In fact, one now is forced to ask whether President Bush would not be doing the country a great service by replacing an increasingly ineffective Paulson now with a secretary of the treasury of President-elect Barack Obama's choosing. This is one of the few moves that might spare the United States and global financial markets yet another two months of downward drift.
If there is a silver lining in Paulson's term as treasury secretary, it must be the salutary lessons that it might send his successor as how not to handle a complex economic and financial crisis.
History will almost certainly judge Paulson harshly for his gross mishandling of the U.S. economy. Not only did he conspicuously fail to anticipate the fallout from the bursting of the housing bubble on the global financial system. And not only did he make egregious errors in his handling of the various crises at Bear Stearns, Fannie Mae, Freddie Mac and Lehman Brothers. Rather, and more damningly, he was also shown to be without any plan once the credit crisis erupted with all of its fury following the spectacular Lehman failure in mid-September.
At Treasury, confusion and incoherence have reigned.
The most vivid indication of Mr. Paulson's lack of even the semblance of an economic strategy have been the many twists and turns in his $700 billion Troubled Asset Relief Program, which he had the effrontery to present to Congress in a vaguely specified three-page proposal. Initially sold as an ill-defined plan to take toxic mortgage backed securities off the banks' troubled balance sheets, the TARP has since morphed into a glorified slush fund with multiple and yet to be fully articulated objectives.
Yesterday, in congressional testimony, Mr. Paulson lamely justified the many changes to his plan on the grounds that, after it was first introduced, the global market crisis had become so broad and severe that made it necessary to move quickly and to take powerful steps to stabilize the financial system and to get credit flowing again.
The main purpose of the TARP now seems to be to infuse capital into the banks on terms that are not particularly favorable to the U.S. taxpayer, without asking these banks very much by way of return in the form of increased lending. At the same time, Paulson is musing about using the TARP to prop up consumer lending and reduce housing market foreclosures. Meanwhile, the initial objective of buying toxic assets from the banks has been unceremoniously scrapped.
It must be of little wonder then that financial markets remain in a state of confusion as to the direction of policy as indicated by still very high interest rate spreads and by the virtual paralysis in the securitization market. Similarly it must be of little wonder that bank credit is now contracting at its fastest pace in the postwar period, while mortgage rates remain at prohibitively elevated levels. The gravity of a dysfunctional financial market is now being underlined by the uninterrupted slew of very weak economic data that can leave little doubt that the U.S. economy is weakening at an alarming rate that will only deepen the financial market crisis.
If there is a silver lining in Paulson's term as treasury secretary it must be the salutary lessons that it might send his successor as how not to handle a complex economic and financial crisis. It has vividly illustrated the futility of searching for a silver bullet to deal with an asset and financial market crisis of a complexity that has no precedent in the postwar period. It should also have taught that financial markets abhor policy uncertainty and that policy vacillation does impose high economic costs.
With each passing day, it is becoming increasingly plain that we are living in extraordinary economic times that will of necessity require extraordinary measures if there is to be a satisfactory resolution of the crisis. These measures will need to go considerably beyond the large fiscal stimulus package that is now being seriously discussed in academic and financial market circles.
What will be needed are bold and unorthodox measures to stabilize the U.S. housing market, which has been a primary source of financial market losses and a major factor in the deterioration of household balance sheets. In addition there will have to be a serious rethinking of the TARP program as a means to recapitalize solvent banks and restructure insolvent banks. Hopefully this will be done in a manner that allows the U.S. to avoid repeating Japan's mistake during its lost decade of keeping alive zombie financial institutions.
One has to hope that President-elect Barack Obama announces in short order his choice for secretary treasury--who might have both the intellect and the courage to take the bold and unorthodox measures that will be needed.
America--and the world--have had enough of Henry Paulson.
Desmond Lachman is resident fellow at AEI.