Bailout protects CEOs, not you

Here's the truth about why Treasury Secretary Hank Paulson wants $700 billion of your money to bail out stupid financial companies. It's not about protecting you, the unwitting American. It's about protecting people like him.

Specifically, people like Morgan Stanley CEO John Mack. With his company's shares in a freefall, Mack sent a memo on Sept. 17 to all employees, telling them “short sellers are driving our stock down.”

Mack offered no facts to support this claim. He also said “there is no rational basis for the movements in our stock.” Actually, there was: Investors don't believe Morgan Stanley's numbers.

No matter. Heeding pleas of people such as Mack, U.S. and U.K. regulators raced to ban short sales of all financial companies' shares. They also opened investigations into “market manipulation” by shorts – investors who sell borrowed shares, hoping to buy them back at a lower price for a profit.

Then on Sept. 19, Paulson, the former boss of Goldman Sachs Group Inc., unleashed the ultimate market manipulation: the bailout, although this isn't really the right word. It's more like a needle-exchange program.

Mission accomplished: Stocks soar. Morgan Stanley and Goldman survive. Armageddon is averted. And here's the important part: People like you stop dreaming of lining people like Mack up against a wall and shooting them.

For now, at least. The problem with Paulson's plan, on paper, is it shouldn't work unless Paulson authorizes government-sponsored looting of the Treasury, which seems likely. Since the financial crisis began last year, banks worldwide have disclosed $519 billion of losses from writing down assets. Consequently, many of them don't have enough capital left to absorb more losses. And unless their stock prices go up a lot, they can't raise any more.

Under Paulson's plan, the Treasury will get as much as $700 billion to buy “troubled assets” from financial institutions.

The word “troubled” seems to mean whatever Paulson wants it to mean. As far as I can tell, the only way this would plug banks' capital holes is if the Treasury pays them much more than the assets are worth.

Even if Treasury pays 100 percent of the assets' balance-sheet value, banks still won't have enough capital. And as the whole world seems to know, the asset values on banks' balance sheets are grotesquely inflated. If Treasury pays only what they're worth, the banks would have to take more writedowns and admit to bigger capital shortfalls.

So, to boost the banks' capital, the Treasury basically has to bribe U.S. banks into staying afloat. As it turns out, Paulson's plan gives him unchecked authority to do just that.

It doesn't matter whether Paulson's plan will work, though. What matters is getting enough people like you to believe it will. If that happens, the banks' stock prices will go up. Then bankers can start raising capital again from people like themselves who, while richer, are no less gullible than people like you.

The supreme lunacy comes from the Securities and Exchange Commission. It passed emergency rules last week to make investment managers disclose their short positions. Now, you might think this would mean someone like Jim Chanos, who runs the world's largest short-only hedge fund, Kynikos Associates, would have to start disclosing his firm's bets. Here's a scoop, though: He doesn't.

Instead, the rules only require short-sale disclosures by funds that held ownership stakes in public companies' securities as of June 30. Kynikos, which has $7 billion under management, doesn't own any securities. It only shorts them. So the rules don't cover Kynikos.

“It does underscore our concerns about the hastiness of these late-night regulations,” Chanos told me, after I called to make sure I wasn't imagining the loophole. He says Kynikos will disclose its short positions anyway, to abide by the rules' spirit.

This goes to show: If the government didn't care enough to make sure its rules apply to Chanos, it probably doesn't really care about short-sellers. It just wants to divert attention by creating an enemy for public persecution. Don't take my word for it, though. Check out what President Bush said Sept. 19 on national television.

“The SEC is also requiring certain investors to disclose their short selling, and has launched rigorous enforcement actions to detect fraud and manipulation in the market,” he said. “Anyone engaging in illegal financial transactions will be caught and persecuted (sic).”

Whatever it takes to save our financial system from descending into oblivion, it will be tried, even if it all but guarantees we'll have a bigger meltdown later. It's not about principle. It's about the money. And it's about people like John Mack protecting themselves from people like you, by whatever means necessary.

Heaven help us all if it doesn't work.