Cosy Deals That Will Not Save The World

Almost nine years ago, at the height of the last great global financial panic, Time magazine interrupted its regular cover-story diet of TV Shows You Can’t Miss and Foods That Will Help You Live To A Hundred and ran a front page that proclaimed boldly “The Committee to Save the World”.

Beaming at readers from the glossy newsweekly’s cover were three toilers in the normally sheltered fields of financial policy now suddenly enjoying their moment in the solar glare of popular attention.

Robert Rubin, then Treasury Secretary in President Clinton’s Administration, Larry Summers, his deputy and later successor at Treasury, and Alan Greenspan, the Chairman of the Federal Reserve, were, we were told, the men who stood between us and global financial collapse.

In Time’s inimitable, breathless prose, it was explained how, by assembling a succession of IMF bailouts, cutting US interest rates and holding the hands of agitated investors and policymakers, these three amigos were steadily restoring stability to a troubled world.

Somebody must have found a copy of that issue of Time in the US Treasury recently because Hank Paulson, the present Treasury Secretary, seems to be on his own Mission To Save The Planet. With markets still nervous about the state of the US sub-prime mortgage market and its impact on the global economy, Mr Paulson is assembling a similar committee armed with clever measures designed to avert a financial disaster.

Of course, in the case of Mr Paulson, one of the original big movers on Wall Street, the committee consists of only one member - Hank himself, the former Goldman Sachs chief and Master of The Universe.

In the past week he has been putting together a plan for major banks to establish a $100 billion (£49 billion) fund to provide liquidity to those of their brethren caught off-guard by the market’s reluctance to trade in certain types of asset-backed securities.

The superconduit, as it is called, will provide help for banks with structured investment vehicles (SIVs), the off-balance sheet funds that took large bets on risky assets in the past few years and now face taking a very wet bath in the coming months as prices for some of the paper they hold fall sharply.

On the face of it, the plan looks suspiciously like a government-orchestrated (but not government-funded – banks will contribute funds) bailout for Citigroup, which has some of the largest and most troubled SIVs. As it happens, Citigroup is now the home of founder Committee To Save The World member Mr Rubin, Mr Paulson’s old partner at Goldman.

Although the Treasury insists the plan is necessary to avoid systemic financial problems that could result from the weakness in asset-backed securities markets, it reeks of favourable treatment for banks. There’s an important distinction between what the Federal Reserve has done in response to the current financial difficulties and what the Treasury seems to be up to. Unlike the Fed cutting interest rates, a necessary measure, broad in scope, that is aimed at protecting the economy but has the unfortunate side-effect of helping financial institutions that might not deserve it, this one fails the moral hazard test. It looks like a continuing and open-ended commitment to insulate certain financial institutions from the unpleasant and impoverishing consequences of some breathtakingly risky moves. Why should banks that made irresponsible decisions in the boom years get government-orchestrated assistance from shareholders of other banks?

It enhances the growing suspicion that Mr Paulson is a bit too close to his old friends on Wall Street.

As I understand from senior administration officials, it is not the only bailout that Mr Paulson is promoting. In internal Bush Administration tussles, the Treasury Secretary has been expressing extreme concern about the state of the US housing market, especially the more than $600 billion in adjustable-rate mortgage debt that is about to reset at much higher interest rates. Mr Paulson, from what I hear, has suggested making funds available to mortgage lenders so that they can restructure those loans. Helping homeowners in distress is surely wise, politically if not economically. But must the money men who helped them into their distress also be rescued?

Mr Paulson’s great strength, when he came to Washington a year and a half ago, was that, unlike his predecessors in the Bush Administration, he had experience on Wall Street. His contacts there mean that he has surely handled the stressful events of the past few months with a deep understanding of the issues confronting American bankers in their hour of need. But there is a point where that understanding can tip over into an unhealthily cosy relationship.

It will do the world - and its financial markets - no good in the long term if the Bush Administration’s financial policymaking apparatus becomes The Committee to Save Wall Street.

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