Parts of bailout are financial sector socialism

The federal government has decided to use $250 billion of the $700 billion financial-sector bailout package to buy equity shares in many of America's largest financial institutions, partially nationalizing the banking industry.

Treasury Secretary Henry Paulson says buying shares in companies like Citigroup, Bank of America, JP Morgan Chase, Goldman Sachs, Morgan Stanley and Wells Fargo is necessary in order to inject liquidity and confidence in the world financial markets.

The Treasury Department, Paulson says, will buy up to $25 billion in preferred, nonvoting shares of each of the targeted companies. The shares will pay annual dividends of 5 percent for the first five years and 9 percent after that.

The rationale for Washington doing this is that it will calm the markets, allow banks to resume lending, and address the public relations problem arising from the public's dislike of the government's plan to take bad mortgages off these companies' hands at taxpayer expense — without guaranteeing whether and at what price they will be resold back into the market.

The government was concerned as well that if financial-sector share prices continued to decline or if additional large banks failed, foreign governments and private investors would jump ship and send the dollar into a major tailspin.

Meanwhile, the move will reinforce the government's ability to impose the new rules in the bailout package that set caps on senior executive pay, including the elimination of "golden parachutes" in employment contracts.

The reality is, however, that the government's acquisition of preferred stock in these companies is nothing less than financial sector socialism. While the government may say that it is not planning to be in the investment business or determine how the companies are run, the reality will be something totally different.

For example, the bailout bill directs the Treasury Department to write compensation standards for senior executives to prevent "unnecessary and excessive risk" in the management of their investment portfolios.

But how can Treasury bureaucrats know what unnecessary and excessive risk is until they scrutinize the investment strategies and risk-management decisions of the executives in the firms? And how will they know if strategies and decisions are unnecessarily risky without second-guessing everything management does?

Inevitably the Treasury's bureaucratic bailout teams in the field will become not-so-silent partners. But what real world experience will they have to know what the wisest and most profitable strategies are? What incentive will they have to get it right, since they will not be risking their own money, but the taxpayers'?