Former Clinton labour Secretary is hardly one of our favourite economists. But in a recent post on his personal blog, he practically sounds like he’s channeling Milton Friedman partner Anna Schwartz. Recapitalizing banks won’t work to get credit flowing, he says, because banks are insolvent and will just hoard the money.
Paulson is recapitalizing the banks — giving them money directly rather than relying on reverse auctions — largely because he’s come to understand that the banks have taken on so much debt that the reverse auction system he told Congress he would use(designed to place a market value on these fancy-dance instruments) will leave too many banks insolvent.
But pouring money into these banks, expecting they’ll turn around and lend to small businesses and Main Streets, is like pouring water into a dry sponge. Nothing will come out of it because Wall Street is so deep in debt that the banks are using the extra money to improve their balance sheets. They’re hoarding it because their true balance sheets — considering the off-balance sheet vehicles they created over the past several years — are in such rotten shape.
In other words, taxpayers are financing a massive effort to save Wall Street’s balance sheets from Wall Street’s previous off-balance-sheet excesses. It won’t work. It can’t work. The entire effort is merely saving the asses of lots of executives and traders who got us into this mess in the first place, and whose asses should not be saved at taxpayer risk and expense.