Hank Paulson’s Cognitive Dissonance

"The Paulson plan belongs in a fictional world where financial institutions
do a good job in regulating and monitoring themselves. Unfortunately, that’s not
the world we live in."

Why the Paulson Plan is DOA


So says Michael Mandel of Businessweek. In addition to the quote above, he goes further, calling the Treasury Secretary to task:

"In the middle of perhaps the greatest financial upheaval since the Great
Depression, Treasury Secretary Hank Paulson is proposing a change in financial
regulations which basically amounts to a big wink to Wall Street. His plan will
go nowhere, both for political and practical reasons. In fact, it does not even
meet the minimum standard of improving transparency, which would reduce the
possibility of a similar crisis in the future…

The most striking thing about the current problems is just how much money the
banks and the investment banks have lost. They apparently had no idea of how
risky their own exposure was. The supposedly smart guys were simply stupid."

I concur with Mandel: In order to avoid these issues in the future,
depository banks and investment banks need full and transparent
reporting of their holdings. No more side pockets, off-the-book SIVs, or buried
derivatives exposures. In fact, they should also clearly report the potential losses they have on their books via exposure to leveraged and risky
counter-parties as well.

How did this all come about? Over the past 25 years or so, we have migrated from a world that was excessively regulated to a new world that was excessively deregulated. The initial problems were too much complexity,  high costs, and time consuming bureaucracy. That’s been replaced with an equally problematic situation: No adult supervision in places where the children require  adult supervision.      

Less financial supervision? More self-regulation? What hallucinogenics were taken prior to making those recommendations?

Bankers are not the folks who should be garnering less transparency, and less onerous regulatory requirements. Only a clueless ideologue would even dare suggest as much. Unfortunately, we have a clueless idealogue running the Treasury department. When confronted with what can only be described as insurmountable evidence that self-regulation has failed miserably, our man at Treasury proposes more self-regulation.

Riddle me this, Batman: If these finance wizards were any good at the job of self-regulation, would we even be having discussions as to how to resolve a global credit crisis? 

If you are wondering how certain people can fail to understand this, the simple answer is cognitive dissonance. If Paulson were to confront reality — lack of supervision is how banks got themselves in this mess in the first place — his entire world view would crumble. Thus, the problem is not one of lack of supervision, its  an issue of efficiency! Hence, we get these absurd attempts to make the lack of regulatory supervision "more efficient."

The Paulson plan isn’t about avoiding future meltdowns in the financial system — its about allowing Hank Paulson (and others) to cling to their now disproven deregulatory fantasies . . .



Why the Paulson Plan is DOA 
Michael Mandel
Economics Unbound, March 30  2008

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  1. Mind commented on Apr 1

    The same modus operandi shows itself throughout this administration: policies blind to reality, beholden to an elitist, neocon world view. With ordinary people, delusion is eventually disabused by the force of circumstance. The Paulson/Cheney/Bush crowd is denying the reality staring them in the face to the point of absurdity.

  2. Ken M. commented on Apr 1

    Yeah, just what we need. Someone should get their attention, a la 2X4 up side the head, and scream at them, AIRLINE INDUSTRY!!

    Another exciting prospect is shifting more oversight to that mysterious OCC. Here’s an interview from the PBS “Frontline” program about credit cards. The gist of it (PBS’s point) is that not only is OCC not doing its job, but when state and local law enforcement tries to take action, the OCC flexes it’s federal muscle and makes the locals back off.

  3. Ken H. commented on Apr 1

    This plan is a bunch of jabber to look like one is doing something. I still feel these guys knew what was going on and chose to let it go for self centered interests. Knowing the American public would take it in the ass like they always do.

    How about just not giving a bailout? I becha the system would self correct instantly. “Oh no, the whole world will collapse if we do that.” Ya, keep drinking the Koolaid! These jerks knew a bailout would come so they just kept churning.

    Here is my plan, simple,…Don’t ever, ever expect a bailout ever again because there won’t be one. To big to fail my ass!

  4. The Financial Philosopher commented on Apr 1

    Greed always seems to “find a way.” Can it be contained with government regulation? Has it ever been contained? Does greed not always manifest itself into different forms? The current crisis indicates the answer would be, “Yes.”

  5. Philippe commented on Apr 1

    It is to be assumed that Mr Polson has more trust in the legal instances of countries than in the supervision bodies ruling banks and financial markets. He may as well know that trusts, cartels are difficult to detect until it is too late (Is ‘not it the same person whom was promoting a super SIV as a remedy to the sub SIV’s)
    Anyway these hereunder threads may give an idea of how well behaved and intelligent is the nowadays financial industry and in trust should they be.
    Should one be willing to forget the primary dealers cheating in the US treasury bills auction, they are much more to come:

    U_S_ securities dealers association fines HSBC Brokerage $250,000 for bond violations – International Herald Tribune.htm

    Charlotte Observer 03-14-2008 BofA, Wachovia, others accused of rigging bids.htm

    UPDATE 4-UBS cooperating in U_S_ bond probe as meeting looms Reuters.htm

  6. Alfred commented on Apr 1

    Correct me if I am wrong, but wasn’t Paulson the boss of GS, the world’s largest sovereign wealth fund, a couple of quarters ago. Entrusting Paulson with regulating the business he helped create, is like entrusting Jeffrey Dahmer with reforming the criminal justice system. Usually business leaders have to step down if they screw up. Just because Paulson escaped in time into the halls of Washington should not obscure the facts. There is but one thing that can rescue the world from Wall Street greed: The Fed has to drop its second mandate of optimal growth, which is of course a bogus mandate, and focus on price stability alone.

  7. BozoTheClown commented on Apr 1

    Hank is stealing my act. As are all of the other clowns on Wall Street and in government. It’s enough to put a guy out of work. When are these assholes going to find their own act and quit raining on my parade? For pete’s sake, I’ve been marginalized. Now everyone is a clown!

  8. Stuart commented on Apr 1

    and if the dollar bounce since is a reaction to this Emperor has no clothes plan vII.7.b, it’s all the more a complete farce. Markets are quickly degenerating into a stage set of the Truman show.

  9. dblwyo commented on Apr 1

    While overall I agree with your sentiments and diagnosis there’s more substance and serious reform in this package, IMHO, than you’re giving credit for. A point as well as associated ones on the structural breakdowns in the markets I’ve made publicly several times. Here’s the catch Riddler – how do you sell increased adult supervision when the folks who’re going to vote on it are themselves prisoners of ideology, even when not adherents themselves ?
    By positioning this as an “efficiency” improvement Paulsen may be able to sell this much easier. In fact this re-positioning the market he’s selling to is as clever as the Fed’s under Volcker hiding behind simple moneterist shibboleths to break the back of inflation at the price of a fairly severe recession.
    One can’t isolate the analysis to just the technical merits of the product but must include its’ marketing – and this could be darn clever. They certainly went to great lengths to time it, position it, line up key Congressional support and get commentators, e.g. Harvey Pitt, to publicly back it.
    May I suggest you can’t post “How to Disagree” which argues for confronting the core of an argument head on with analysis and evidence without applying its’ tenets. And one of those, in my view, was looking at the Big Picture of everything that’s at play here.

  10. VennData commented on Apr 1

    It’s interesting to see how Paulson’s original Super-SIV has come to fruition in the guise of the TAF, TSLF, and the Fed-backstopped JP Morgan guarantee. The bailout – and if you don’t think the shareholder were bailed out, at least admit the Bear Stern’s bond holders were bailed out – has (sort of) proved out his original concept.

    So maybe there’s something to this guy? It looks to me like the Paulson plan is simply an org. chart and the regulations that follow will be harmonized in committee.

    I like the idea of a national insurance regulator as opposed to the silly state-based structure we have. What is different about insurance in Ohio and Indiana?

    A question that needs to be asked is why did so many European and Asian/Pacific etc. banks – with their stricter regulations fall – into subprime slime?

  11. Marcus Aurelius commented on Apr 1

    Posted by: dblwyo | Apr 1, 2008 8:33:32 AM


    If you’re counting on marketing to make this reality disappear, you place far too much faith in marketing. Good marketing of a bad product will sell that product once – and never again.

  12. john commented on Apr 1

    There is clearly some substance in this package although it does little or nothing to address the main ills that have caused the financial meltdown. But what difference does it make because it is clearly going nowhere in its present form. Despite all the hype it’s going to be off the public and govt radar in a couple of days. Some of the ideas are going to be incorporated in a likely massive overhaul of financial markets initiated by the next president and congress. Where that settles clearly depends on the color of the next congress and president but expect it to contain many more features abhorrent to the industry and expect them to fight it tooth and nail. How rigorous it ultimately proves will probably depend on the duration and depth of the recession and the banking crisis. The former in particular will give the political impetus to move regardless of what the industry’s lobbyists try to do to stop it. All this said you do have to roll your eyes at Paulson’s statement that inadequate regulation had nothing to do with the current crisis. He completely destroyed his own cred with that one statement.

  13. Roundabout commented on Apr 1

    And,predictably, the first comment out of the box on this thread tries to inject politics into the issue. This transcends politics.

  14. Howard Veit commented on Apr 1

    Here’s the cause of the market “dislocation.” Back in the days when I was learning about markets a guy from some Wall Street hell hole gave a lecture in which he laid out a very strange case. He pointed out that Britain’s (then) near financial mess, including a complete collapse of their manufacturing base, could be laid to the fact that their educated class (intellectuals) were all taking cushy jobs in Insurance, Government, and universities rather than risk getting their hands dirty doing real work. It was a given that intellectuals would next slither to into the stock markets, both in London and New York, where they could all do non-working jobs sitting down in offices. Their naturally complex ideas would take hold and their methodologies would destroy both the markets and capitalism if left unchecked. He told us that the smartest guys in the room would lead the markets to disaster, mostly because when they started to do things you shouldn’t do none of us would understand what they were doing.

    Many years later we have had Long Term Capital Management manned by Nobel Prize Winners leading us to near disaster, The S&Ls captained by some of the most brilliant minds in finance, Enron with their cross hedging BS, and now the “whatever it is we have” in which financial instruments (so-called) that no one can understand that are designed by PhDs from all the usual places are the investment vehicles in “hedge funds” mutual funds, blah blah blah, and are so complex that it takes main frame computers to estimate their market positions and contents. They are too much of the markets.

    So, to parse Shakespeare: First, “let’s kill all the people with advanced college degrees.”

    Why not?

  15. Unsympathetic commented on Apr 1

    Why is it ever a shock that people who create models have never been successful traders.. and successful traders never create models?

    Barry, I TA’d basic stats for engineers for just over 2 years in grad school. People who couldn’t hack that course aced the business school! Of course financial models won’t get the downside correct.. because the models weren’t created by people who fundamentally “get” the need for the most basic of engineering rigor: validating every test case.

    Roundabout, the issue doesn’t transcend politics — only the Bush administration has faith that deregulation “works,” all evidence to the contrary. I expect to hear Paulson say that tax cuts will solve the credit crunch.

    Bush and the Republican party deserve to be thrown on the scrap heap of history. If they aren’t voted out, America will be there as well.

  16. Stuart commented on Apr 1

    Strategic pumps and shoot the messengers = all is well, all is fixed, everything under control, so move along folks, nothing to see.

  17. CaptiousNut commented on Apr 1

    I can’t believe anyone thinks the government should be more involved in ANYTHING.

    Full transparency on banks?

    Well, then in the next crisis y’all will just blame hedgies, sovereign wealth funds, or some other opaque “under-regulated” bogeyman.

  18. MarkD commented on Apr 1

    I like the idea of a national insurance regulator as opposed to the silly state-based structure we have. What is different about insurance in Ohio and Indiana?
    Posted by: VennData
    Bad,bad,bad idea instead of 50 people with their eye on the ball we’ll have some political fund raising patronage hack not regulating anything. when the cat is spayed the mice will play.

  19. Loren Steffy commented on Apr 1

    BizLinks | 4.1.08

    Congress to grill oil execs as gas prices set record highs On Paper, Wall Street Gets Its Way Northwest CEO would benefit from quitting in June — 8 million reasons to leave. Hank Paulson’s Cognitive Dissonance Pemex Missteps Pare…

  20. larster commented on Apr 1

    So D Bank and UBS announce huge writeoffs, D Banks chairman says that conditions have worsened in the past few weeks, and the market opens up. Looks like things are working, Hank.

    The ideologues line is that people need to exercise more personal responsibility. Well, how about the regulators admitting that they wre asleep. Can’t do that. Paulson says that this is in no way connected to regulatory mistakes. I guess it’s all a matter of how much money you have. What a sorry state of affairs, I say.

  21. michael schumacher commented on Apr 1


    more “unexpected” losses.

    WTF is all I can say to +150 on that “great news”


  22. DonKei commented on Apr 1

    The only needed regulation is that of the market place. Let Bear, Lehman, Citi, et al, fail. The world won’t end, and Wall Street bankers might think twice about 34:1 leverage ratios in the future.

    Leverage got us here. Allowing the pain of develeraging will get us out of it.

    When LTCM imploded, it was solely the result of a nearly 50:1 leverage ratio. At 50:1, every bet has to pan out (and you gots to have a lot of moxie to think they all will–but hey, they were Ph.D.s–some w/ Nobel prizes). When the Russian bond and currency markets stayed irrational longer than LTCM could stay solvent, it destroyed them.

    Now John Meriwhether of LTCM fame runs a hedge fund that specifically limits itself to a 15:1 ratio. Still high IMO, but far less dangerous than 50:1. It has lost money lately, but not so much it is doomed to destroy the financial system any time soon. He learned something, it seems. Let Bear and the rest learn the same.

    The worst regulation is that which yields a federal government as the de facto guarantor of bad investment bank bets. The market, allowed to work, would do a much better job. And remember, J6P’s money is not tied up in Bear Stearn’s accounts (at least not until the fed took on $29 b of its liabilities). Perhaps Champagne Jim’s money is, but not Joe Six Pack’s. Let Champagne Jim feel the pain of non-returned principal, and he might just look next time before he leaps.

  23. Wayne Mulligan commented on Apr 1

    I just wish I could’ve been a fly on the wall of some of the board meetings that discussed some of the bank’s exposure to risk. Somebody, at some point, had to go, “Hey guys, we really have a lot of paper out there – maybe we should start to limit our downside a bit” And then somebody else must’ve told that guy to shut the hell up and just play the game. And that’s really what this all is – a big game where eventually somebody loses and it’s considered a cost of doing business – albeit for some firms a much bigger cost than others (ahem, Bear).


  24. ECONOMISTA NON GRATA commented on Apr 1

    Gentlemen! Gentlemen!:

    This is clearly a case of “Non-Overlapping Magisteria (NOMA)”

    “the magisterium of science covers the empirical realm: what the Universe is made of (fact) and why does it work in this way (theory). The magisterium of finance extends over questions of ultimate meaning and dollar value. These two magisteria do not overlap, nor do they encompass all inquiry (consider, for example, the magisterium of art and the meaning of beauty).”

    We should all rest comfortably and serenely in knowing that reason, knowledge and fact do not apply to “the faith based doctrines” of the current “disgraced” administration.

    My best regards to all,


  25. Oracle of Atlanta commented on Apr 1

    Hank Paulson is reported to be a devout Christian Scientist. As a former church member (20+ years), I can only assume that Mr. Paulson is doing what all good CS students do: if reality doesn’t meet your expectations, deny it and label it as error. Then mentally try to transcend the problem. Good luck with that.

  26. Francois commented on Apr 1

    VennData wrote:
    “So maybe there’s something to this guy? It looks to me like the Paulson plan is simply an org. chart and the regulations that follow will be harmonized in committee.

    I like the idea of a national insurance regulator as opposed to the silly state-based structure we have. What is different about insurance in Ohio and Indiana?”

    At first glance, I’d be for the concept of a national insurance regulator, if this was to be applied in a country like Canada or UK.


    Because, contrary to the US, Canada and UK have a very strong tradition of civil service that is fairly independent from political power. Here, the team arriving to power bring their own political appointees to promote the President’s agenda.

    We can debate ad nauseam the pros and cons of the two approaches, and I’m pretty sure quite a few pearls would emerge from such debate.

    However, the experience of the last 8 years clearly showed the dangers of the US way of doing things. As Ken M. pointed out in an earlier post, “…shifting more oversight to that mysterious OCC […] not only is OCC not doing its job, but when state and local law enforcement tries to take action, the OCC flexes it’s federal muscle and makes the locals back off.” Let’s also recall what happened to Spitzer and colleagues when they tried to go after predatory lenders. Instead of focusing on the problem at hand, the incompetents dimwitted idiots at the federal level, instead of taking the ball from there and DO something useful, took the State AGs action as an intolerable infringement on THEIR turf, and devoted their energy to stop an initiative that could have seriously mitigate the mess were in now.

    For that reason alone, leaving aside the dangerous ideological blindness this Administration suffers from, I’d say this proposal just doesn’t cut it.

  27. Timba commented on Apr 1

    What makes you think 50 state-level patronage hacks are getting the job done in terms of regulating insurance? At best, only a few states have good, knowledgeable administrators overseeing their industry. At worst, they create artificial barriers to entry (“you must include aromatherapy coverage!”) to protect home field players. At least a national market would take one layer of costs out of the products and might create better insurance options, particularly for private medical care.

  28. Peter_BK commented on Apr 1

    I believe we will get exactly what we deserve as a country. Anyone who believes this is not a political problem is lying or just plain ignorant. This administration has politicized EVERYTHING at the federal level. There are no federal agencies that work to protect the National interest, all efforts are put to promoting the interests of the Republican party and their “ideals”. How we can impeach a man for getting a blow job, and yet let this administration lie and get away with the criminal deconstruction of our government and economy still baffles me. And yet once again they come forward with a solution to a problem that “no one could see coming”.

    So this could be 1)Another example of this administration saying one thing while pushing policies that further their crusade for deregulation
    2) The first time in 8 years that Bush and Company have done something to really help the country as a whole.

    (I think they really mean it this time)

    Here is a link to a great dissection of the Treasury plan:


  29. mw commented on Apr 1

    The “Boys” (Ben and Hank) are going to try to get as much ram-rodded through before Congress “smells a rat”. Congress is clueless on financial matters or economics in general( Goldman CEO Bernanke??)

  30. shtove commented on Apr 1

    I don’t think it’s cognitive dissonance. All that stuttering is caused by a good old fashioned guilty conscience.

  31. Karl K commented on Apr 1

    MORE regulation? We need MORE regulation?

    And who is putting that regulatory regime? The GOVERNMENT?


    Those who call for increased regulatory regime s are working under the assumption that, you know, markets and human behavior are PERFECTIBLE.

    This just in — they are not.

    Moreover, all regulation is ex post factor, often in the worst way. Think Sarbanes Oxley.

    Ultimately – and only — what we need is complete transparency from the public companies AND private companies that have the potential to disrupt smooth funcitioning markets.

    No UP markets or DOWN markets but smooth functioning markets.

    In the end, these companies should be required to provide their SAP/ORACLE/Peoplesoft/SAP files. Data should be given to the markets like sushi — RAW.

    Then let the markets decide, not some financially ignorant Congresspeople.

  32. VoiceFromTheWilderness commented on Apr 1

    Nice Commentary Barry — thanks for, as usual, representing the reality based community, and doing it so well.

    Ya gotta love though, all the ‘true free market’ believers out there though (you listening Mish?) that think the current problem is ‘proof’ that ‘governments always fail’. Actually of course what it is is proof that ‘free markets’ always were supported as a concept only in so far as it got people with real power ahead of the game. And that ‘Free Market Principles’ amount to having blinders on about everything except first year econ — and better make sure you don’t have one of them radical econ teachers who might expose you to notions like ‘externalities’, and ‘failure of the complete information hypothesis’, much less ‘market inefficiencies’, which of course ‘don’t really exist’.

    The whole thing would be hilarious if it weren’t so important to so many people.

  33. Frederick commented on Apr 1

    Even beyond more regulation, most of Wall Street just needs to go away. The self importance of men like Henry Paulson and communities like Wall Steet is simply stunning. Their analysts are as correct as the coin I have in my pocket, and their ‘rocket scientists’ are such geniuses that they blow up the system every ten years. If the average U.S. citizen understood just how pedestrian the ablities of the average Wall Streeter were, the country would not tolerate this nonsense. Wall Street shrouds itself in as many useless layers of complexity as possible so nobody can figure out just how rudimentary their business model is of fleecing people less in the know than them.

  34. Gary commented on Apr 1

    There’s a couple of things that when I string them together make me very nervous here:
    * Paulson, the former head of GS is advocating MORE regulation?!
    * A member of the Bush administration is advocating MORE regulation?!
    * A “streamlining” of agencies has been on the Bush team’s agenda since before this crisis
    * A desire to “do something” about Iraq existed long before 9/11
    * Post 9/11 provided the environment for going into Iraq
    * Is the credit crisis providing the environment to “do something” about finance-related agencies and regulation?

    I hope the 200 page proposal is given a very careful and thorough review.

  35. ZackAttack commented on Apr 1

    If this turns out to be true (and not an April Fools’ hoax), I am simply incensed by Paulson’s reported letter to the NY Fed.

    About 48 seconds into this video:


    we learn that there was a letter from Sec Treas Henry Paulson to the NY Fed governor indicating that the Fed can just “bill Treasury” for any losses it takes on the Bear Stearns bailout.

    Wow. Just, wow.

  36. Darkness commented on Apr 1

    >A question that needs to be asked is why did so many European and Asian/Pacific etc. banks – with their stricter regulations fall – into subprime slime?

    Well, one obvious human explanation would be that the as highly-regulated institutions, they assumed their peers in the U.S. were equally trustworthy. They were buying a AAA “rated” product, remember? Stupid of them to assume that meant anything, it turns out, but over there, it would, perhaps mean something.

    Those calling for letting the market continue to run itself into the ground with no adult supervision, have no concept of a market. Put down the neocon koolaid for just a moment and imagine a future where wall street loses everything (like how soon before Europe is stupid enough to buy anything from us?) and is well understood by everyone to be the bunch of thieves they are. With no oversight there is no reason to assume they’ve reformed. An unregulated system does not reward honesty by any individual player. Honest players don’t make enough profit.

    With no trust, there will be no money entering the market, because only an idiot would invest anything. No trust, no money, no market. How hard is that to grasp?

  37. jult52 commented on Apr 1

    The case for deregulation doesn’t rest on the belief that the private sector always does a perfect job. Clearly, the private sector doesn’t. It rests on the belief that the government won’t do a better job.

    In terms of regulation, the real moves probably have to come from non-governmental bodies like FASB and the Basel Committee.

    A lot shrill ranting in this post. Not very impressive.

  38. dug commented on Apr 1

    I don’t see how a regulatory failure is an argument for more regulation. Every intervention in a free market causes problems which then require a choice between either more intervention or eliminating it.

    It’s pretty clear which way the US is going. The activities of any market can destroy wealth, cause disruptions, or not be “orderly” so if that is deemed to demand intervention in one area there is no basis for refusing it everywhere else.

    I can hear Hillary now “They say the banks are too big to fail, but we say it should be too small to fail!”

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