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Treasury Secretary Henry Paulson briefing reporters on September 19. (AP Photo)

How much will the Paulson package cost, and where’s the money coming from?

ASK THIS | September 20, 2008

Martin Lobel notes that under Treasury secretary Henry M. Paulson’s proposal, all key decisions would be made by him or his designees and would not be reviewable. Shouldn’t that raise some questions?

By Martin Lobel

The financial crisis we face is worldwide in large part because so many institutions bought U.S. paper, which means we are going to have to cooperate with other countries to bring liquidity to the market again. So whatever steps we take are going to have to be viewed in a larger context.

A chief problem is that the value of the assets (housing in particular) underlying so many of the derivatives is going to keep declining as the bubble deflates until they reach a fair market value as measured by more traditional indices. That decline in value is going to be shifted to the taxpayers under what Treasury Secretary Henry M. Paulson, Jr., has proposed.

Taxpayers would either hold those financial instruments until the housing market recovered or sell them and recognize a more immediate loss. Of course, the devil is in the details, like how are they going to price the derivatives they purchase: book value, market value, as determined by what, etc.? Are decisions going to be made for economic or political reasons? Under the Paulson proposal [click here for the text], all those decisions would be made by him or his designees and would NOT be reviewable! Shouldn’t that raise some questions?

The next question is: Where is the money going to come from? Although Paulson is projecting a cost of about $700 billion, the real cost is likely to be more than $1 trillion. No one is talking about raising the taxes necessary to fund the rescue. Leaders, including the presidential candidates, are still talking about cutting taxes! And, the financial industry, recognizing that whatever comes out as emergency legislation in this short a time is likely to make sausage look like a T bone steak, is still at the trough. According to a Wall Street Journal article (subscription required), they've told Congress, among other things, that they won't stand for limits on executive salaries at institutions that need to be bailed out.

Lenders reportedly have told told Congress they won't allow bankruptcy judges to cram down mortgages on first homes, although they can do so on second homes and yachts. “Cramming down” means a judge can change the terms of a loan to make it workable. For example, if a person in bankruptcy had a $100,000 mortgage on a house that has lost value, the judge could reduce the mortgage, say to $80,000. Banks are concerned that if judges had that power it would give homeowners an incentive to fight over mortgages that exceed the value of homes, and, in some instances, banks would have to share some of the loss.

In my view, there are a couple of essentials: We need a government dedicating to policing, rather than excusing, the markets which probably means we need to revamp the regulatory agencies so that they reflect the functioning of the market now, not as it was in the 1930s. It will take time to do it right, but in the meantime we must insist on transparency and personal responsibility.

Allowing Citibank to hide $82 billion of derivatives in an off the books entity after Enron, borders on criminally negligent oversight. The same can be said of allowing $62 trillion of unregulated credit default swaps to be carried as assets on the books of our financial institutions and thereby endangering our entire financial system. Credit default swaps are really nothing more than naked bets and should be treated as such. Even bookmakers don't make those kinds of bets. If a few CEOs were made to regurgitate their salaries because they breached their fiduciary duties to shareholders, that would have a salutary effect. But I can hear the cries now about those perfidious lawyers.

We are going to have to live within our means for the foreseeable future, which will be painful for the vast majority of voters who will not have the access to easy credit they were used to, will have to pay higher prices for goods and probably will have to pay higher taxes. We need to know how the candidates and Congress propose to make these changes without inflicting undue pain on the middle class. The Bush administration was able to act like a drunken sailor trying to max out a credit card, assuming, I’d say, that the next President would have to clean up the economic mess. Now we need answers.

One long overdue solution is to change the tax system, especially as it applies to multinational corporations which, according to a recent IRS report, paid 4 percent on their overseas earnings as opposed to the nominal 35 percent rate. A unitary system would prevent these companies from shifting their profits to offshore tax havens and level the playing field for domestic companies. We also need to simplify our tax code and make it more equitable, for example, by changing the treatment of carried interest, the billions of dollars earned by hedge fund managers which is only taxed at capital gains rates when they decide to repatriate it, or by eliminating unjustified tax subsidies, like those we give the oil companies, so we can lower overall rates.

The media must alert the public to the real consequences of this kind of emergency legislation. Until we have a better idea of what the real implications of the Paulson package are, caution should be our guide. Do we really need to give the Treasury Secretary or his designee such unreviewable discretion? Doesn’t that invite substituting political for economic judgment?

How to raid the treasury
Posted by DeanOR
09/20/2008, 05:35 PM

"Do we really need to give the Treasury Secretary or his designee such unreviewable discretion?"
Yes. It's the best way to make sure the loot goes to the right people.

"Doesn’t that invite substituting political for economic judgment?"
It doesn't invite it, it insists on it. We're still in Bushland.

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