It’s Paulson’s Own Mess

They said it was "too big to fail." This multi-billion dollar
firm was now on the brink of bankruptcy. Although not a bank, the
firm held complicated financial assets such as derivatives and
traded with just about every big bank on Wall Street.

So company officials called on the administration of George W.
Bush, hoping to get a lifeline. Big Wall Street executives,
including former government officials, phoned the Bush Treasury
Department to plead their case to save this company.

Treasury’s response? "Not a chance!"

The company described above was not Bear Stearns or American
International Group, although it had a lot in common with those
firms that the government this year decided must be bailed out by
taxpayers. It was Enron Corp., just before it went bankrupt in

Did Enron’s failure somehow pose less of a systemic risk than
that of Bear Stearns, AIG, or the thousands of other financial
firms that could now be bailed out under the administration’s new
plan? Not really. Enron was the seventh largest public company in
the U.S., employing nearly twice as many as Bear did prior to its

And like Bear, Enron traded derivatives and other financial
instruments with counterparties that were some of the biggest
commercial and investment banks in the country, such as Morgan
Stanley and Citigroup, which would have been heavily exposed to its
losses And these instruments were concentrated in energy, a sector
equally as important, if not more important, to our economy than
housing is.

No, what was really different in 2001 was who was heading
Treasury and other economic agencies. The Enron failure shows how
much the Bush administration, as much as conservatives ripped it,
has moved in an interventionist direction under Treasury Secretary
Henry Paulson.

authoritative account of Enron’s demise, Enron head Ken Lay was on
speed dial to government officials looking for "a lifeline." He
called then-Federal Reserve Chairman Alan Greenspan and then
Treasury Secretary Paul O’Neill. And Robert Rubin, who had just
gone on to become an executive at Citigroup after serving as the
Clinton administration Treasury Secretary, phoned a Treasury aide to see if the Department could
intervene to keep Enron from being downgraded by the credit rating

The responses? Nada, nada and nada. Enron’s bankruptcy was
complicated, but despite Lay and Rubin’s dire predictions of what
would happen if Enron failed, the economy kept growing in 2002 and

But Enron most likely would have had more luck if it had gotten
into trouble after Hank Paulson left his post as CEO of Wall Street
investment bank Goldman Sachs to become Treasury Secretary in 2006.
With the exception of Lehman Brothers, Paulson is truly "Dr. Yes,"
having never met a Wall Street bailout he doesn’t like: $29 billion
here, $200 billion there, and now possibly upwards of $700 billion
over there, and pretty soon even Washington
starts to realize it’s real money.

In terms of not just the bailout, but the unprecedented
intervention in setting prices of company stock in mergers, picking
new CEOs, and encouraging
the abrogation of mortgage contracts, Paulson has gone where no
Treasury Secretary — Republican or Democrat — has gone before on
the road to socialism. In the way he has persuaded a GOP
administration to betray what conservatives stand for, he is —
metaphorically speaking — the late Dick Darman on steroids.

Darman’s convincing of the elder Bush to raise taxes pales in
comparison to these bailouts and the new $700 billion bailout
scheme before Congress. If this "mother of all" bailouts passes, it
will leave an albatross around conservatives’ necks for years,
allowing new arguments for intrusive regulations to prevent
taxpayers from paying for business failures.

YET CONSERVATIVE CRITICISMS of Paulson so far (maybe until this
week) have largely been muted because of two myths propagated by
the media. One is he was a free-market believer until catastrophic
economic events forced him to intervene. The other is that no
matter how bad the financial industry woes are now, the economy
would be much worse off but for his interventions. The first myth
is demonstrably untrue, and the second is under contentious

Paulson did raise a lot of money for the GOP — more than
$100,000 in 2004 — but has always been something of a political
chameleon and has never been an ideological conservative of the
fiscal or social type. As Robert Novak reported last year, he has also contributed to
Bill Clinton, Bill Bradley, the feminist Emily’s List, and "Wall
Street’s favorite Democrat, Chuck Schumer." And, in moves leading
my organization — the Competitive Enterprise Institute — to
oppose his nomination, Paulson supported and Goldman
Sachs partnered with anti-property rights "green" groups.

As to the second myth, Paulson certainly isn’t responsible for
all the factors that have caused the credit crunch, such as the
growth of the government-sponsored enterprises Fannie Mae and
Freddie Mac. But far from saving the economy, there is ample
evidence that the March bailout of Bear Stearns’ creditors simply
prolonged, postponed and added to the pain.

This is because "moral hazard," — the ability to take risks
knowing that someone will bail you out — was increased, and firms
didn’t make the hard choices about restructuring. As Manhattan
Institute scholar Nicole Gelinas, a chartered financial analyst,
wrote in the Wall Street Journal, "the
Fed, by being so quick to jettison the bankruptcy process, cut off
a valuable source of new information to financial markets and
blurred the critical distinction between sophisticated and
unsophisticated investors." And in a recent paper presented at the prestigious
Jackson Hole Symposium held by the Federal Reserve Bank of Kansas
City, professors from the University of Pennsylvania’s Wharton
School and the University of Frankfurt conclude that, "Given the
characteristics of the markets where Bear Stearns operated, it is
quite possible that…no contagion would have occurred."

Yet Paulson has staunchly refused to provide financial firms any
regulatory relief from one problem that experts, including the
authors of the paper mentioned above, say is contributing strongly
to the contagion: mark-to-market accounting. As I wrote last weekend in the Wall Street Journal,
these recently imposed rules force even healthy banks to face
"regulatory insolvency" because they have to value their loans
based on any sick bank’s fire sale, even if they have no plans to
sell the loans and the loans are still performing. In fact,
Paulson’s proposed new mega-bailout may exacerbate this problem.

Yet Paulson, in a stunning statement at the New York Public
Library in July, said basically that if the rules are good enough
for Goldman Sachs, they’re good enough for every community bank.
Paulson said, "I think it’s hard to run a financial
institution if you don’t have the discipline which requires you to
mark securities to market."

If John McCain is looking for someone else on the Bush economic
team to fire, the answer is right in front of