Henry Paulson's Approach is Bass Ackwards

Lets get it straight. The key underlying cause of the financial crisis is income stagnation and fall in real wages of the consumers. There has been a lack of growth in well paying jobs for past several years. The debt levels, including credit card debt and mortgage debt, have risen to alarming levels. What makes the rising debt levels really alarming is that they are not supported by a concomitant rise in incomes.

Henry Paulson's approach to deal with the crisis is to re-capitalize the banks so they can start lending again. This is exactly the "bass ackwards" approach that is not going to do anything to solve the financial crisis of the century. Let me explain. The real problem is not lending, in fact, it is reckless lending to credit unworthy masses which led to the problem in the first place. We will not solve the problem by simply lending more at a time, when income levels are stagnating, number of well-paying jobs are dwindling (outsourced by globalization) and consumers are neck deep in debt (mortgage & credit cards). Getting the banks to start the lending cycle all over again would be akin to treating an alcoholic by giving him more alcohol for medicine.

It would seem that Henry Paulson and his rescue team are either in denial of the underlying cause of this crisis or they are merely pretending to be ignorant. Unless a proper diagnosis is done to determine the root cause, only treating the symptoms would be pointless. The current freeze in the credit & lending markets is the symptom of the problem, and not the underlying cause. If a doctor treats only the external symptoms of a disease, it is only a matter of time before the disease symptoms would resurface. At best, it would only push the problem out a few years but the next relapse could be even more severe.

The long term solution has to be stimulating income growth by creating more well paying jobs. This can be done by investing in infrastructure projects, innovative technologies for the future and making investments in hi-tech R&D. To focus on short term results while ignoring investments in R&D for the long term is like eating seed corn. This economic stimulus has to be accompanied by common sense regulations on lending practices and complex financial instruments to ensure proper functioning of the financial markets in the future. Executive/CEO compensation should be linked to long term performance and not to short term stock movement.

These steps would be like nourishing the tree at the root, which would help restore the health of the entire tree including trunk, branches and leaves, as opposed to Henry Paulson's approach that merely waters the leaves at the top. It is common sense that a tree must be watered at root for proper nourishment, washing the leaves is cosmetic at best.

That said, in the short term, it is alright to take measures to ensure proper functioning of our financial system but over the long term these measures must be complemented with radical steps to support the economy at its roots: income growth for consumers who support the real economy. Eventually the economic growth will be restored only by re-emphasis on innovation leading to real products and services of real value and ultimately real income growth.