Wednesday, October 15, 2008

Paulson and Shocking Acts of Thuggary

TWO OF THEM: Moe could not make it for this picture.
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Today I read a paragraph from a news story that shocked me: "The chief executives of the nine largest banks in the United States trooped into a gilded conference room at the Treasury Department at 3 p.m. Monday. To their astonishment, they were each handed a one-page document that said they agreed to sell shares to the government, then Treasury Secretary Henry Paulson Jr. said they must sign it before they left."... rest of long story here.

Can you believe it? The Secretary of the Treasury instructed the heads of the nine largest banks that they must sign a one page document agreeing to his terms before they could leave the room? And this was tactics Paulson had to use on the people he was supposedly bailing out with our money. Imagine how against it we are going to be when they send their agents around to collect from us all of this money we are supposed to be giving away.

The plan was that the banks would issue an enormous number of shares of preferred stock that the government would buy. The non-voting shares would pay 5% of the initial purchase price in annual dividends- if the banks getting the money had any profit to pay towards stock dividends. This would increase to a 9% annual payout after five years in order to encourage the banks to buy back the stock at that time.

The healthy banks at the table initially did not like the idea. The mis-managed banks loved it. The poorly run banks get the advantage here because they can take the money from the shares and pay little or nothing for it. The reason is that they are not likely to make enough profits in the next few years to even pay the full dividends. The healthy banks on the other hand, will wind up paying the full five percent for this capital, which is above market rate. They could raise the capital for less using traditional methods. Regardless, the Godfather of the Treasury made them "an offer they couldn't refuse".

This plan is an absolute disaster in the making. It once again takes us in the exact opposite direction that the free market is signaling we should go. The market says that banks who made stupid loan decisions should be punished, and perhaps removed from business. The portfolios of the failed players should be acquired by healthy banks who have shown the capacity to manage risk better. The Paulson plan does the reverse: it punishes the well-run banks by keeping incompetent players in the game and actually rewarding them for their mismanagement by giving them access to capital at an effectively lower rate than the healthy banks will pay for the government capital.

Banks won't loan to one another because they don't trust each other. This plan to keep mis-managed banks in the game will not restore that trust, and the market is sending a signal that it has no confidence in Paulson's scheme.

The other thing the market is trying to tell us is that the mis-managed banks made too many marginal loans. Credit was too easy to get, even for projects that were not sound investments or for home buyers who were not good credit risks. The market is telling us that credit needs to tighten some. The government wants to override the market and keep expanding credit. By forcing even the healthy banks to take billions of dollars at five percent, they are trying to force these banks to extend even more loans at a time when a prudent lender might want to cut back on all but the safest loans.

I am really fearful when I see the crudity of their tactics and the thuggery of their implementation. It is very apparent that the people nominally in charge of our country have absolutely no clue how to lead us out of this mess. They may not even be trying. They may simply be acting like rational parasites on the national production of our citizens. That is to say, when the host was healthy, they were careful not to suck out so much life-blood that the host would be harmed, for they depended on the host. But now that it is clear that the host is going down, they are simply trying to suck out as much life as they can before the host's demise.

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