Paulson comes up short on bailout explanation

November 12, 3:01 PMEconomic Policy ExaminerJoseph Hight

Previous Next

Comment Print Email RSS Subscribe

Subscribe

Get alerts when there is a new article from the Economic Policy Examiner. Read Examiner.com's terms of use.

Email Address   Include other special offers from Examiner.com Terms of Use

So what is a bank and what is a non-bank financial? And what is an investment program and what is a spending program? And why is Treasury Secretary Paulson so keen on making such distinctions?

Secretary Paulson - Treasury Department photo 

The Treasury Secretary repeatedly and painstakingly tried to make such distinctions in his November 12 news conference at the Treasury Department.  According to Paulson, the government purchase of shares in the nation’s top banks is an investment, as is the $172 billion in loans to insurance giant AIG.  But using some of the bail out rescue money to readjust mortgage terms and payments is spending and not investment, especially if it were to lead to the lowering of the principal on mortgages for strapped homeowners facing foreclosure on homes worth less than what they owe.  The latter is a spending program, involving a government subsidy, and, under his interpretation of the rescue legislation, not authorized.  And neither is a loan to auto manufactures such as General Motors.  Not an investment, he says.

This is a distinction that may be too nice.  The chances are very large that the government will never get back the full $172 billion AIG loan with interest that justifies the risk of the initial investment; otherwise private investors would have been eager to make the loan.  And chances are pretty good that government equity investments in the banks will not provide returns that justify the risks.  Again, if it were otherwise, private capital would have found its way to the banks.  Making a government investment in an asset that is highly likely to pay too low a return for the risk involved is a subsidy, and that is spending in my book.

So why is Paulson trying to make such a distinction between bailing out the banks and bailing out General Motors or individual home owners– one being spending, the other being an investment?  For the simple reason that the Administration is opposed to direct government bail outs for non-financial firms and individual home owners.  Now there may be good reason for this position, but it has nothing to do with whether bailing out banks is an investment and bailing out General Motors or individual home owners is spending.  Both are government spending.  It’s just that the Administration is for one kind of spending but not the other, probably because it thinks one kind of spending is wise, while the other is not.  But that is a judgment call.

Similarly, Paulson wants to make a clear distinction that the government bail out rescue is for the financial industry, and not for other industries.  His interpretation is that the rescue package is to be limited to “investments” in financial institutions, and not only to banks.  Banks take checking account deposits, and one of their most important functions is to provide loans to businesses, often depositing the loan proceeds directly to the borrowers’ bank checking accounts.  But banks do many other things as well.  They buy and sell financial assets, including mortgage backed securities and their derivatives – the things that got us into this mess.  And they buy and sell securities backed by consumer debt – auto loans and credit card debt.

But financial institutions that are not banks also buy and sell securities, thus providing funds to commerce.  That is how the loan to insurance giant AIG has been justified.  And Paulson wants to provide relief to other financial institutions by buying equity positions in them like he has done for the banks.  But so far the bail out money under the capital rescue plan has been limited to investing capital in banks and not in non-bank financial institutions. 

In fact, American Express – a credit card company - has recently been reclassified by the Federal Reserve as a bank holding company and therefore eligible for  the same kind of bail out money that has so far been limited to banks.

But now Paulson wants to be able to help financial institutions that are not banks directly – so they would not have to be reclassified as banks before receiving aid. In his press conference remarks Paulson said, “Non-bank financial institutions provide credit that is essential to U.S. businesses and consumers.”  So he will consider capital needs of non-bank financial institutions not eligible for the current Capital Purchase Program.

Look for the government to begin buying shares in credit card companies.

Can General Motors be reclassified as a bank?  After all it does have a financial services division.  Could we then call assistance to General Motors an investment as opposed to spending?