Paulson: Taxpayers Should Bail Out Subprime

Can you imagine this? Former Goldman Sachs (NYSE: GS  ) CEO Hank Paulson came out and said, "This nation's taxpayers should bail out those who took risky home mortgages and cannot afford them."

Those weren't the words he used, of course. Doing that would have been political suicide.

Instead, Paulson capped his punish-the-public debtor bailout plan with a call to Congress to let taxpayers be bled by their local governments in order to fund the bailout. Hey, no one can accuse the administration of taxing the responsible to pay for the greedy and ignorant if they don't do it directly, right? Sorry, Hank, but we're on to you.

The details are in The Wall Street Journal. The new Paulson hit on taxpayers would come via legislation that Hank is pushing to allow municipalities to issue more tax-free bonds and use the proceeds to bail out the people who made stupid or greedy bets on real estate with loans they can't afford anymore.

This is probably the dumbest and most venal of the cavalcade of bailout plans. It's venal because it would shift the cost of homebuyer and Wall Street greed onto innocent bystanders -- us, the people who fund those bonds. It's dumb because it presumes that municipalities are smart enough to allocate capital intelligently in the mortgage markets.

I would love to hear Hank P. explain to us how local governments will acquire the requisite expertise to assess mortgage risk or values so that they can effectively buy, sell, refinance, and/or insure mortgages.

Keep in mind, this is a job so complex and fraught with risk that it was royally screwed up by a multibillion-dollar industry full of "experts" -- that is, until the going got tough and they decided to throw in the towel. There's no way municipalities can be expected to make good decisions about whom to bail out, or what the right price would be.

Finally, it will introduce the moral hazard that hamstrings real markets by institutionalizing the notion that every Wall Street and Main Street excess should be bailed out by us commoners whenever our elected officials deem it convenient. That is, whenever the press looks too ugly. And don't be fooled -- this is about political posturing in the face of bad press.

As another Journal article explains, the current problem with subprime isn't really ARM adjustments; it's that the borrowers couldn't afford the loans in the first place, even at the teaser rates. Moreover, this problem will continue for years, well beyond "subprime." There's plenty of "Alt-A" ARM paper out there that will be resetting until 2010 and beyond.

But Paulson and his puppet-masters aren't talking about that. They're concerned with looking like they've done something to help and that means sacrifice for us. When things are bad, we all share responsibility.

The profits on the housing bubble that caused the problems, of course, are another matter. Those have long since been socked away by the bonus grabbers at Goldman, Bear Stearns (NYSE: BSC  ) , Merrill Lynch (NYSE: MER  ) , and Morgan Stanley, and the stock-dumping insiders at Toll Brothers (NYSE: TOL  ) and Countrywide Financial (NYSE: CFC  ) .

Infinite upside along with taxpayer-subsidized downside insurance -- for some, anyway. Who said housing isn't the American dream?

For more on government attempts to bail out the bubble at every Fool's expense:

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