Does the Bailout Pass the Smell Test?

Editor's Note: The following article was contributed by Paul Craig Roberts and may not reflect the views or opinions of EconomyInCrisis.org. Feedback is welcome.

The explanation that has been given for the financial crisis does not match up with the solution that has been devised. Moreover, the windows into the crisis offered by the authorities are opaque rather than transparent.

The only clarity we have is that the crisis is resulting in financial concentration and that the bailout constitutes a massive raid by financial crooks on both taxpayers and central bank reserves in the U.S. and Europe.

The public monies that are being directed to private financial institutions are huge. According to news reports, Germany is devoting $540 billion to shoring up German banks, England is devoting $73 billion, and France has pledged over $400 billion. The U.S. now has four separate bailouts underway, $800 billion for banks, $200 billion for Fannie Mae and Freddie Mac, $85 billion for the insurer AIG, and $25 billion for the U.S. auto industry. These figures add to more than $2.1 trillion.

Some of these public monies are for purchasing troubled paper assets. Others are to be directly injected into the banks as public supplied capital for private financial institutions, an ironic outcome for the free market ideology that resulted in the deregulation of the U.S. financial system. According to news reports, in England the entire $73 billion is being poured into banks as publicly supplied new capital. In Germany $135 billion is for recapitalizing troubled banks. In the U.S., Treasury Secretary Paulson is talking about using bailout money to purchase non-voting bank shares.

How is it possible that a financial crisis of such magnitude hit with such suddenness and urgency, is catching finance ministries and central banks unaware?

If the problem is what the public has been told, namely that defaulting subprime mortgages are reducing the income flows through to the holders of the mortgage backed securities, why isn't the bailout money being used to refinance the defaulting mortgages and to pay off the foreclosed mortgages? That would restore the value of the mortgage backed securities, and it would not be necessary to pour huge amounts of taxpayers' money into recapitalizing banks and purchasing their bad assets.

There is not an unmanageable number of defaulting mortgages. According to the U.S. Treasury estimate, 90-93 percent of the mortgages are good. How does a 7 percent or 10 percent default rate on U.S. mortgages translate into a systemic worldwide financial crisis?

The popping of the U.S. real estate bubble could not produce a worldwide systemic financial crisis without the mark-to-market rule, short-sellers and a great deal of hype and orchestration. Why did Secretary Paulson let Lehman Brothers fail when every other firm is bailed out? Did Lehman's failure, by unwinding its own large portfolio, push hedge funds and banks into panic sell-offs that spread the crisis at home and abroad?

It is unclear how the bailout will play out. The monies for the U.S. bailout will have to be borrowed abroad or printed. If foreign central banks need their dollar reserves in order to bail out their own banks that are polluted with toxic U.S. financial instruments, the U.S. Treasury might not have an easy time in the debt market. Moreover, the interest expense on an additional borrowed $700 billion will raise the U.S. current account deficit and burden U.S. taxpayers with higher interest payments. If the money has to be printed, inflation and dollar devaluation will depress living standards for most Americans.

If the U.S. economy sinks deeper into recession, lost jobs and rising interest rates on troubled mortgages will result in more defaults and foreclosures, thus further impairing mortgage backed securities and requiring Congress to put more burdens on hard-pressed U.S. taxpayers on behalf of the banks.

The authorities have blamed subprime mortgages for the crisis. Why then does their solution fail to address the problem of the mortgages? Instead, the solution directs public money into an increasingly concentrated private financial sector, the management of which is not only vastly overpaid, but also has escaped accountability for the financial chicanery that, allegedly, threatens a systemic financial meltdown unless bailed out by the taxpayers.

Perhaps my nose is too sensitive, but this bailout doesn't pass the smell test.

Authors Bio: Paul Craig Roberts, a former Assistant Secretary of the US Treasury and former associate editor of the Wall Street Journal, has held numerous academic appointments. He has been reporting shocking cases of prosecutorial abuse for two decades. A new edition of his book, The Tyranny of Good Intentions, co-authored with Lawrence Stratton, a documented account of how Americans lost the protection of law, was published by Random House in March, 2008.

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