How's That Bailout Going?

Henry Paulson's bank-rescue program was always a turkey of a deal.

| Wed Nov. 26, 2008 4:00 AM EST
Perhaps this is stating the obvious, but the big US bailout plan hasn't worked so far. I don't just mean the $700 billion granted by Congress through the Economic Emergency Stabilization Act on October 3. I mean none of the related measures have worked, either.

Treasury Secretary Henry Paulson convinced Congress that the sky would fall without a $700 billion cushion. The Fed has initiated a loan program for troubled financial firms, spending trillions of dollars to bail out any company that ever overleveraged anything, and it has chopped interest rates in concert with its global central bank brethren.

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And yet, the bloodbath continues. This week jobless claims clocked in at a 16-year high—and these figures don't even include the 53,000 job cuts announced by Citigroup, 3,000 by JPMorgan Chase, or up to 6,000 by Sun Microsystems. Nor do they count the cuts that will come from the auto industry, which will be in the tens of thousands if the Big Three survive, and in the millions if they don't. Last week, the Department of Labor announced that in October the US Consumer Price Index had staged its biggest drop in 61 years.

Why are we still listening to painful debates about whether to fix the bad decisions made by top corporate executives, rather than addressing the people at the foundation of the economy?

Recently, Sheila Bair, chair of the Federal Deposit Insurance Corporation, deftly explained the very sensible idea of helping homeowners in danger of foreclosure, as opposed to Paulson's idea of injecting arbitrary amounts of money into banks. This isn't a shot-in-the-dark solution Bair's offering; it's one that the FDIC has made work in a very short period of time. The same period during which Paulson's decisions have, well, not worked.

Bair wants private lenders to do what the FDIC has done successfully: help distressed borrowers. Since the FDIC seized Pasadena-based IndyMac in July, it's been able to reduce loan payments for some borrowers to 38 percent of their income by reducing interest rates, extending terms, or deferring principal payments.

According to the FDIC, "IndyMac has sent out more than 23,000 modification letters to eligible borrowers and has completed more than 5,300 modifications..." With that kind of proven efficiency, Bair proposed a similar $24 billion government-backed bailout program to be used for homeowners more generally.

Paulson didn't warm to her approach.

Since the bailout package was signed into law in October, the global economy has nose-dived. Maybe that wasn't Paulson's fault, but buying equity in banks was his choice.

In mid November, members of Congress on both sides of the aisle were incensed that Paulson flip-flopped on the original intent of his Troubled Asset Relief Program, which was purchase toxic assets from imperiled financial firms, deciding that injecting capital into troubled banks was the best way to dethaw the frozen credit markets. The rest of us can let that concern go. Buying junky assets would have been just as ineffective as buying stock in the companies that processed the junk. On October 28, the Treasury Department spent $125 billion to purchase preferred shares in Goldman Sachs, Merrill Lynch, Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, State Street, and Bank of New York Mellon. Since then, shares in those firms have plummeted an average of 55 percent. That makes the $125 billion investment worth about $69 billion right now.

The big lie was that this capital would go toward easing credit, but it hasn't. Nor will it, for three reasons. First, with banks like Citigroup trading at roughly 10 percent the price of McDonald's shares and struggling for survival, they need to conserve all the capital they can. Second, as long as there is uncertainty among banks as to what kinds of losses lurk within their books, there will be no true credit flow in the industry. And third, consumers will always come dead last on their list of priorities.

But as the nation turns to the next bailout question, whether to come to the rescue of the auto industry, we've got to ask if capital injections or loans are the best way to go. Perhaps the leaders of the Big Three need what the finance industry needs: a Sheila Bair-style solution.

The problem with automakers is their lack of operating cash, not withstanding the group CEO trip to DC to ask for $25 billion more of it. Simply providing cash will only prolong the problem. If Bair's plan can convert 5,300 loans to manageable assets rather than declining ones, and keep people in their homes, maybe a similar program could help GM, Ford, and Chrysler. Say the FDIC took these firms over. A comparable plan could negotiate affordable loans (since banks are sitting on their money) for consumers to purchase auto inventory with appropriate incentives, like upgradeability to energy-friendly cars as they get produced. A sustainable program providing ongoing cash infusion through inventory movement while reducing leverage could have a shot.

But even that might be too late. The fact that their cars weren't selling (first because the companies weren't forward thinking, and then because consumer throttle back on big ticket purchases in general) has created a potentially irrevocable cash shortage. There are those who blame this on pension and health care programs. But GM had $17 billion The Joy of The Mundane used under a Creative Commons license.

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