Hank Paulson

There is so much fear wrapped up in this financial crisis that government leaders are willing to support anything, even if this means the bailout bill was concocted mostly between Henry Paulson and his former colleagues as Goldman Sachs.

It is true that action is needed to contain the financial crisis. Many of the most gifted economists--Paul Krugman, Lawrence Summers, and Joseph Stiglitz, for instance-are now in favor of a bailout. Stiglitz, a Nobel Laureate, is the pioneer of "moral hazard" theory, so it's hard to argue that this group doesn't understand the dangers of public largesse.

As Congress and others engage in the entirely necessary efforts to get Secretary Paulson and Chairman Bernanke to (i) explain why what they're proposing is necessary--beyond a promise of Armageddon if Congress doesn't follow, quickly, like lemmings; (ii) build some serious accountability and oversight into any program; (iii) ensure the United States taxpayers get significant upside for whatever they spend; and (iv) maximize the likelihood that whatever is done to stabilize markets not only actually accomplishes that result but also stabilizes affected households (both homeowners and renters) and communities, I get the awful feeling that $700 billion is starting to feel like play money.  It isn't.  No one suddenly gave us $700 billion to spend, no matter how eager the Secretary is to make it sound that way.  It will come from new borrowing, which we and our children will have to pay back, with ever more interest.

What I said is that they were adequately capitalized. And they were adequately capitalized according to the law on June 30th.
-James Lockhart, Federal Housing Finance Agency Director (September 8, 2008)

This was not the case according to Morgan Stanley, which was pulled in by Treasury Secretary Hank Paulson to analyze the health of Fannie and Freddie in early August.

After the Fannie and Freddie bailout, many law makers will try to create independent oversight over these large Government Sponsored Enterprises (GSEs). But Morgan Stanley reported that a bailout would cost upwards of $50bn, while William Poole estimated it may be as high as $300bn. Furthermore, the bailout will not turn around falling house prices, which are more the result of a massive price correction and not of the price of mortgages.

Promises by the U.S. Treasury and Federal Reserve to support Fannie Mae and Freddie Mac have not reassured shareholders. By noon Tuesday, shares of Fannie Mae dropped 23.5% and Freddie Mac plunged 24.9%. Given the loss of investor confidence in these mortgage finance companies, it appears that the promised equity investment by the Treasury may be utilized. In addition, Paulson proposed increasing Fannie and Freddie's $2.25bn credit lines to an undetermined amount to ensure "flexibility" and "minimize taxpayer risk."

Snapshot asks, what is the limit of taxpayer responsibility to maintain Fannie and Freddie's share price and help maintain financial stability?

Wall Street Journal - Bernanke, Paulson Aim for Stability with Fannie, Freddie Proposal
U.S. Treasury - Testimony by Secretary Henry M. Paulson, Jr.
Ben Bernanke - Semiannual Monetary Policy Report to the Congress

The first proposal to reform the financial system since the subprime crisis was announced yesterday by Treasury Secretary Hank Paulson. The proposal aims to create a regulatory environment in which "capital can seek out its most productive uses in an efficient matter." Before his time as Treasury Secretary he worked as co-chief executive at Goldman Sachs, where he argued for reduced regulation and consolidation of regulatory agencies. Yesterday's proposal sought to combine regulatory agencies and expand the powers of the Fed.

Snapshot asks, what parts of the Paulson plan will survive?