Treasury Secretary Henry Paulson is the man of the hour. This weekend he drew a clear line in the sand: no more federal bailouts. Not for Lehman Brothers. Not for global insurer AIG. Not for Merrill Lynch. Not for anyone.
It was a gutsy decision for the former Wall Street bigwig -- and one that he had to step back from when it became clear that the collapse of AIG would be catastrophic and government intervention was necessary. But he is standing firm on letting other companies, such as Lehman Brothers, survive or fail on their own.
Paulson came to Washington two years ago thinking he could reform Social Security and perhaps the tax system, as well. In the process, he hoped to clean up the federal budget books, maintain an open trading system, and persuade China to take on a more flexible currency and reform its own banking system. But history can be a cruel master, and Paulson's agenda was completely altered by one of the worst financial crises in American history.
Last March, acting in conjunction with Fed head Ben Bernanke, Paulson safeguarded the banking system and the whole global financial structure by backstopping a JPMorgan Chase deal to acquire the ailing Bear Stearns with $29 billion in loan guarantees. The action succeeded in stabilizing markets, but it put U.S. taxpayers on the hook big-time.
Then last week Paulson stepped into the breach again by backstopping mortgage lenders Fannie Mae and Freddie Mac. It was a necessary action. It prevented a global money meltdown. But it raised the stakes for taxpayers once more.
So this time around, as the Lehman stock headed for zero, Paulson said enough is enough. We are now in for some Schumpeterian gales of creative destruction. But this is how it must be.
"Moral hazard," said Paulson, "is something I don't take lightly." He's saying bad financial behavior must be penalized, not rewarded. That's the essence of the issue. The risk of failure is (SET ITAL) essential (END ITAL) to an efficient economic system, and that includes financial risk.
In our capitalist system there are losers as well as winners. There are failures as well as successes. Harking back to the eminent economist Joseph Schumpeter, the old failures will be replaced by new enterprises.