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Another Angle on the Paulson Bailout Scheme: It’s OPM All Over Again

Posted on October 6, 2008

As you may well know as the credit crisis gained momentum the Fed relaxed it’s lending requirements and has been allowing nearly any financial institution to borrow money against nearly any type of financial collateral. In a somewhat comic state of affairs, now the Treasury is going to use $800 billion to buy back from the banks what basically amounts to the same collateral that it has been lending against to the banks!

The analogy would be if a bank, let’s call it Bank OPM, lends you $1 million to buy a house that is supposedly worth $1 million. You then take the money, and subsequently default on the loan (it’s possible you never even buy the house, which is a “phantom” house). Instead of just taking over the house as in a normal foreclosure, Bank OPM decides to actually buy the house from you at whatever you think is the right price for the house. Of course, you’d be jumping for joy, since this would be the craziest thing you could ever imagine. What could be the motivation of OPM bank to do this?

Let’s say Bank OPM agrees to buy the house from you for $500K, you walk away and are now $500K+ richer (or more depending on if the house was originally really worth $1 million). Not a bad deal for defaulting on your loans. OBM Bank, of course would be out $1.5 million and be sitting on asset worth at most $500K. In order for OPM bank to make money, though, the house would need to more than triple in value, an impossibility.

Of course, such a situation, as described above, would be completely outrageous and considered criminal by anyone examining OPM bank’s books. Anyone looking at these transactions would obviously assume (correctly) that you and some executives at OPM bank are in cohoots and are just stealing money from the bank.

However, the Fed and the Treasury are somehow now allowed to operate as the fictional OPM bank described above. Instead of just seizing the assets against which they already lent against to failed banks, the Treasury is now agreeing to pay insolvent banks for the same assets it has already lent them money on. It’s simply incredible that nobody has actually asked Paulson how this alchemy is going to work.

So the banks essentially walk away with $800 billion in new capital, for which they don’t put up a dime, and get to default on the initial $800 billion or so, which they have already borrowed from the Fed (and did what with?). Great deal for the banks, but bad deal for the Fed, the Treasury, and the US taxpayer.

What could be the motivation be for such a scheme? We’ll let you decide.

I believe the logic of the above is irrefutable which would clearly explain why confidence in the US financial markets is completely broken. Incredibly, considering the price of treasuries, people are still lining up to give more money to the US Government to support the above criminal scheme. But, the faster they give the money to the Fed the quicker it will disappears into the financial black hole of banks. At some point, investors will recognize that giving money to the Fed to launder is not going to safeguard their money or help the economy. The most it will do is allow Paulson and his Goldman buddies (every single person on Paulson’s rescue team is from Goldman), to steal more money from the US. When foreign investors clearly see Paulson’s motivations, what emergency measures will then be concocted to save our financial system? Maybe they’ll actually ask Paulson and the rest of the bankers to pay back the money that was stolen? Fat chance.

Note: Guess who’s overseeing the TARP? Neal Kashkari, a former Goldman Sachs banker. Now you can see why Buffett bought into Goldman. If you can’t beat em’, join em’.

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