Wall Street still has its golden parachutes
Politics and business are full of convenient myths and useful fictions—that democratic government is driven primarily by the will of the people, for instance. Deep down we suspect these things aren’t exactly true, but they help keep the system moving.
These little delusions have their uses, but there are times when it’s important to focus on cold, hard truths. And when public officials decide they are going to spend close to a trillion dollars of taxpayer money to rescue a slew of private financial institutions from their own foolhardy misadventures, it’s time to cut the bull. Last week, the U.S. Congress approved Henry Paulson’s controversial US$700-billion bailout plan, after the House initially rejected it just four days earlier. How did they manage that abrupt about-face? In part, they did it by offering a handful of handy myths, designed to make Main Street feel better about funding a gargantuan economic do-over for the titans of Wall Street.
The first of these myths revolves around the idea that the plan will save the economy from the deep and painful recession lurking around the corner. For the average person on the street, this is the whole point of the Paulson plan, but even a cursory glance at the most recent economic data blows this hopeful idea sky-high. On the very day that the House of Representatives was ratifying the bailout, the U.S. Labour Department reported that 159,000 Americans lost their jobs in September—the worst one-month plunge in more than five years. That brought total job losses in the U.S. to 760,000 so far this year. The “official” unemployment rate is holding steady at 6.1 per cent, but that doesn’t really tell the whole sad story. When you include people who have given up actively looking for a job (known in government jargon as “discouraged workers”), unemployment now stands at 11 per cent—the highest since 1994. U.S. manufacturing activity slipped in September to its lowest level since the month after the 9/11 terrorist attacks. Josh Shapiro, an economist for MFR Inc. in New York, broke the bad news in a note to clients on Friday: “A consumer-led recession is upon us, and it promises to be a serious one.”
Pulling out of this funk won’t begin until people get confident enough to start buying houses again. Even if Paulson’s bailout can clear the decks for banks to restart lending, there will be precious few people eager to make a big investment when the economy is in the tank. The more people lose their jobs, the more foreclosures we will see, and the more prices are likely to fall. As of July, house prices in 20 major U.S. markets had fallen 16.3 per cent in a year and are still dropping, amid a record number of foreclosures.
Well, even if it can’t save America from a recession that’s already begun, proponents of the rescue say at least it will strike a major blow against the greed and excesses of Wall Street. They point to the bill’s prohibition on fat executive severance deals as proof. This too is a fantasy. The bill only prevents new golden parachutes for executives at companies taking part in the bailout. Washington can’t go back and abrogate existing employment contracts, so executives who already have their deals inked (which they all do) will still walk away with millions whenever they choose to quit, retire or get fired.
Does that matter? Not really, according to the mythmakers, because if the CEOs end up getting rich, the taxpayers might too! Last week, the bill’s sponsors and its boosters in the media floated the idea that, in the long run, government might actually end up making big profits off the toxic mortgages it’s buying from the banks. They argue that these plunging assets really aren’t so bad as they seem. It’s just that the world’s biggest and most sophisticated investors are acting irrationally, they say. Only government has the patience and foresight to take on all these loans, hold them to maturity and turn a profit. This is pure, giddy optimism, masquerading as rational thought. Barry Ritholtz, an economist and head of Ritholtz Research, last week issued a million-dollar public wager that the Paulson plan will end up to be a “ginormous money loser” for the American public.
“There are trillions of dollars sitting around in cash, yet [no investors] see any value here?” Ritholtz wrote on his blog. “I guess that Hank Paulson, George Bush and Ben Bernanke—all of whom have been unequivocally, expensively, tyrannically wrong about the entire crisis from the beginning—are smarter than both the markets, and all of the private equity pools, about this paper? Does that sound right to you?” No. No, it doesn’t.
Nevertheless, the plan’s proponents continue to insist that it’s a “good deal” for the taxpayer, which brings us to the final and biggest myth of all. Last week, White House spokesman Tony Fratto insisted “it is not a bailout for Wall Street” and urged reporters to drop the b-word from their vocabulary. By his reasoning, because government is getting an ownership stake in the ailing banks, and will get assets in return for its money, this plan should be seen as a public investment rather than a handout. That’s very comforting indeed, except the fact remains that the U.S. taxpayer is taking on a staggering amount of debt to buy assets that nobody else wants, at prices nobody else would pay—in hopes it’ll prevent an even bigger disaster than the one we’re already in. It’s like someone putting a gun to your head and saying “don’t think of this as a mugging, think of it as an investment in safety. By giving me your wallet, you’re helping reduce the murder rate.”
Don’t get me wrong, Paulson’s bailout has its merits. It may end up reducing the suffering for millions of people at risk of losing everything. And it may give the U.S. a fighting chance to rebound from a terrible mess. Given our huge reliance on America’s economic health, Canadians should root for its success. But if this plan is going to work it is essential that we face it with clear eyes and leave the convenient fictions aside. The bailout is a desperate measure for desperate times. Sugar-coating it only makes it harder to swallow.