Drinking and Driving in Mr. Paulson's Neighborhood

The luxury coupe first rolled into the neighborhood in early 2006 and can be spotted most weekends speeding to and from a nearby car wash.

My coupe-spotting helps to feed one of my recently formulated fantasies, in which the vehicle is jointly shared up and down the street via a rotating schedule: odd-numbered houses on Monday, Wednesday, and Friday; even-numbered ones on Tuesday, Thursday, and Saturday. Sundays would be reserved for the vehicle's owner, who bartered the balance of the car's week in exchange for the inflation, salary freezes, and job losses that all of us odd and even neighbors have experienced as of late.

This is just a fantasy, mind you, but it's rooted in present-day realities, and, of course, the coupe owner lives and breathes, and does in fact drive the object of my neighborhood's affection. Let me explain. Since last fall, the Fed has responded to an economic slowdown brought on by the collapse of the subprime mortgage market by lowering interest rates -- a necessary move, most economists agree, but one that has made us ill-prepared to fight off inflation. Prices for goods purchased by American business jumped by nearly 10 percent in July -- the sharpest increase in prices in more than 25 years, according to a Department of Labor report released last month.

Does anyone not believe that Wall Street is to blame? Clearly, our president thinks so. Speaking at a recent Dallas congressional fund-raiser, George W. Bush told the gathering: "Wall Street got drunk. ... It got drunk and now it has a hangover. The question is how long it will take to sober up, and not try to do all of these fancy financial instruments." Posted on YouTube, the president's video short enjoyed a nationwide audience last month when TV anchor Tom Brokaw shared it with Treasury Secretary Hank Paulson on NBC's Meet the Press.

"There's a lot of truth in what the president said," Secretary Paulson began. "And in terms of Wall Street, there is too much leverage in the system, and more leverage than was appropriate, and the leverage came into the system in the form of highly complex structured products that were difficult to understand." Asked by Brokaw whether it was tough for a Republican from Wall Street to say "more government regulation is required," Paulson, the former chairman and CEO of Goldman Sachs, replied: "It's not tough for me. I understand the importance of regulation and I understand the importance of moral hazard, market discipline."

The phrase "moral hazard" commonly refers to a situation in which one party in a transaction has more information than the other. And, as is too often the case, the party with more information comes upon an incentive to behave inappropriately from the perspective of the party with less information.

In the case of highly complex structured products, the party with more information was Wall Street, while the party with less information was everyone else -- which brings me back to my fantasy. You see, the coupe's owner has made no secret of the fact that when it comes to "fancy financial instruments" he has in the past profited handsomely from some of the extra leverage Secretary Paulson describes. This being the case, while I'm not by any stretch an economist, it's very apparent that all of industry is now paying the price for the questionable behavior of my neighbor, along with his professional peers collectively known as Wall Street.

The notion that Paulson, given his stature as a Republican and his influence in the finance community, could play a central and perhaps historic role in helping Wall Street to accept its regulatory medicine has not been lost on the leadership of both political parties.

Alas, it is not to be. Paulson has stated firmly his plans to end his term as Secretary at the conclusion of the current Bush administration. Perhaps the Secretary -- an advocate of free markets -- would prefer not to be best remembered as a courageous regulator. Too bad. The unique blend of leadership skills that will be required to address this regulatory challenge are in rather short supply on Wall Street these days.

Meanwhile, the more I think about it, a few days a week in the coupe hardly seems like a fair trade. I guess some of us are better traders than others.