Churchill’s Dictum

Another contribution from my former Princeton colleague, Uwe Reinhardt, now Professor of Political Economy, Economics and Public Affairs at the Woodrow Wilson School and the Department of Economics of Princeton University.  Enjoy!


            “In the long run, Americans will always do the right thing-after exploring all other alternatives,” Winston Churchill famously said during Word War II, as Americans still were debating whether or not to enter the European war theater.

One is reminded of Churchill’s dictum on observing a hyperkinetic Treasury Secretary Henry Paulson, in a managerial style that makes former Secretary Defense Secretary Rumsfeld look good by comparison, flail about frantically in search for an effective response to our financial crisis.

Paulson began this fumbling search with a counterproductive, three-page legislative bailout proposal roughly akin in tone and thrust to a teenager’s request to borrow his parent’s car for the evening, with the parent’s promise not to remark on any new dent the teenager might put into the car.  By the time Congress had taught former Goldman Sachs CEO Paulson that the Treasury is not quite like a banker’s executive suite –where CEOs reign supreme and apparently can behave like brash and reckless teenagers — the stock market had become so spooked by the Secretary’s brashly but poorly developed proposal that eventual passage of the bailout legislation was greeted by the market with a succession of sharp drops in stock prices. So much for the market’s trust in the sagacity of the nation’s chief financial officer.

Paulson’s newest new thing has been to cram $125 billion of new “equity” capital down the throats even of banks that neither need nor desire such a bailout, with the preamble that “Government owning any stake in business is objectionable to many Americans, me included.” In truth, of course, this plan is not really given taxpayer’s an effective equity stake in the rescued banks at all. It’s just more of Paulson’s tomfoolery.

Under this latest bailout installment, the taxpayer would guarantee bank deposits without limit, guarantee all new debt issued by the banks, and inject billions of federal dollars into the networth section of the banks’ balance sheets – all in return for a completely passive “ownership” stake consisting of non-voting preferred shares that pay a dividend rate about half as large as that offered to private investors-e.g., Warren Buffet. Furthermore, instead of making these preferred shares convertible into the banks’ common stock at a fair conversion ratio that might reward taxpayers for the risk they take on, the shares actually are callable by the banks after three years, at the banks’ option, without even the call premiums traditionally imposed on convertible debentures. On top of that, the Secretary still wants to use hundreds of billions of taxpayer dollars to relieve mismanaged banks of their dodgiest assets, undoubtedly at prices highly favorable to the banks and commensurately risky to the taxpayer. It instills no great confidence that this daunting operation is to be managed by a 35-year old former Goldman-Sachs employee with only six years of experience in finance. Finally, any restrictions on the compensation of bailed out bank executives are apt to be cosmetic and can most likely be evaded. Paulson, former recipient of such largesse, apparently abhors such restrictions as well.

One must wonder whether American taxpayers will grasp the irony of it all. While Paulson loathes the idea of giving U.S. taxpayers a genuine, voting equity stake in the banks taxpayers are forced to bail out – and possibly a seat or two at the board table chosen on behalf of taxpayers from among Main Street chief financial officers who actually understand corporation finance and concepts such as “leverage” – Paulson sees nothing wrong with extending such voting privileges to foreign investors, including the sovereign wealth funds of Middle Eastern potentates or of Communist China. For example, Paulson most likely was cheered by news that Mitsubishi UFJ, Japan’s largest megabank, will receive a genuine equity stake of up to 20 per cent in Morgan Stanley for a cash injection of about $9 billion. On the other hand, for an injection into Morgan Stanley of $10 billion of their funds, U.S. taxpayers will receive merely non-voting, callable, preferred stock, which effectively tells U.S. taxpayers to sit at a separate table and to shut up, like good little children.

What prompts the Secretary of the Treasury to treat American taxpayers so contemptuously, as second-class stakeholders? Why is it so much more abhorrent to him to have designated representatives of U.S. taxpayers sit at a bailed out bank’s board table than granting that privilege to, say, a Middle Eastern sheik or a Japanese banker? Secretary Paulson is reported to fear that letting American taxpayers own voting common stock in the bailed out banks they are forced to bail out would dilute the stock value of existing or future private shareholders. Does he realize that the existing shareholders’ equity stake will be diluted also by any sale of new common stock to private domestic or foreign investors at current fire-sale stock prices?

If, after this deal, anyone still believes that our hyperkinetic Secretary of the Treasury works tirelessly for the American taxpayer, rather than for his former colleagues on Wall Street who helped push the nation to the current economic precipice, I would offer that true believer some choice ocean-front property in Iowa. As John Kanas, CEO of North Fork Bancorp was quoted on the bailout in The Wall Street Journal (October 15, 2008: A16): “It looks like a pretty good deal for the recipients and probably a pretty tough deal for taxpayers. It seems quite explicit that there’s no strings attached to this money. It seems like a gift.”

The hard-working and now hard-pressed American taxpayer deserves better than that. In my view, that taxpayer deserves Paulson’s early retirement and replacement – at least for some time — by a much wiser person Americans can trust: former Federal Reserve Chairman Paul Volcker. If asked, he just might do America this one more patriotic service in a long life of wise and faithful service.


Uwe Reinhardt’s e-mail address is:

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website