Just Keep Digging

The New York Times has obtained a copy of the proposal of the Treasury Department’s bailout plan. I am not a lawyer nor am I an economist, but this strikes me as both unprecedented and chock a-block of moral hazard.

Section 2(a), for example, allows the Treasury Secretary to purchase mortgage-related assets from any financial institution. In other words, Treasury will now have the power to act as Lehman Brothers, Countrywide, Fannie Mae, and many other fallen companies. It will buy mortgages that companies want off their books for risk and chargeoff reasons. This will enable banks to avoid the consequences of their actions as well as saddle the Treasury with the absolute worst assets possible. How could that come back to bite us?

Section 2(b)(2) sets aside section 3109 of Title 5. By my reading of that section, this means that Paulson can hire consultants at whatever rate for whatever purpose without any oversight by the normal federal channels. He was previously chairman and CEO of Goldman Sachs: I wonder if he’s got some cronies that need some easy money from an advising gig.

Section 2(b)(3) allows Paulson to designate financial institutions as “financial agents” of the federal government and perform whatever duties that might entail. It seemed vague until I started looking around for what a “financial agent” does. The covering part of the code suggests that it just means that they can accept public money or public bonds. The Code of Federal Regulations goes into more detail, naturally, and I think I can see why this seemingly unimportant section was added to the proposal. The regulation expands on what the code means by “national banking association” and lists credit unions, commercial banks, and other financial instutions that are backed by governmental deposit insurance.

The proposal generalizes these specific references to just “financial institution” and I think this means that investment banks will be able to act in this regard. I am not an expert on this but I am fairly well-versed on how the Federal Reserve System operates—this might enable investment banks to participate in that System such that federal bonds created out of thin air could be routed through them. In other words, the Federal Reserve could “extend credit” (read: print money) to investment banks at the federal funds rate.

Section 4 says that Paulson will let Congress know what he’s done in three months and then every six months after that. Section 8 further limits the oversight by making Paulson’s actions “committed to agency discretion.” Knowing that every word in this proposal has specific legal meanings, I discovered that “committed to agency discretion” basically takes the Supreme Court out of the equation. If Congress passes this proposal as law, it will have written off our precious system of checks and balances—all in the name of “doing something.” Again, I can’t see how this could possibly backfire.

Section 5(b) gives Paulson the right to manage the mortgage-related assets, which seems like a given, but expands it to include the revenues from those assets. (There could be something insidious about managing portfolio risks, but I’m not familiar enough with that side of the equation to speculate.) So Treasury gets to control the proceeds of these mortgages: if they can be rehabilitated, they could provide quite a funding source that’s outside the province of the House of Representatives. That’s a little conspiracy theorist, to be sure, but the words are there and they mean something.

Section 5(c) authorizes Paulson to sell the assets at whatever price and terms he decides. He can also do some other financial transactions with which I am unfamiliar. I can envision a day when things settle down and Paulson just repatriates the assets. Or makes a killing and secures a nest egg for the Executive to use at its discretion.

Section 5(d) indicates that though this authority will only last for two years—two years!!—on new assets, it will continue on existing assets for as long as they’re held. Actually, it doesn’t even have to be an existing asset so long as Paulson commits to buying the assets prior to the authority’s expiration. This is about as “in for the long haul” as government gets.

Section 6 puts taxpayers on the hook for up to $700 billion. But it’s not just a total of $700 billion, but $700 billion at any one time. So the amount actually spent could greatly exceed that depending on portfolio churn and decreasing valuation of those assets. Aside from the incredible size of the outlay, this amounts to a blank check on the taxpayers.

Section 10 raises the debt ceiling of the federal government to $11.315 trillion from $8.184 trillion—an increase of $3.131 trillion. Looking at 31 USC 3101, it’s hard to believe that the debt ceiling was $2.8 trillion back in 1989 or $5.95 trillion as late as 2002. The amount of this increase is unprecedented and one wonders if $700 billion represents just the direct outlay. This $3.131 trillion expansion might represent the true costs of the bailout, hidden from general revenue through bond issuance.

Finally, section 11 asserts that this proposal conforms to the Federal Credit Reform Act of 1990, which enables Paulson et al. to not have to adhere to its strictures and prove that it conforms. I wasn’t at all familiar with the FCRA, but its purpose is to “provide a more realistic picture of the cost of U.S. government direct loans and loan guarantees.” From what I can gather, the FCRA eliminated the cash accounting reporting of loans and loan guarantees in favor of a more accurate, long-term view of the funding. By asserting compliance, they may be able to circumvent this requirement and present a rosier picture of their activities.

In short, this proposal grants the Treasury Secretary far-reaching and unaccountable powers. It sets up extensive moral hazards for both public servants and private financial institutions and opens up an unlimited line of credit on the American economy. Most importantly, it is an overreach of the proper function of our constitutionally-limited government. The government has no business being so entwined with business: it is time for “a separation of state and economics, in the same way and for the same reasons as the separation of state and church.”

[UPDATE: There is now a lot more analysis of the proposal that suggests I’m reading things correctly.]

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