Here are the issues as I see them in the bailout:
- The Treasury can’t do it as if they are autocrats.? The powers of the other branches of our government should not be curtailed here.? The Treasury should submit to oversight from Congress and be subject to the Judiciary.? Fortunately, it seems like that is happening.
- Second, if you are going to bail out firms that are still alive, you must ask them for equity stakes that are somewhat punitive.? The Dodd bill does that, and though there are areas where I might disagree, it is a lot fairer to the American taxpayer than the original Treasury proposal.? Bailouts should always be painful, making the rescue a last resort.? (Note, in the Dodd plan, the key weakness is that the finances of the firm selling distressed assets to the government might will likely see its stock price weaken after the purchase, leaving not enough protection by the time of sale.? But it is better than the Treasury proposal.)
- Third, the bailout still needs a way to deal with insolvent institutions.? The Resolution Trust Corporation was a way to deal with those problems.? It’s possible that a new entity could absorb the assets of failed financial institutions, but given the nature of regulated companies, deciding on the proper transfer price is difficult.
We are on slippery ground here, and I’m not sure that the market would react badly if no plan were put in place.? A bad plan is worse than no plan, and I believe the market fell on Monday because the original Treasury plan was horrid.? If something like Dodd’s plan were enacted, I think the market would rally, even with its deficiencies.? We need oversight, and compensation to the taxpayers.
To all my readers, I still say, contact your Congressmen and Senators, and tell them to stand up to the Treasury, and demand compensation for any bailout, and if no compensation, we only bail out insolvent firms.? Bailouts must hurt.
PS — For an entertaining view of one possible future as we socialize the financial system, read this piece from the ever-wise Caroline Baum.
A $700 Billion Bailout is a Bad Deal for Taxpayers
The current credit crisis and subsequent bailout proposal Treasury Secretary Henry Paulson has created an emotional response from the both the public and members of Congress. Many in the public wonder why taxpayers should foot the bill for mistakes made by private financial firms. Others point out that if multi-billion dollar financial firms are going to get government assistance, should not they get help preventing their homes from going into foreclosure? The truth is that financial firms facilitate spending through loans to businesses and consumers alike. A breakdown in this flow of money would have a crushing effect on our economy and be felt by most if not all Americans. For this reason, most agree that some action to assist private financial firms is necessary.
I am writing this letter in hopes that I may influence Congress to provide a measured response to the current financial crisis. While I agree that some action should be taken soon, I do not agree will the current proposal to authorize the immediate purchase of $700 billion in mortgage-backed securities. I do not think it is wise to make such a purchase immediately or to assume that Treasury Secretary Henry Paulson has the best interests of taxpayers in mind.
My understanding of the crisis is that financial firms own ill-liquid assets, such as mortgage-backed securities, and need to liquidate those assets in order to maintain their credit ratings. With poor credit ratings, the cost of borrowing for financial firms goes up in a manner that would force the financial firms to go into bankruptcy or at least stop issuing new loans ? hence the ?credit crisis.? The credit crisis is not an indication that financial firms can not afford to lose money on their mistaken investments in mortgaged-backed securities, but an indication that some mechanism to turn mortgaged-backed securities into liquid assets is required for financial firms to resume their normal lending practices. In fact, to maintain the structure of capitalism and prevent incentives for irrationally risky lending practices in the future, the financial firms deserve to lose money on their poor investments. Instead, the plan proposed by Treasure Secretary Mr. Paulson does significantly more by forcing taxpayers to retroactively indemnify financial firms from losses caused by their poor decisions.
We should not write Mr. Paulson a blank ($700 billion) check to bail out his associates in the financial industry. Doing so will ensure that the treasury (and taxpayers) pays more for the mortgage-backed securities than they are worth, lowering the value of the dollar through its dilution and saddling my generation with even more debt. It will also encourage risky behavior by financial firms in the future. Instead, the government should implement a system to buy mortgage-backed securities in a manner that ensures taxpayers are getting good value out of any money spent to purchase the securities.
$700 billion does not need to be spent right now to alleviate the credit crisis. Instead, Congress should authorize the immediate purchase of a smaller amount of ill-liquid assets now (say $100 billion) and set-up a timeline for additional purchases in the future (maybe every 2 months). Then, the treasury can hold a reverse auction, where banks bid to sell their ill-liquid assets to the treasury, and the treasury will only purchase the cheapest $100 billion in ill-liquid assets. A reverse auction that provides for a limited purchase of ill-liquid assets will create competition between financial firms that is necessary to ensure that the taxpayers are not overpaying for the securities. In contrast, the blank-check proposal by Mr. Paulson would not result in any real bidding between financial firms to sell their ill-liquid assets as there would be a practically unlimited ($700 billion) pool for the financial firms to draw from.
The mere knowledge that mortgage-backed securities can be sold to the treasury in the future will immediately improve the liquidity of those securities on the open market. In the event that more liquidity is required, the timing and amount for future reverse auctions can be adjusted as necessary to alleviate the credit crisis while maintaining competition that ensures taxpayers are not over paying for ill-liquid assets from financial firms. In addition, the value of mortgage-backed securities will be defined on the open market, which will not occur if the treasury were to purchase mortgaged-backed securities without competition between financial firms. This restoration of the open market for mortgage-backed securities will provide the foundation for the treasury to sell mortgaged-backed securities back to the private sector in the future.
In contrast, a reverse auction including a blank check [$700 billion] will result in taxpayers overpaying for the securities purchased and will not define the actual value of such securities. Such action is not necessary to alleviate the credit crisis, and will cost the taxpayers an exorbitant amount only to retroactively indemnify financial firms for their poor decisions.
I am very fearful that an overreaction will unnecessarily burden taxpayers and further weaken the United States? standing as an economic power in the world economy. Congress should alleviate the current credit crises using a measured response, not by writing a blank check retroactively indemnifying financial firms for their poor decisions.
I think the biggest question is why we think this $700 billion lipstick will work.
Paulson is proposing to prop up prices on a derivative market while doing nothing to support the fundamentals of the underlying (mortgage) market. Imagine if traders in S&P futures said they couldn’t trade any more without $700 billion of capital — you think that’d make your investments more valuable? Or that even if you got “equity” in the trading houses, there’d be anything there when you went to collect?
I can’t figure out why Paulson believes in an Industrial Policy of sinking $700 billion into “reinvigorating” the financial industry, the second-least productive industry in the US (after building McMansions, which, if anything, decrease our output per man-hour). What an anchor on the US economy!
Even with full benefit of doubt, the Mother of All Bailouts is hugely wasteful, and will only speed removing America from the leadership of the Free World. Sad.