Saturday, July 18, 2009

Paulson Forced To Revisit '08 Events

Former Secretary of the Treasury Hank Paulson sat before a congressional panel this week to answer questions about his handling of the events surrounding the Bank of America/Merrill Lynch merger. The inquiry is the third of a series into the matter, the first being of BAC CEO Ken Lewis, and the second being of Fed Chairman Ben Bernanke.

Nearly the entire event, when not tragically repetitive, proved to be quite entertaining and worth watching. Most of the members of the committee, rather than questioning Paulson, took the opportunity to launch into 5 minute tirades against the various inconsistencies and obfuscations not only present in the BAC/MER issue, but in the TARP program, AIG bailouts and Paulson's favourable treatment with his former company, Goldman Sachs.

The hearing in its entirety (3.5 hours) can be watched uninterrupted below:

The meat of the hearing can be found between 43:00 and 1:14:00 where congressmen Kucinich, Jordan, Kanjorski, Burton and Lynch take their turns going over the events of late September and early October. Equally as hostile were questioning by congressmen Chaffetz and Turner as well as congresswomen Speier and Kaptur (2:38:00).

It is interesting to go back to those days and think about what was considered unthinkable at the time. Unemployment figures of 10% were being thrown around like grenades. It happened anyway. Talk of major damage to the stock market was often used as reason for pushing through the bailouts without delay (or even members reading the bills before voting). That ended up happening in November and even further in March anyway. They said banks would fail without action. 55 banks have failed thus far in 2009. And they said that systemically important firms would bring down the entire economy. And the result has been not a reduction in the size of these firms, but rather a massive increase. They also said that large employers would not have access to capital (debt markets) in order to fund their operations without any assistance. As it turns out, these companies (like GM and Chrysler) as well as small business lenders Advanta and CIT Group have ceased operations or entered bankruptcy protection.

Nearly every doomsday justification used to promote this idea of bailing out financial institutions happened anyway. So while the stock market is currently rallying on a media fueled inventory rebuild and trading firms reaping huge profits, essentially everything the bailouts were supposed to do failed miserably. But throughout Paulson's entire testimony he trumpets the terrible things that "would have happened" as justification for the illegal actions taken in Sept/Oct. I suppose that logic can be extended to anything. A doctor whose negligence caused the death of 100 people can say, "hey, good thing I didn't kill a thousand."

The congressmen and women on this panel are not buying the arguments of former Treasury Secretary Paulson. Nor did they buy what Lewis and Bernanke were telling them. And I doubt they will be more civil when questioning former SEC Chairman Chris Cox and FDIC Chairwoman Sheila Bair next fall. Now that they have seen the real world damage take place without regard to the trillions thrown around on Wall Street, they realize how foolish the actions of 2008 seem.

The reason this is important is not necessarily to pin the blame on any one person or group of people, however justified that may seem. It is important because it marks a change in the attitude of lawmakers in the US. Previously, they had been all too willing to go along with any recommendations given to them by Wall Street bankers. There appears to be, now, bipartisan agreement that such an act can not be tolerated again. So when the time comes for the next round of support by the taxpayer, none will be forthcoming. It will be entirely up to the Fed to provide such support. Something they may not be willing or able to do.

It is also important for the psychological impact it will have on future generations of wall street executives. They have now been warned, that if they do something that the average person feels has been wrong, then they are liable to find themselves taking the stand under oath. With such knowledge, they are not likely to simply continue their reckless behaviour as before (GS may be the exception here).

A total backlash against the banking industry is to be expected as a result of this episode. Many people are talking about a potential sequel to the Pecora commission of the early 30's. I believe that will happen once the second leg of this crisis begins to become apparent. It will likely go too far in its attacks on the banking industry, targeting even innocents who were "just following orders." Such is the nature of angry mobs.

The point is, the financial industry will never be the same. And to those who think that a new financial bubble can have any legs under such circumstances will likely prove to be disappointed. It is for this reason, among others, that attempts to expand credit that has worked in every attempt since the recession of the late 50's, will fail this time around. And it is corollary to that, that I believe hyperinflation is an impossibility anytime in the foreseeable future.

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Fish10 said...

Good post.

Fish10 said...

Maybe you should do a post responding to Faber's hyperinflation points:

mannfm11 said...

Matt, as you may know, I have been in the deflation camp for years, but I won't go so far as to say it is impossible to have hyperinflation. I would venture you are familiar with Bob Hoye, who lives in Vancouver. I was surprised to hear him say the same, that hyperinflation was at least highly unlikely in a credit economy. I recognize Bob as a goldbug, which is the source of such surprise.

My nagging doubt about the idea that massive inflation couldn't suddenly happen is that the dollar is based on the credit of the US government and the capacity of the Fed to act as intermediary. It appears to me that neither the government or the Fed seems too concerned with this duty to perform any of these functions.

My contention has always been that we would reach a point where the inability to take on more debt would set in and the system would suck cash into a black hole. The outside talks about the multiplier effect of reserves, while I think the factor is instead regulatory net worth. You can't change regulatory net worth by selling your treasuries and mortgages to the Fed. The system has to have an asset for a liability and this process changes nothing. The money has already been printed. The best this process can do is allow for transfer of cash between banks.

The problem the Marc Faber idea has is the world has to have something to shift to. China is pulling the worlds leg about a gold linked money, if for no other reason than the gold would immediately be demanded. Plus, the debt structure is already to the point that there isn't an interest rate that would allow for enough credit or enough gold to sustain the credit necessary to keep the world from deflating. If there is too much money, the governments can tax it away and few ever hesitate to do so. My best guess is the current situation is going to result in more bad debt and more deflation.

Matt Stiles said...

Without beating a dead horse (I don't think we'll see new, previously unthought of reasons for potential hyperinflation) it is my opinion that as an institution, government will attempt to do anything it has to in order to preserve justification for its existence. Hyperinflation is an endgame for whatever regime is in power - as is highly visible inflation of any sort. So I think that if the debt situation gets to the point where there are strong doubts of the ability to repay, selective default will be the most popular option among the electorate. All that is required, first, is a justification for targeting foreign creditors - which we know governments have never had much difficulty finding.

As far as a dollar collapse causing the hyperinflation, I've been pretty clear in stating that with the problems in Europe, nobody is going to be all that quick to rush into Euros, Yen or Pounds. See Mauldin's post yesterday for more on Europe:

Lastly, an anecdote: I was out washing my new truck (used, but new to me) while a neighbour approached to introduce himself. An old navy guy. He asked of my occupation and not 30 seconds thereafter, he was talking about how he heard on some radio show that the USD was about to collapse. He wanted to know how soon I though it would happen.

"What everybody knows isn't worth knowing." Best advice I've ever received.

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