Use access key #2 to skip to page content.

JakilaTheHun (99.92)

ROI, the Paulson Plan, and the Rise of Neo-Mercantilism



September 24, 2008 – Comments (0)

As our government continues to recklessly spend its way into an increasingly larger debt, it's about time that American society embraces a different disposition towards government. For years, we've all heard "pro-government" versus "anti-government" arguments but this strikes me as nothing more than an exercise in ideological hogwash. Government is absolutely necessary in certain areas and not needed in others; it's difficult to dispute this. Moreover governments are a lot like corporations --- sometimes they are run well and sometimes not-so-much. Hence, "more government" or "less government" is not the correct question; rather, the following questions should be asked in regards to any policy proposal:

Can the government provide a service more efficiently than the private sector? If the government can provide something more efficiently, does the government plan being proposed achieve that objective? Does the government plan achieve the greatest societal return on investment [ROI]?

It's a mystery to me as to why the concept of ROI is constantly evoked in the business world, yet almost never used when evaluating government policies. If the government can complete a task more efficiently than the private sector, then by all means it should do so. If it cannot, it should keep away.

Unfortunately, our government has a rather dismal record of providing things in a cost-effective manner. In fact, I'd argue that the one of the biggest problems with the American government is not that we pay "high" taxes --- rather it's that we pay high taxes and receive very little in return when compared to other nations with similar taxes. In essence, we get a very poor return on our investment.

The Paulson Plan

All this brings me to the Paulson bailout plan. Make no mistake about it --- this could potentially be the most radical change to American economic policy in the past few decades. Certainly PNTR and NAFTA have changed American society to a great extent, but neither seemed to change the mechanisms of American capitalism quite like this bailout plan might.

There has been a scary trend going on in government for quite awhile. It only occasionally makes the front pages, but it's there all the same. Various American governments have increasingly been taking the risk away from the private sector without gaining any of the rewards. The most notable parallel is the stadium construction proposals that various cities, states, and localities have given out --- the major complaint about these proposals is that the private sector profits while the taxpayer receives the bill. In essence, it is a shifting of wealth from the taxpayers (who come from lower, middle, and upper income classes) to individuals that are already wealthy. Or to put it in another way, it does not provide much of an ROI to taxpayers.

The Paulson bailout plan is a stadium construction plan on a grand scale --- the only difference is, the taxpayers don't even get a football team out of it. Instead, we are being asked to subsidize the losses of major financial institutions without receiving any of the benefits. To their credit, a majority Democratic Congress has at least tried to pressure the Administrator into a modified package that would give the taxpayers (via the U.S. Government) an equity interest in these financial institutions in exchange for the bad assets. However, even at that, this policy does signal a frightening acceptance of a doctrine of shifting risks to the taxpayers while most of the rewards remain in the private sector. To go back to our theme of government and ROI, I am not seeing how this plan creates the highest ROI for the taxpayers.

So What's the Rush?

Congress is being pressured by the Administration to rush through the proposal. Apparently, it's imperative to pass legislation that could have far-reaching ramifications on the American economy system for decades to come in a few days time.

Haven't we seen this before? It has become a pattern that this Administration uses any and every crisis as an excuse for usurpation of power from the Legislative Branch. Yet, Congress keeps biting. It was irritating when a Republican Congress passively accepted Executive attempts to seize power from it (presumably on the basis of party loyalty), but it's going to be even more infuriating if a Democratic Congress allows the Administration to do the same thing to it. All the same, it wouldn't surprise me if that is exactly the way it goes.

Will It Even Work?

While I've already mentioned some of the negative socio-economic ramifications of this proposal, it's worth asking if this will even work? Are we going to spend $700 Billion of taxpayer money on a plan that has maybe a 50-50 chance of achieving its short-term objective? Let's not even focus on the long-term questions yet (which are numerous!) Senator Richard Shelby (R-AL) has echoed these concerns stating:

In my judgment, it would be foolish to waste massive sums of taxpayer funds testing an idea that has been hastily crafted and may actually cause the government to revert to an inadequate strategy of ad hoc bailouts.

Reading over various articles, it's very clear that this wide-reaching proposal that has the capacity to change the functioning of the American economic system for many decades to come is nothing more than a skeletal draft. We don't know if this proposal only deals with "mortgage-related assets" or any "troubled assets." Little thought has been given to the scope and there appears to be virtually no oversight. This proposal sounds a lot like trying to bake a cake by randomly grabbing the first ingredients you can find in the cabinet. And if your idea of a great cake involves vanilla icing, cayenne pepper, and horse radish sauce, maybe this plan seems like a great idea.

Long-Term Ramifications

In the short-term, the plan might work or it might not work. But even given a best-case scenario, what are the long-term ramifications? For starters, the plan will create even more inflationary pressures. That's a frightening thought given that Former Federal Reserve Chair Paul Volcker already believes the actual inflationary rate to be around 11% at the present time. Could the U.S. experience 20%+ inflation in the near future? It doesn't seem all that far-fetched. Better horde up on precious metals!

Then there's that whole "housing bubble" thing. You see --- for some reason, Federal policymakers have convinced themselves that the problem is not ineffective market mechanisms that allow prices to become extremely out-of-whack with underlying valuations. Rather, we've heard from many policymakers that the real problem is that housing prices have gone down. Hence, the solution is to drive them back up. Yet, isn't this essentially the same boneheaded wisdom behind rent controls? Just because the government forces prices upwards does not mean, what we'll call the "market reality" for a lack of a better term, will necessarily follow.

Until the recent bursting of the bubble, it was no stretch to suggest that housing prices had gotten insane. Lower and middle income earners had an extremely difficult time affording housing in that environment. In a sense, the bursting of the housing bubble was the greatest thing to happen for a lot of people who couldn't afford things at the overpriced rates things were going for. The only reason prices skyrocketed upwards was because reckless lending practices were increasing demand to absurd levels.

With the bailout proposal, the Feds are sending the message to the lending institutions to start handing out loans without much of a care again. So in essence, if I read the Feds correctly, the problem wasn't the nature of a system that encouraged reckless lending practices, drove housing prices sky-high, and created a bubble that was bound to burst. Rather, the problem was that the Feds did not come up with policies that allowed the bubble to stay artificially inflated for all of eternity.

So here we are with a bailout proposal that attempts to reinflate the bubble. Another 3, 5, 10 years down the road, the thing merely bursts again and it's even worse than it was this go around because we have a government that refuses to address underlying issues, only thinks in short-term, and is more concerned about symbolic reform that makes the national airwaves rather than fixing real problems in our society.

The Rise of Neo-Mercantalism

To be sure, the short-sighted economic policies of our government have put us in a lose-lose situation and, at this point in time, all that is left is to find the least-worst solution. Yet, the Paulson plan seems far, far from that. Rather, it affirms a dangerous trend of redistributing wealth via taxpayer monies to a class of people that are already wealthy. It's yet another step towards destroying the American middle class. And without the American middle class, the American economy suddenly becomes only a fragment of what we have become accustomed to in the not-so-distant past.

What's even worse that the plan completely undermines basic market mechanisms like risk-reward. This isn't a simple tweak to the system like Paulson suggests --- rather, this is a shift towards an alternate system. Some have called it "socialism" --- a strange misnomer since socialism involves the working class taking power and essentially redistributing wealth to the lower and middle classes. This isn't socialism at all, but history does reveal a somewhat similar system we used in the past.

Remember mercantilism? It was an early form of capitalism where the government and certain business interests acted in concert. Government established monopolies and hindered real competition with policies that favored certain interests over others. It was this exact system that Adam Smith criticized in The Wealth of Nations for the extreme inefficiencies that resulted. Yet, we appear to officially be entering an age of neo-mercantalism here in America.

The Alternatives

If we are indeed in a lose-lose situation, what are we to do? There seems to be few good options. We could keep government out of this, let the institutions that fail go ahead and do so and ride this out. One way or another, we are going to have to suffer the consequences. It might take a few years to see the light, but contrary to what some suggest, I believe we will emerge eventually.

Another plan I am intrigued by is one mentioned by Seeking Alpha blogger Jason Lindt. His plan calls for a Reconstruction Finance Corporation that invests in preferred stock of financial institutions, which would increase their capital cushions and potentially allow them to ride this thing out. While this still gets into the sphere of government investing in companies, it is an infinitively less intrusive plan than Paulson's, it would probably cost much less, and it makes a whole lot more sense. Though, I worry more about the second part of his plan since it would seem to reinflate housing prices to some extent.

Regardless, if the government is going to create a plan, it needs a much more cost-efficient and well thought out plan than Paulson's. We can't simply rush forward a plan that radically changes the American economic system while giving little thought to the ramifications.


The Paulson proposal increases our Federal debt substantially without guaranteeing any real return. The question we all us taxpayers should be asking is whether or not we will see a good return on our investment. If we adopt Paulson's original version, the answer is undoubtedly no! The Democratic proposal is a bit iffier since the taxpayers would at least own an equity interest in these companies. However, even that modified plan seems too expensive and way too intrusive. We should consider alternative plans that are not quite as intrusive to market mechanisms such as the Lindt plan.

The Paulson plan also seems to signal a dangerous shift away from liberal market mechanisms into an age of neo-mercantilism. This should concern both American conservatives (destruction of Smith's Liberalism) and American liberals (since the system naturally favors certainly wealthy interests at the expense of largely lower and middle income taxpayers). While it's unlikely we'll all line up around the country while holding hands and decide to agree everything, certainly we should agree that a government that takes our taxpayer monies and distributes it out to already-wealthy individuals who have shown a reckless disregard for managing that money in the past does not provide us with much of an efficient return on our own investment.

0 Comments – Post Your Own

Featured Broker Partners