, Ben Bernanke, since the Great Credit Crash began in August 2007. Small wonder the global markets can't sustain any belief in the two men's tandem policies. Neither understands the cancer cells spreading in the corpus of the U.S. (and now world) economy.

First, we had Paulson's fatuous analysis that the summer 2007 spasms were just a real estate matter that would be easily contained. Tonto Bernanke agreed. Then came the Treasury Secretary's little remembered autumn proposal to set up a "SuperSIV" to handle the financial sludge that Citigroup and other big banks had parked in tricky off-the-books vehicles.

No sooner was the SuperSIV gambit ignominiously dropped than it was time for March's $29 billion Fed rescue of the investment firm of Bear Stearns. Although former Fed Chairman Paul Volcker called that one barely legal, Paulson and Bernanke said it would stem the tide. It didn't. Since then, we have seen the Washington-facilitated rescue of Merrill Lynch, the shrugged-off failure of Lehman Brothers, and the last minute bail-out of AIG, the too-cocky insurance giant. This regulatory triple-play failed to strengthen international confidence, and the Crash just kept on Crashing.

Eventually the towering T-Man and the bearded banker decided that perhaps skeptics were correct in surmising the world's biggest financial crisis since the 1930s. So during the week of September 15, they forswore the hapless doctrine of piecemeal bail-outs, assembled their crack staffs and consulted the memories of Herbert Hoover and J. P. Morgan. Then, in a mere three page emergency document approved by "President" Bush, they proposed that Paulson be made America's financial czar empowered to use $700 billion of the taxpayers' money to bail out Wall Street scofflaws by buying up the half-worthless or toxic financial products that other Wall Street geniuses -- all too many working in the same hotshot firms -- had pioneered.

The public, rightly perceiving a staggering ego trip and shameless bail-out, inundated Congress with a wave of letters, telephone calls and e.mails, and on September 22, the House of Representatives voted to reject the Treasury-Fed power grab. This stunned the financial community, which bathes 24/7 in the aura of its own importance, and global markets shuddered. Within ten days, the Senate had acted on a new rescue package -- loaded up with $100 billion of baubles, tax breaks and fresh pork to sway public opinion and bribe several dozen congresspersons. On October 3, the House accepted this version, but the global markets scoffed and sank for three straight days -- October 3, 6 and 7.

Here we must keep in mind that while Paulson and Bernanke got much of what they were looking for -- $700 billion and powers that verge on unconstitutionality -- some potentially important conditions were attached. To over-simplify somewhat, companies that turn in their junk paper to the Treasury's new subsidized rescue office can't have overcompensated top executives, and Paulson's Treasury has to make some details of the arrangements public within a few days. Meanwhile, the Secretary did not get the full immunity he sought -- above-the-law financial czar status -- and the Treasury still has a small degree of accountability. The upshot is that if Congressional committees, state attorneys general, consumer and civic groups, watchdog organizations and public interest law firms and research groups set up serious bailout monitoring and response mechanisms, they can quickly identify and publicize any improper pigs lining up at Washington's new public trough.

And hopefully they will.

But the largest reason to the doubt any major success of the just-enacted Washington bailout is that it does not go to the heart of the problem -- the gross excesses of the U.S. financial sector and the need for sweeping reforms and indictments, both ethical and legal. Or to put it differently, given the last decade's malignant transformation of U.S. finance, providing federal transfusions without needed corrective surgery is not medicine but unwise favoritism and cosseting.

Bad Money, my book published this Spring, detailed at length the recent rise of the U.S. financial sector. Over the last two decades, the financial sector has grown from 15-16% of U.S. Gross National Product in the mid-1980s to 20-21% of the current Gross Domestic Product calculus in 2006-2007. Manufacturing, meanwhile, has dropped to a mere 12% share. This upheaval is closely related to the ballooning of total public and private debt in the U.S. -- the great bulk of it is private -- from some $11 trillion in 1987 to some $47 trillion in 2007. Debt and credit, in all its new forms and mutations, from exotic mortgages to securitization and credit default swaps, has become one of this nation's top industries. Alas, the displacement by finance of manufacturing represents as far-reaching a changeover as manufacturing's displacement of agriculture did a century ago. However, the national media refuse any discussion, an information gap that cripples national policymaking.

Something similar, albeit milder, happened to the previous leading world economic powers -- most recently Britain and Holland (in the 17th century when New York was still New Amsterdam). I have described these prior financialization patterns in several previous books, and I will not repeat the discussion here. However, the recent transformation of the United States is a much deeper and more systemic development. In looking at Spain, Holland and Britain and their decline patterns, I described financialization as a late historical stage, a symptom of national aging, and an arteriosclerosis of sorts. Some others have made similar points.

But looking at the financial interactions, complications and surprises of 2007-2008, I think that we can usefully consider a further analogy - positing the U.S. variety of experimental mega-finance and "scientific" speculation as a kind of historical cancer, a dangerous stage in the historical biology of nations and economies.

Even the mainstream financial press has been using pop scientific terms to describe the new economic behaviors, miscalculations and hard-to-explain interactions. "Toxic" and "contagious" are two popular, if imprecise examples. Toxicity, for its part, leads to the subject of cancer, which science only really began to understand in the 20th century.

Interestingly, on the American Cancer Society's website, their short "History of Cancer" begins as follows: "Cancer develops when cells in a part of the body begin to grow out of control. Although there are many kinds of cancer, they all start because of out-of-control growth of abnormal cells." Such cells develop because of damage to DNA, usually among older adults. Then "cancer cells often travel to other parts of the body, where they begin to grow and replace normal tissue. This process, called metatastisis, occurs as cancer cells get into the bloodstream or lymph vessels of our body."

My thesis is that the Frankenstein finance of the last two decades -- the crazed borrowing, pseudo-science, frenetic growth, greed and gambling -- did something roughly similar to the once-normal cells of our American economic corpus. So we don't know exactly what is happening now, why, or with what kind of contagious complexity. Radiation and even surgery (cutting out institutional tumors) may be in order. Over to you, doctors Paulson and Bernanke.
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Kevin Phillips' new book Bad Money: Reckless Finance, Failed Politics and the Global Crisis of American Capitalism, published by Viking in April, is now back on the New York Times non-fiction and business bestseller lists.