The Paulson Plan: Triumph of Cynicism & Why it'll make things Worse

Democrats fear running against Republicans who will say they voted for the biggest corporate welfare package in history. Republications are afraid that doing nothing (or almost nothing) could lead to a bigger meltdown that anticipated, and they'll get blamed for that if a bail out ultimately does not go through.

So, the bail out plan will accomplish this: it'll contain enough perks and pork and favors that have nothing to do with the current "crisis" just to get enough votes to get it passed; it'll artificially keep the stock market up — for a while, and it'll be re-structured in such a way until each side feels that if things go south one way or the other, they can blame the guy across the aisle.

And things are almost certain to go south one way or the other.

John Samples explains the cynical political dynamics that will shape the ultimate bail out plan:

John Samples directs Cato's Center for Representative Government, which studies campaign finance regulation, delegation of legislative authority, term limits, and the political culture of limited government and the civic virtues necessary for liberty. He is an adjunct professor at Johns Hopkins University. Prior to joining Cato, Samples served eight years as director of Georgetown University Press, and before that, as vice president of the Twentieth Century Fund. He has published scholarly articles in Society, History of Political Thought, and Telos. Samples has also been featured in mainstream publications like USA Today, the New York Times, and the Los Angeles Times. He has appeared on NPR, Fox News Channel, and MSNBC. Samples received his Ph.D. in political science from Rutgers University.

Update: 10 . 03 . 2008

House Majority Leader Steny Hoyer noted, “there’s no doubt in my mind that the Senate added this [AMT provision] because they thought that’s the only way they could get it passed.”

Thus, despite the outpouring of public opposition to the bailout, Congress is determined to rig the vote and grab the people’s money anyway it can. The Senate is essentially saying to the public: “We won’t impose a $60 billion tax hike on you next year if you let us bailout Wall Street. And don’t worry about the $700 billion, we’ll just tack that on to the $5 trillion in public debt that your children and grandchildren already owe.”

There are too many insider experts and economists driving this debate, and too little recognition inside the Beltway about the basic injustice of a bailout. As many callers to the talk shows are saying, the government wants to take $700 billion from average hard-working families who followed the rules and give it to people who made bad, irresponsible, and even disastrous decisions. (Chris Edwards, Cato Institute, Cynical Senate Vote).

As for all the good it will do:

There is also a consensus among economists that the bailout bill is not the right policy. None of the above economists, for example, is enthusiastic about the bailout. My bet is that all of us think that the bailout has a substantial likelihood of failing. The support that exists is born out of hope and fear not judgment and experience. Nevertheless, the political consensus is that a bailout is what we will get whether it is likely to work or not. (Marginal Revolution, The Economic Consensus v. Politics).

For the fact is that the plan ... is a stinker - and inexcusably so. The financial system has been under severe stress for more than a year, and there should have been carefully thought-out contingency plans ready ... Obviously, there weren't: the Paulson plan was clearly drawn up in haste and confusion. And Treasury officials have yet to offer any clear explanation of how the plan is supposed to work, probably because they themselves have no idea what they're doing.

...at best, the plan will buy some time to seek a real solution.. (Economist View, Paul Krugman: Edge of the Abyss).

And finally,the mainstream financial media outlets have started to wake up to just how deeply flawed the bailout bill is — BreakingViews: Bailout Bill to Worsen, Prolong Recession:

Treasury secretary Hank Paulson’s plan uses money borrowed by the US government to buy value-impaired debt left over from the credit bubble. In a period of freely available credit, that might not matter. Good investments would get funded and, since additional money is available, some bad investments would, too. Diverting some money into unproductive uses should affect mainly those bad investments, with only modestly negative economic effects.

When money is tight, however, as it is likely to be for some time, withdrawing $700bn from the funding pool to support failed, past investments has a more serious effect on the economy, because capital flows are restricted by market illiquidity and investor trepidation. If that reduces asset prices, it exposes more loans to losses. If it prevents good investments by crowding them out of any chance of getting funding, it reduces economic activity. Either way, it makes the economy less efficient.

Herbert Hoover’s Reconstruction Finance Corporation of 1931-32, which made loans to politically connected companies, didn’t do much to alleviate the Great Depression. An equivalent amount of welfare handed out through the “Veterans’ Bonus”, which Hoover opposed, might have boosted consumption and stabilised the economy more quickly.

Japan’s 1990s infrastructure spending spree also diverted capital from more productive uses, helping to cause consumption to stagnate and the downturn to extend for 13 years. Paulson’s plan differs from both these examples in some ways, but is similar in that it may divert capital from its most productive uses. The danger is that the rescue plan could have similar consequences.