Why is the United States treasury propping up shaky banks?

GOLDMAN SACHS TOWER -- NEW YORK CITY

GOLDMAN SACHS TOWER -- NEW YORK CITY

Last Monday, U.S. Treasury Secretary Henry “Hank” Paulson called a meeting in Washington of the CEOs of banks that Mr. Paulson wants the American taxpayer to prop up.  Attending the meeting were Kenneth D. Lewis, CEO of Bank of America; Jamie Dimon, CEO of J. P. Morgan Chase; Lloyd C. Blankfein, CEO of Goldman Sachs Group; John J. Mack, CEO of Morgan Stanley; Vikram S. Pandit, CEO of Citigroup; Robert P. Kelly, CEO of Bank of New York Mellon; John A. Thain, CEO of Merrill Lynch & Co.; and Richard M. Kovacevich, CEO of Wells Fargo.

It is expected that the U.S. Treasury will buy $25 billion in preferred stock in Bank of America, J. P. Morgan and Citigroup; between $20 billion and $25 billion in Wells Fargo; $10 billion in Goldman Sachs and Morgan Stanley; and between $2 billion and $3 billion in Bank of New York Mellon Corp. and State Street Corp.  The “Bush’s bank bailout” rescue program will make the United States the biggest owner of banking shares in the country.

University of Missouri, Kansas City (UMKC) economist Michael Hudson referred to the stock purchase plan as “Plan B.”

“Bailout ‘Plan A’ (buy the junk mortgages) has failed” and Plan B is to to “buy ersatz stocks in the banks to recapitalize them without wiping out current mismanagers,” Mr. Hudson wrote in Counterpunch.

Paulson makes an abrupt about-face

“The latest show of government firepower is an abrupt about-face for Mr. Paulson, who just days earlier was discouraging the idea of capital injections for banks,” reported The New York Times.  Mr. Paulson recently told Congress that “the right way to do this is not going around using guarantees or injecting capital,” arguing that Japan had limited success with similar solutions in the 1990s.

“The new plan is designed to bolster bank balance sheets by providing  new capital, removing rotten assets and taking new steps to make sure they have access to the funds they use to operate,” said a front page article in The Wall Street Journal.  “All told, the moves are designed to get money flowing through the system so that banks will lend to companies, consumers and each other.”

Plan B provides for the U.S. Treasury to be granted preferred shares without voting rights or the right to be involved in day-to-day management decisions.  The shares will have a five percent dividend increasing to nine percent after five years.  The participating banks will be prohibited from raising dividends for ordinary investors for three years.

Reporting on his meeting with the bank CEOs, Mr. Paulson stated: “I don’t think there was any banker in that room who was going to look us in the eye and say they had too much capital.”

A retreat from the first rescue plan

According to The New York Times, Plan B “is the largest government intervention in the American banking system since the Depression” and amounts to “retreating from the rescue plan [Plan A] that Mr. Paulson had fought so hard to get through Congress only two weeks earlier.”

Sen. Charles Schumer (D-N.Y.), a cheerleader for Plan A, is now a cheerleader for Plan B.

“The administration’s initial approach to the crisis was to propose buying troubled assets from banks,” Mr. Schumer wrote in an op-ed piece in The Wall Street Journal.  “But direct capital injections into financial institutions . . . always offered a far better prospect of success.”

Mr. Schumer claimed that he along with Democratic leaders Sen. Chris Dodd and Rep. Barney Frank were in favor of Plan B before they were in favor of Plan A.  He claimed that the three of them “made explicit our desire to make direct infusions of capital a part of the approach to solving the crisis during negotiations with the Treasury” before Plan A was passed.

Plan B is prudent even though “[t]here is little question that making the government a major investor in American banks raises thorny questions, especially about the role of the public sector in private markets,” Mr. Schumer wrote.  “So let me be clear — this is a temporary solution to an unprecedented crisis, and the government’s role must be limited.”

Schumer’s claim of being “clear”

Even though Mr. Schumer said that he was being “clear” with Americans, Mr. Schumer did not give any indication of what he considered to be “temporary.”  However, he apparently believes that for the Treasury to take approximately $250 billion in equity stakes in potentially thousands of banks is a “limited” role.

“The only clarity we have is that the crisis is resulting in financial concentration and that the bailout constitutes a massive raid by financial crooks on both taxpayers and central bank reserves in the U.S. and Europe,” wrote a former Assistant Secretary of the Treasury in the Reagan administration, Paul Craig Roberts. 

Mr. Paulson said Tuesday that “we regret having to take these actions [i.e., Plan B].”  He called Plan B “objectionable” but apparently unavoidable.

“In addition to the capital infusions, which will be made this week, the government said it would temporarily guarantee $1.5 trillion in new senior debt issued by banks, as well as insure $500 billion in deposits in non-interest bearing accounts, mainly used by businesses,” The New York Times reported.  “All told, the potential costs to the government of the latest bailout package comes to $2.25 trillion, triple the size of the original $700 billion rescue package, which centered on buying distressed assets from banks.”

No meaningful job creation

Neither Plan A or Plan B provide for any meaningful job creation, which is vital to any effective recovery effort.  The proposed solution to the financial crisis “is a Keynesian policy for banks and big businesses, and the Mellon plan for everyone else,” wrote James Ridgeway, the senior Washington correspondent for Mother Jones.  “This is consistent with the longtime Republican approach, which offers government support to corporations and the rich in the name of stimulating the economy but denies it to the working people who actually create the wealth.”

The preferred equity financing “provides financing on very favorable terms — much more so than those  exacted by [Warren] Buffett’s Berkshire Hathaway . . . when it provided infusions of preferred equity recently to Goldman Sachs or General Electric,” wrote Randall W. Forsyth of Barron’s.  “Good thing for major banks issuing huge chunks of preferred that the master investor has opted to stay in Omaha rather than move to Washington [to become Secretary of the U.S. Treasury].”

“We’re providing large sums of money to financial institutions without receiving anything in return — no job creation, no investment in the country’s infrastructure, no reduction of foreclosures — just plenty of money to buy stock in banks which probably would have failed otherwise,” wrote Ron Shimshock, founder of Freeople, a website that supports pro-freedom candidates for public office.

“Leaving the issue of fraud aside, the bail out scam is also doomed to fail because it avoids diagnosis and dodges the heart of the problem: the inability of more than five million homeowners to pay their fraudulently ballooned mortgage obligations,” wrote Drake University economist Ismael Hossein-zadeh in Counterpunch.  “Instead of trying to salvage the threatened real assets or homes and save their owners from becoming homeless, the bailout scheme is trying to salvage the phony or fictitious assets of the Wall Street gambler and reward their sins by sending taxpayers’ good money after gamblers’ bad money.  It focuses on the wrong end of the problem.” 

Not enough good money to redeem all the bad money

Mr. Hossein-zadeh added: “The second major problem with the bailout scheme is simply that it is unfeasible and ineffectual because there is just not enough good money to redeem all the bad money that has ballooned or bubbled to a multiple of the good money and/or real assets.”

The risk of Plan A and Plan B is on the American taxpayer. 

“Should banks fail despite the capital injection, the Treasury would be likely to lose most, if not all, of its investment,” wrote Floyd Norris of The New York Times.  “The government would be treated the same as other preferred stockholders, who generally suffer major losses in bank failures.”

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