I'm surprised that more people haven't come to this conclusion, but I do feel validated when a professor at Columbia agrees with me. Paulson is either a genius or a fool, and I'm really not sure which one scares me more. Here are the salient points: until there can be some value attached to these "assets" this deleveraging will not stop, that a solution is best done by helping struggling homeowners, that politics as usual is interfering with the solution. By the way, I'm not the only one saying these things, but nobody in power is listening. Here's some highlights of the interview:
The Paulson Plan: 'Truly Idiotic'
Deal Journal: What the heck is going on out there? The Citigroup bailout isn’t a good sign of confidence in the overall financial system, is it?
Charles Calomiris: The key thing we’ve learned during the downward spiral of confidence is that you have to deal with the problem in the mortgage market directly. There are probably 18 million subprime and Alt-A mortgages out of 57 million total. Probably half will end up in foreclosure.
In the middle of a financial crisis, we’re using half measures designed in an inappropriate way, and we don’t accompany them with other measures. This has just been a completely mismanaged policy response.
DJ: There’s this perception that we can “fix” the price of individual mortgages. But shouldn’t the price of homes find its natural equilibrium?
CC: The market price is not decreed by God. The market price is an outcome of a variety of things. Recapitalizing the banks is helpful for giving them breathing room, and for providing credit in the meantime. But it doesn’t resolve the problem.
The problem is the completely opaque distribution of losses because no one knows how to value these mortgage losses. The way to solve the problem is from the bottom up.
DJ: What about creating government incentives for the formation of new banks?
CC: Recapitalizing the banks is a good idea in principle. Starting new banks is a good idea. It’s all fine, but we have to come to grips that unlike any financial crises – and I’m an expert on them – this one is a complete outlier. In other crises, the uncertainty on the total of the losses was resolved in a matter of months. We’ve been trying to resolve mortgages and CDO tranches for a year and a half. It’s not going well.
DJ: Why isn’t anyone listening to these ideas?
CC: The point is that they have made huge errors in the design of their assistance plan and they were forecastable errors.
For instance, Paulson doesn’t want there to be a stigma [around capital injections.] Does he really believe that by getting J.P. Morgan to participate, he creates the perception that JPM and Citi are the same?
Does he really believe that injecting preferred stock into banks is socialism but buying assets at above market price isn’t? Does he really believe that?
There actually is a stock of knowledge about this. The scandal is that when Congress has been considering this, not one independent economist has been allowed to testify. Do you know why they weren’t? Paulson and Bernanke didn’t want anyone causing problems.
DJ: Wait, that sounds like a conspiracy.
CC: Democrats didn’t want anyone [economists] testifying because it was before an election and no one was willing to stand before that bulldozer known as Paulson. No one wanted to make tough political decision before the election. They didn’t empower any experts to come in and testify. Why is that? They were playing politics, too. That’s what we’re dealing with–a complete leadership failure in Congress and the administration.
Don’t underestimate the role of politics in the decision not to fix things.