Hank Paulson doesn't seem to be reading this blog. Otherwise, he'd stop what he's doing and try something else. A table from the San Francisco Chronicle shows the bailout so-far. Of $8.5 trillion pledged, $3.2 trillion is committed. Remember that big chunks of that $3.2 trillion are loans, guarantees or other financing that will be paid back. Its not all money out the door. Still, $3.2 trillion is a really big amount of money. Really big. The site MegaPenny (mentioned earlier today on this blog) says that you would need 2.6 trillion pennies to make a life-sized replica of the Sears Tower. US GDP is around $14 trillion, so the US Government has already put up the equivalent of 25% of GDP to fight the crisis. But its not working. Bank lending remains tight. International shipping prices have plunged 90% in the last 3 months. The near collapse of Citi Group last week was primarily due to a new understanding that the rotten US Consumer debt extends far beyond the sub-prime mortgage market.
The problem with Paulson's solutions is that they do not come to grips with the underlying crisis. He's trying to put Humpty Dumpty back together. But the system is fundamentally broken and can't be put back together. At its simplest level, the crisis is due to US Consumer debt. Real wages in the US have moved little since the early 1990's. Most of the growth in per-capita spending was due not to increased incomes, but increased debt. New ways of packaging consumer debt created new investors for that debt, and new ways for consumers to finance their debt. All of this is OK as long as 1) the consumers don't take on too much debt and 2) the assets they buy with that debt don't go down in value. As long as the packaged debts represent normal consumer behavior, everything should work out properly. Consumers get cheaper debt, banks can lend without holding the debt on their balance sheets, and investors get a very low risk investment vehicle. In other words, as long as the systems works the way its supposed to, the system will work the way its supposed to.
As we are all now aware, however, the system did not work the way it was supposed to. Rather than take existing debt and re-package it, banks found collateralization so lucrative, that they set out to create new debt. People figured out quickly that they could get any amount of money they wanted against their house. They re-mortgaged as their houses went up in value and spent the proceeds. That is how Americans increased their standard of living through debt. But for the system to work, it has to be driven by economic activity, not create economic activity. At this point, the US Government is facing two intertwined problems. First is that economic growth has come to rely on increasing levels of consumer debt. Second is that collaterallization has become the main way consumer debt is financed in the US. Its a grand game of musical chairs. As long as the music continued, and the supply of chairs kept increasing, nobody worried. But now the music has stopped and some of the chairs have turned out to be paper mache.
The success of securitization of consumer debt has pushed all other kinds of debt management out of business. Now that securitization has failed, the US no longer has alternative ways of financing its huge debt. That is the real reason markets have frozen. Not because banks don't trust each other, government guarantees have taken care of that. But because the way banks finance debt no longer works. Nobody trusts collateralized consumer debt. That's why GM can't get money to lend people who want to buy its cars. The entire system of collateralized debt has to be unwound and re-created using either the old tools or new ones not yet invented. In the meantime, all that crappy debt sits there rotting on bank balance sheets, threatening their very existence.
Hank Paulson's problem is that US growth cannot continue to be financed by increasing consumer debt. His other problem is that the entire system of creating consumer debt (the good as well as the bad) has broken down. Pension funds in Toulouse no longer want securitized US mortgages. So even if GM invents a perfect electric car for $10,000 and everyone wants it, there's no way to lend them the money. GM can't do it because it can't sell the debt. The banks can't do it because they need to lower their lending due to the crappy assets on their balance sheets. Paulson can try to prop up the collateralization industry as much as he wants, but in a crisis caused by too much debt, more debt is not the answer. Another game of musical chairs won't solve the problem.
