That's What Friends Are For

Thinking back on the last Asian crisis, it is hard to recall an instance of crony so-called capitalism greater than that perpetrated in the United States by Treasury Secretary Henry Paulson.

Paulson’s conflict of interest is on such a scale that it is remarkable that neither the US Congress or US media has even noticed it. So obsessed have they become with "saving the system" by printing vast quantities of new government debt that they have conveniently forgotten who bears heavy responsibility for it in the first place, and who has now conducted the "rescue" in a manner calculated to give maximum help to the firm which he himself headed until some two years ago.

Goldman Sachs may have been smarter than most of its peers, but under Paulson’s leadership it played a primary role in the creation of the pyramid scheme of debt and opaque derivatives that has just come tumbling down, endangering not just the American taxpayer and investor, but also a global economy based both on trust and the free flow of capital. Paulson was in the thick of the massive over-leveraging of the investment banks, a major beneficiary of obscene levels of remuneration for those who gambled with other people's money.

Asian creditors of the US should not stand silently by and watch their assets being eroded by Wall Street sleaze, but should be saying loudly and publicly that they will not invest another penny in US Treasury stock or financial sector companies until it addresses fundamental issues, including the removal of Paulson for his record of creating the pyramid then using public funds and regulatory powers to selectively save his friends’ skins.

Note that after letting Lehman Brothers go to the wall, after rescuing Fannie Mae and Freddie Mac – a reasonable action as they were always government-linked enterprises – and in effect forcing Merrill Lynch into the arms of Bank of America, the finger of fate was pointing at the two remaining major investment banks, Goldman and Morgan Stanley.

Paulson then contrived a three pronged intervention which was clearly aimed not just at stabilizing the system but specifically protecting these two, and Goldman in particular. First there was the announcement of a US$700 billion or so package of government money to pick up any amount of dodgy assets created by Goldman and others, be they simple sub-prime mortgages or complex derivatives which Paulson himself probably does not understand.

Then he arranged the banning of short selling of financial stocks, causing Goldman’s price to rise 40 per cent in a matter of minutes. Short selling – which involves borrowing stock to sell – is just as legitimate as buying stock with borrowed money. But no, to help save the skin of Goldman and co, Paulson now banned the very thing which he and his firm had long declared to be central to the proper operation of markets.

But not even those two measures were enough to erase the doubts about the survivability of Goldman and Morgan Stanley. So in yet another exhibition of sleaze and cronyism the two were given permission overnight to change their status to regular banks, giving them not only an enhanced aura of respectability but also additional access to borrowing from the Federal Reserve. The fact that their capital to total assets ratio – approximately 23 to one in the case of Goldman – is more than double that thought prudent for a commercial banks was ignored by so called regulators. No wonder the US is in such a mess. Just when there are calls for tighter regulation of the financial sector, the Federal Reserve and Treasury conspire to trash their own rules to help two unworthy institutions. Quite how spivvy Goldman will acquire a stable deposit base and sufficient new capital to reduce to become a stable and properly capitalised institution remains to be seen. Maybe it will now follow the Morgan Stanley route and attract Asian capital – in Morgan's case Mitsubishi UFJ. That would probably have been impossible without the change of status to commercial bank.

But cash rich Asians should still be beware of any new injections given that the financial crisis in the US and UK is far from over. And Americans should ponder exactly how two unelected public officials – Paulson and Fed chairman Ben Bernanke – could use public funds and regulatory powers in a manner which was clearly selective and biased towards their institutional cronies.