Paulson is right that it makes sense to allow the big banks to wipe their balance sheets clean of as many bad loans as they can identify, and put them into a special agency that then sells them for as much as possible. The agency would bundle or unbundle the risky loans, slice and dice them as needed, with the goal of getting the most for them on world markets by creating a market for them.And Sebastian Mallaby points out that it is dishonest to compare this to the Resolution Trust Corporation in 1989:
But there's no reason taxpayers need to be involved in this.
Whether you call it a reorganization under bankruptcy or just a hellova fire sale, the process should resemble chapter 11 under bankruptcy. Any big financial institution that wants to clear its books can opt in. But the price for opting in is this: Investors in these institutions lose the value of their equity. Executives lose the value of their options, and their pay (and the pay of their directors) is sharply limited. All the money from the fire sale goes to making creditors as whole as possible.
The first is whether the bailout is necessary. In 1989, there was no choice. The federal government insured the thrifts, so when they failed, the feds were left holding their loans; the RTC's job was simply to get rid of them. But in buying bad loans before banks fail, the Bush administration would be signing up for a financial war of choice. It would spend billions of dollars on the theory that preemption will avert the mass destruction of banks. There are cheaper ways to stabilize the system.Instead, Mallaby points out a few alternative options:
Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles.And here's a nice coup de grace via an email sent to Naked Capitalism by someone who was present at the negotiations:
Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.
Anyway, I wanted to let you know that, behind closed doors, Paulson describes the plan differently. He explicitly says that it will buy assets at above market prices (although he still claims that they are undervalued) because the holders won't sell at market prices. Anna Eshoo pressed him on how the government can compel the holders to sell, and he basically dodged the question. I think that's because he didn't want to admit that the government would just keep offering more and more.And again, Naked Capitalism sums up its antipathy to the bailout:
Losses on the paper acquired are guaranteed. This is not a bug but a feature. The whole point of this exercise is an equity infusion to banks. The failure to be honest about it upfront will lead to a taxpayer backlash (or will lead to the production of phony financial statements for the rescue entity, which will lead to revolt by our friendly foreign funding sources).I would suggest that you send as many congresspeople and senators as you can a hundred or so links explaining why this bailout is not such a good idea. The worst thing about socialized capitalism is it takes the worst aspects of Socialism (rigid central government control) and the worst aspects of Capitalism (freedom for private sphere entities to be as stupid and risky as they want to be) and combines them. Now that the bailout plan is out, I'm expecting the media tide to turn (tomorrow, probably, when the week is up and running). There will be a lot more doubt in the coming days.
Taxpayers have no upside participation.
There is no regulatory reform as part of the package. This would seem to be a minimum requirement for a donation of this magnitude.
There is no admission that deleveraging is inevitable. This plan seems to be a desperate effort to keep bad debt from being written down. Yet the sorry fact is that a lot of these assets simply will not be repaid.
There appears to be no intention to do triage. The financial services industry, on the back of an explosive growth in debt, has reached an unsustainable size. The industry will have to shrink. Yet the Administration does not address this issue; indeed, it appears it intends to forestall the inevitable. Regulators need to decide who will make it, who won't, and figure out what to do with damaged institutions. Instead, the reaction is ad hoc. The stunner was the contemplation of a possible merger between Morgan Stanley and Wachovia. As far as I can tell, the only thing the two firms had in common was coming into crisis on roughly the same timetable. For all I know, their IT systems are not compatible (many an otherwise promising bank merger has been scuttled over IT integration issues).
Update: At Open Left, there are two emails from anonymous congressional Democrats angry about the Paulson plan. This one is quite enlightening:
Here's the industry's play: progressives will approach Nancy with ideas for reform, and she'll agree to push for their proposals, and she'll really mean it. Then industry lobbyists will go to Dennis Moore, Melissa Bean and a few other Democrats, and tell them how dire the consequences of the proposals would be, and that the members who understand how the economy works need to step up to stop Nancy and the crazy liberals from doing something rash. Then those Democrats will go to Steny and tell him how terrible Nancy's crazy ideas would be, and how we can't rush into something like that without much, much more thought. Maybe Barney will try to talk to Dennis or Melissa, but it will become apparent quickly that they have no idea what they're talking about; they're just repeating by rote what the lobbyists told them to say. Melissa may actually be dumber than Sarah Palin. Barney will realize he might as well talk to the lobbyists directly and save a step. The lobbyists will agree to something inconsequential, but certainly nothing that would really affect the industry's conduct. Then the leadership will do the math and conclude that because the vast majority of Republicans will vote against any bill, we can't get enough votes without the Dennis and Melissa crowd. The only way, our leadership will conclude, to get anything at all passed is to include nothing more than the inconsequential proposals that the lobbyists agreed to. Then we'll all go along because it would be wildly irresponsible not to act when we're staring over the brink of a complete collapse of world financial markets.