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The U. S. government will be using at least $250 billion out of the $700 billion bailout package to buy equity shares in the some of the largest financial institutions in the country. In other words, as President George W. Bush, Treasury Secretary Henry Paulson, and Federal Reserve Chairman Ben Bernanke confirmed Tuesday, Washington will use more than one-third of that $700 billion for a partial nationalization of the banking industry. At his news conference, Paulson said he regretted the government having to buy shares of large banking corporations such as Citigroup, Bank of America, JP Morgan Chase, Goldman Sachs, Morgan Stanley, and Wells Fargo. But he said it was essential to inject liquidity and confidence in the U.S. and global financial markets.
In fact, Paulson views it so essential that, according to several news reports, he strong armed all of the major banks to agree to the government buying equity shares in their companies. He was afraid that if some banks signed up while others did not, it would publicly "embarrass" the receipient banks that they had gone on the government dole. The U.S. Treasury Department will buy up to $25 billion of preferred, non-voting shares in each of the targeted companies. The shares will pay annual dividends of 5 percent for the first five years, and 9 percent beyond that. The shares would be redeemable, i.e., bought back by those banks, after three years. Government would also hold warrants that would enable the government to convert the preferred shares into common stock. The rationale for Washington buying bank shares is that it will address a public relations problem. Many Americans dislike the government's plan to buy bad mortgages from private companies at taxpayers’ expense and with the uncertainty of whether and at what price the securities will ever be resold back in the market. In addition, the government has become very concerned that if share prices in the financial sector continue to decline or if any more large banks were to go under, foreign governments and private investors around the world might jump ship and send the dollar into a major tailspin. At the same time, the move will reinforce the government’s ability to impose the new rules in the bailout package that will set caps on senior executive pay, including seeing to it that there are no golden parachutes in employment contracts. In reality, the government's acquisition of preferred stock in these companies is nothing less than financial sector socialism. Washington is not just another private investor who takes his chances on a profit while also running the risk of a loss.The government may say that it is not planning to be in the investment business, and determining how the companies are run. But most assuredly the reality will be something totally different. For example, the bailout bill directs the Treasury Department to write compensation standards for senior executives to prevent “unnecessary and excessive risk” in their management of the investment company’s portfolio. But how can the bureaucrats in the Treasury know what unnecessary and excessive risk is until they scrutinize the investment strategies and risk-management decisions of executives in the individual firms? How will they know if strategies and decisions are unnecessary risks without second-guessing everything done or planned by the company’s management? Inevitably, the Treasury’s bureaucratic bailout teams in the field will become not-so-silent partners. What real world experience will they have to know what the wisest and most profitable strategies are? What incentive will they have to get it right--assuming they could--since they are not risking their own money, but the taxpayers? Is it really likely that politics will not start rearing its inevitable and ugly head? How long will it take before the pressures from congressmen, lobbyists, and special interest groups start influencing if not determining much of what these companies do and for whose benefit? In deciding to pour tens of billions of dollars in selected banks the government is "picking winners" and implicitly saying which companies can be "losers" that are allowed to go down the drain. Once having picked these winners at a huge taxpayers' expense, it's not likely that the government would let many of them fail and admit that all those taxpayer dollars were spent for nought. It is far more likely that Washington would pour more good money after the bad, force its merger with one of the other government-backed winners, or just take over the still-troubled company with the government directly going into the banking business. Wherever government has either nationalized an industry or bought into a “partnership” with business, the outcome has been expensive for the taxpayer and for the society at large. The history of nationalized industries all around the world has almost always been inefficiency, excessive costs, and operating deficits that the government had to cover with taxpayers' hard-earned money. Government-business partnerships also have almost always ended in mismanagement and corruption. Too often the company’s business is no longer production for profit by satisfying the consumers in the market, but production for political pandering and plunder for privileged groups at everyone else’s expense. The current economic crisis is a serious one, but financial sector socialism is not the cure.
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