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The Greater Fool

SOURCE: AP/Bebeto Matthews

The National Debt clock ticks upward in New York. The $700 billion bailout of the financial sector could push the debt up to $11 trillion.

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Financial market participants, deep down, rely on what’s known as the “greater fool” theory—the belief that someone can always be found to pay more for something. This week on Capitol Hill there are all manner of financiers looking to turn the American taxpayer into the greater fool.

The latest version of the $700 billion financial sector rescue package placed before Congress by the Bush administration is dangerously close to ballooning out of control due to special interests attempting to sell their bad assets to the U.S. government even though these bad investments have nothing to do with the root cause of the current global financial crisis—the ailing U.S. housing market. Initially, this mammoth rescue first unveiled late last week was targeted specifically at purchasing hard-to-value residential mortgage-backed securities, which because of their complexity no one will buy at less-than-steep discounts.

Buying up these troubled securities at appropriate prices, restructuring them and then selling them back to investors could be money well spent if it helps the U.S. housing market recover. But ever since U.S. Treasury Secretary Henry Paulson on Friday went to Congress to explain that mortgage-backed securities needed to be expunged from global credit markets, all kinds of other troubled assets have been added to the proposal purchase package.

The next day, in fact, Paulson revealed he would include commercial real estate-backed mortgage securities. By Monday, the administration wanted taxpayers to pony up $700 billion on any “troubled asset,” presumably including securities tied to auto loans, credit card payments, student loans, and perhaps other types of troubled commercial loans.

That’s a very bad idea. The current financial crisis did not arise because of souring commercial real estate debt, or credit card debt, or auto loan debt, or student debt—all of which Wall Street wrapped into securities and sold to investors worldwide. That kind of debt has traded in the markets for many years now, and continues to trade today even as the value of these securities falls amid the current economic downturn.

The purpose of the proposed bailout is to deal with the extraordinary circumstances of the mortgage market, not to relieve lenders of every bad loan they have on their books through the normal course of business. There is no reason for the U.S. government to purchase troubled debt securities backed by these bad loans to rescue the financiers of these securities. If they want to sell them instead of hold them on their books, they can sell them today for what they are worth in the marketplace. Their only motivation for having the U.S. government buy these loans is that the lenders think they can get the U.S. taxpayers to overpay for them—to be that greater fool.

What’s worse, the financiers of auto loans want to sell more than just their troubled assets to the U.S. government. They want the U.S. taxpayer to buy new securitized auto loans because institutional investors will no longer purchase them after realizing just how badly the Bush administration policed our financial system. Auto loan financiers want the U.S. government to keep the asset securitization process going as the investor of last resort—further involving taxpayers in their lending practices.

They and other special interest groups are in search of a greater fool and seem to be finding a willing enabler in Secretary Paulson. Congressional leaders should not let the Bush administration turn U.S. taxpayers into the greater fool. They should strictly limit the purchase of troubled securities to the residential mortgage marketplace as they craft this $700 billion rescue package in the coming days.

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