US Treasury Secretary Henry Paulson addresses a press briefing on Friday at US Treasury Department in Washington, DC.

Treasury Secretary Paulson’s grand scheme to buy US$700 billion of toxic derivatives from ailing financial institutions is a pipe dream that logic and history show will not work.

The Paulson plan is nothing but manna from heaven for distressed institutions. No doubt there will be a momentary burst of confidence and markets will rally but longer term serious problems remain.

The bailout is an attempt to bring confidence back to the lending market that has seized up in fear and is not making loans. The concern is that the cessation of liquidity and lending will exacerbate the meltdown on Wall Street and ripple broadly into the economy. The Paulson plan fails to address the issue of fear that is behind the crisis.

History shows the plan is doomed to fail

Over the past few weeks we have been consistently told that we face an epic crisis comparable to the 1929 stock market crash with its ensuing Great Depression of the 1930’s. So why are the lessons of the Great Depression being ignored?

During the Great Depression lending similarly dried up and confidence swooned. Lending and borrowing came to a standstill. The lesson of the Great Depression was that it is next to impossible to get institutions to lend and companies/consumers to borrow once fear sets in. Renowned economist John Maynard Keynes said that trying to get banks to lend and borrowers to borrow during a banking crisis is like trying to “push on a string”—in other words it is impossible. Similarly in the 1990’s the Bank of Japan found trying to resuscitate lending in the wake of the Japan ’s stock market collapse was impossible. The Bank of Japan even went to the extreme of making interest rates negative, in other words they paid you to borrow, and it proved ineffectual.

While pushing on a string refers to monetary policy, which the Fed has kept lose, and the Paulson plan is about buying assets they are similar because they are attempts to get banks to lend. Buying the bad assets of institutions is going to at best provide a temporary return to lending. Ultimately you can lead a horse to water but you cannot make him drink.

“All we have to fear is fear itself”

In his first inaugural speech FDR voiced the greatest challenge facing America and the world at the time when he said, “All we have to fear is fear itself.” Today fear has again set into the financial markets and is beginning to spread. Turning this tide is next to impossible.

The market runs from the extremes of greed to fear and once a mentality sets in it stays for a very, very long time. Nobel Prize winning economist Robert Mundell described the reticence of consumers to buy things in the 1930’s as a deflation (falling prices) mentality. Because demand fell off a cliff retailers were forced to reduce prices to sell their products. Consumers eventually realized that by postponing their purchases they could save money. As they held off buying retailers were forced to reduce prices further to entice buyers. This created a self fulfilling spiral pushing prices lower that eventually had many buyers forgoing buying totally.

Admit that Reaganomics and free market don’t work

The unfortunate thing is that the Bush administration and Republicans refuse to admit that the problem we are suffering from today is the failure of free market and Reaganomics ideology. The cause of our current problems from the meltdown on Wall Street, to higher gas prices, to higher cooking prices can be traced squarely to the failure of free market/neoliberalism/Reaganomics ideology.

Government needs to regulate and get rid of the excesses created by the free market’s binge of the past few decades. Bold and aggressive initiatives such as the government seizing control of financial institutions are needed at this time. Fear has set in and throwing good money at bad as we have done successively with bailouts since the 1987 stock market crash have not worked. Bailouts create a moral hazard and reckless behavior that necessitate further bailouts where eventually you reach a point where the size of the bailout bill is insurmountable. Today we are being forced to fork over a massive $700 billion.

Capitalism is failing again as it did during the 1930’s with the Great Depression. They say “fool me once shame on you, fool me twice shame on me.” How many more times will we allow ourselves to be fooled?

Free market ideology does not work! Bold initiatives that empower “we the people” are needed.

By Madis Senner*

* Madis Senner is an ex-global money manager turned faith-based activist. He has written on geopolitical and economic matters for publications including The New York Times, Wall Street Journal’s weekly publication Barrons, International Financial Review. Senner can be reached at madiss@verizon.net.