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Friday, February 12, 2010 11:22 AM

EU Tries Paulson's Bazooka Ploy; Bazooka Theory vs. Historical Results

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In a desperate attempt to rein in problems in Greece, EU leaders once again offered moral support, this time with a Bazooka aimed right at Greece.

Please consider EU Leaders Deploy ‘Bazooka’ to Repel Attack on Greece

European leaders closed ranks to defend Greece from the punishment of investors in a pledge of support that may soon be tested.

German Chancellor Angela Merkel and her counterparts yesterday pledged “determined and coordinated action” to support Greece’s efforts to regain control of its finances. They stopped short of providing taxpayers’ money or diluting their own demands for the country to cut the European Union’s biggest budget deficit.

“It’s like Paulson’s bazooka,” said Nielsen, Goldman Sachs’s chief European economist in London. “It’s a difficult balancing act -- saying something comforting to the market without committing money and hoping the market will take their word for it.”

After a three-month long plunge in Greece’s bonds amid speculation it was facing the threat of default, euro-region leaders yesterday ordered the country to slash its budget deficit and warned investors they would be willing to defend the country from speculative attack if necessary.

The pledge lacked specifics and officials are now working on measures such as establishing a lending facility for Greece, with each country making a contribution according to its size, an EU official said yesterday on condition of anonymity.

With Ireland forcing public workers to accept pay cuts of as much as 10 percent to meet EU budget rules, Merkel and other leaders are trying to convince voters that Greece won’t get an easy escape after a decade of fiscal profligacy.

Money For Free?

“This is not money for free,” said Luxembourg Prime Minister Jean-Claude Juncker, who heads the group of euro-area finance ministers. “This is a strong commitment imposed on Greece.”

With the Greek crisis testing Europe’s ability to run a common currency with 16 separate national fiscal policies, leaders want to avoid Paulson’s fate. In July 2008, he won power from Congress enabling a government rescue of Freddie Mac and Fannie Mae, calling it a “bazooka in your pocket” that would make a bailout less likely.

Markets soon tested the pledge and the government seized control of the mortgage lenders two months later.
Bazoooka Theory vs. Actual Results

"If you have a bazooka in your pocket and people know it, you probably won't have to use it." Paulson said at a July 15 Senate Banking Committee hearing. The reference was in regards to Fannie Mae and Freddie Mac.

Paulson believed that if he had the power to bailout Fannie Mae, the market would react to that possibility and no bailout would be necessary. Was that a blatant lie to get Congress to commit funds or was Paulson simply stupid?

Since then both Paulson and Bernanke have tried various bazooka ploys.

Inquiring minds may wish to review theory vs. actual practice.

September 16, 2008: Bazooka Bernanke: Fed To Bailout AIG?
Paulson: "If you have a bazooka in your pocket, and people know you have a bazooka, you may never have to take it out."

Mish: "It seems to me Paulson took out his bazooka, fired it, and shot Fannie Mae in the arse. After Fannie Mae blew sky high, Paulson was adamant not to fire another shot."

Bernanke has a Bazooka in his pocket that he is hoping he does not have to fire. Whether or not Bernanke fires that bazooka, AIG is not going to survive in its present form, if indeed it survives at all.

Remember that in the bailout of Fannie Mae and Freddie Mac that equity holders and preferred shareholders were both wiped out. Expect the same if there is an AIG bailout. Expect taxpayers to be on the hook for another $90-200 Billion if it happens.
October 15, 2008: Compelling Banks To Lend At Bazooka Point
Bazooka Theory

There seems to be a fine line between ...

1) Illegally forcing supposedly well capitalized banks at bazooka point to take money on questionable terms

2) And illegally forcing those same banks at bazooka point to lend it

Banks Unwilling To Lend

And so here we are. The Fed slashed interest rates to 1.50% and banks are unwilling to lend.
November 10, 2008: Battle Over Bazooka Point Lending
Paulson asked for and received the right to do damn near anything he wanted with the $700 billion bank bailout money appropriated by Congress. His next step was to cram money down banks' throats whether they wanted it or not, at conditions that did not make a lot of sense to several banks.

Because of rising unemployment, rising credit card defaults, rising foreclosures, and the need to increase loan loss reserves, banks are sitting on the money or using it for mergers. Clearly that is a quite a rational thing to do.
March 15, 2009: Bazooka Boomerangs: Banks Return Bailout Funds
In what any sensible person knew would eventually happen the moment the program was announced, Banks are now scrambling to return bailout funds.

Now that Paulson is gone, banks are doing the sensible thing, returning the money. And so another Bazooka Point policy has failed.
Fannie Mae and Freddie Mack need still more bailouts and are in government receivership. Banks did not lend the money Paulson forced down their throats at bazooka point, instead they returned it. Banks are still undercapitalized and not lending.

So-called excess reserves total $1.2 trillion (see Fictional Reserve Lending And The Myth Of Excess Reserves for details)

So much for Bazooka Theory.

Mike "Mish" Shedlock
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