September 29, 2008Economyfinancial marketsPublic PolicyUnited States

The Post-Paulson Plan world

A few notches down

This is an archived blog post from The Acorn.

Commenting on his piece in Mint, V Anantha Nageswaran says (in an email) that at the time he wrote it, he had expected the US Congress to approve Treasury Secretary Henry Paulson’s $700 billion bailout plan. In the event, the lower house voted it down, but he expects Mr Paulson to come back with a new version.

Four conditions must be met in any government rescue:

  1. Those who need to be bailed out, get bailed out and no one else.

  2. They must be bailed out of their losses but if they make gains, they go to the supplier of the bailout.

  3. Those who created the conditions that brought about the bailout should be punished and removed and their privileges—golden parachutes, bonuses and suchlike—stripped.

  4. Others who took the risk of investing in such an enterprise with such management share the pain and contribute to the bailout. Risk-taking means bearing losses too.

Unfortunately, the Paulson Plan failed the test.

In the end, the rejection of the vote is a positive. It rejected a flawed plan. It could now become slightly better. Unfortunately, because it was a flawed product to start with, it won’t get a lot better. That is why sometimes the slate needs to be wiped clean. [V Anantha Nageswaran] In his Mint piece, he contemplates a new international exchange rate regime.

The problems that the US and the rest of the world face today with credit destruction and crisis were caused by the Bretton Woods II exchange rate regime. In that regime, many countries kept their exchange rates in a quasi-peg to the dollar and lent to US households, which borrowed heavily. That has to be played out all over again for the bailout plan to work. In other words, the US is expecting to repeat Bretton Woods II to solve the problems created by Bretton Woods II. That does not sound like much of a solution but more like the creation of a new, bigger problem. [Mint]

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