Bush's Disastrous 'Rescue' of the Finance Industry

BLACK MONDAY, SEPT. 15, 2008, marked the collapse of a Bush administration policy, dating from the first subprime tremors of mid-2007, of trying to rescue America's biggest banks and investment firms, piecemeal.

The administration never had an overarching strategy for purging the financial system of its bad debt, or of systematically recapitalizing the biggest banks, or defining who deserved taxpayer bailout, or setting clear ground rules going forward. The rescues were all done on the fly.

Bush's treasury secretary, Henry Paulson, former CEO of Goldman Sachs, went to Washington in 2006 with a blueprint for even less government involvement with Wall Street, not more. In the improbable role of emergency government financial czar, Paulson ran the rescues in the manner of a private investment banker. He viewed each collapse as an occasion for a merger, acquisition, or restructuring. Flying without a regulatory compass, Paulson and Federal Reserve Chairman Ben Bernanke extended taxpayer money and lines of credit from the Fed to get through each crisis of the day.

Their strategy was to find white knights and erect firewalls. If Bear Stearns could be saved from bankruptcy by a shotgun merger with JPMorgan Chase, then all of Bear's creditors on Wall Street would not take a hit. If Fannie Mae and Freddie Mac could be rescued with $200 billion of taxpayer money, maybe the mortgage crisis would not deepen. If the Fed could advance enough credit to brokerages and investment bankers that were not even part of the Fed system, maybe it would buy time to clean up their balance sheets.

The strategy boiled down to allowing Wall Street to privatize the gains while government socialized the losses. After the fact -- after more than a decade of letting Wall Street operate like a casino -- the government had little choice: If a sufficiently large bank went bust, it could take the whole system down with it.

But after the creation of ever more exotic bogus securities running into the trillions, subprime loans being only the most notorious, there are simply too many worthless investments clogging the system. In ordinary times, bargain-hunting buyers can be found to scoop up bad investments at so many cents on the dollar. But in this crisis, there are few buyers, save the government. As confidence collapsed, stockholders fled even the largest and soundest financial institutions, further undermining their capital base.

Paulson ultimately found that it was just not possible to nationalize all of Wall Street one firm at a time. The Federal Reserve has already tied up something like half of its own available cash -- offering to exchange good bonds for bad ones -- to keep financial firms on life support and buy time. Sunday evening, the Fed announced that it would accept even lower-grade collateral.

In the Lehman Brothers case, however, the Treasury and the Fed decided it was time to draw a line. History could well record this decision as a big mistake, the one that toppled other dominoes. But the bigger mistake was the absence of a broader strategy.

In frantic weekend meetings, Timothy Geithner, president of the New York Federal Reserve Bank, called in heads of Wall Street's biggest firms and warned there would be no government bailout of Lehman. But by yesterday morning, no private buyers materialized -- sending more shudders though the financial system. If Lehman went bust, many billions that it owed other firms would vaporize. Other storied firms tottered -- AIG, even Merrill Lynch.

Looking backward, it's clear that the Bush administration needed a more comprehensive approach. The last time the financial system imploded, in the 1930s, the Franklin Roosevelt administration combined government recapitalization with tough regulation. But the government-loathing Bush administration has pumped in capital only in fits and starts, and remains allergic to regulation.