Hank Paulson has acted like the secretary of Wall Street rather than the secretary of the Treasury. This economic crisis manifested itself in August 2007 and nothing that Paulson has done has been a remedy for the problem. His solutions have only propped up his cronies on Wall Street. He is sidestepping the real problem in the market: counterparty risk. Only an independent clearing house can solve this crisis.
Secretary Paulson’s bailout package does nothing for the problem. It injects money into bankrupt institutions by buying preferred stock, which only solves the easy part of the crisis. What if the stuff on the banks’ books is worth less than they say? We will still have a problem. The crux of the problem is that there is so much counterparty risk that banks will not lend to each other. This has frozen what’s called the interbank credit market. Banks do not trust each others’ financial statements. This is why our credit system is clogged.
There are only two ways to get rid of counterparty risk. One is don’t trade with each other. This is not an option; it’s what is happening today. The other is to trade through an independent “clearing house” that erases counterparty risk by guaranteeing each trader is solvent. Once we recertify trust, the credit market will unlock and trading can resume.