da bailout...or not?

[spartonboat1]

Copyright laws may not allow this, but this oped piece by Sebastian Mallaby is from today's Sep 21 Washington Post regarding the pending actions to legislate a bailout. Frankly, he makes a reasonable case for much less drastic alternative solutions:
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A Bad Bank Rescue

By Sebastian Mallaby
Sunday, September 21, 2008; Page B07

With truly extraordinary speed, opinion has swung behind the radical idea that the government should commit hundreds of billions in taxpayer money to purchasing dud loans from banks that aren't actually insolvent. As recently as a week ago, no public official had even mentioned this option. Now the Treasury, the Fed and congressional leaders are promising its enactment within days. The scheme has gone from invisibility to inevitability in the blink of an eye. This is extremely dangerous.

The plan is being marketed under false pretenses. Supporters have invoked the shining success of the Resolution Trust Corporation as justification and precedent. But the RTC, which was created in 1989 to clean up the wreckage of the savings-and-loan crisis, bears little resemblance to what is being contemplated now. The RTC collected and eventually sold off loans made by thrifts that had gone bust. The administration proposes to buy up bad loans before the lenders go bust. This difference raises several questions.

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.


In the 1980s, the government did not need a strategy to decide which bad loans to take over; it dealt with anything that fell into its lap as a result of a thrift bankruptcy. But under the current proposal, the government would go out and shop for bad loans. These come in all shapes and sizes, so the government would have to judge what type of loans it wants. They are illiquid, so it's hard to know how to value them. Bad loans are weighing down the financial system precisely because private-sector experts can't determine their worth. The government would have no better handle on the problem.

In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals. If the government bought the most from the sickest institutions, it would be slowing the healthy process in which strong players buy up the weak, delaying an eventual recovery. The haggling over which banks got to unload the most would drag on for months. So the hope that this "systematic" plan can be a near-term substitute for ad hoc AIG-style bailouts is illusory.

Within hours of the Treasury announcement Friday, economists had proposed preferable alternatives. Their core insight is that it is better to boost the banking system by increasing its capital than by reducing its loans. Given a fatter capital cushion, banks would have time to dispose of the bad loans in an orderly fashion. Taxpayers would be spared the experience of wandering into a bad-loan bazaar and being ripped off by every merchant.

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.

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.

Congress and the administration may not like the sound of these ideas. Taking bad loans off the shoulders of the banks seems like a merciful rescue; ordering banks to raise capital or buying equity stakes in them sounds like big-government meddling. But we are in the midst of a crisis, and it shouldn't matter how things sound. The Treasury plan outlined on Friday involves vast risks to taxpayers, huge complexity and no guarantee of success. There are better ways forward.

smallaby@cfr.org
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Comments? On this site? shed the thought...

[Genesis]

http://fedupusa.org

'Nuff said. Go there, view the videos, read the papers.

Its right in front of your face.

Then do the right thing.

[Nonchalant1]

It's much bigger and wider than banks. He's WAY oversimplifying the issue by talking about banks. The biggest problem is that of real corporations that own securitized mortgages in their asset portfolio. These assets must be "marked to market" because of current gov't regulation laws, and when the money markets all over the country almost collapsed last week, many companies were going to get huge "margin calls" from their clearing houses, just because there was a mad rush on money market funds after one of them went belly up and two others stopped accepting requests for liquidating positions. It is a much bigger and potentially more dangerous thing than the writer, or the general public knows.

While I disagree with giving one person control over spending 700B with no real accountability or oversight, and Karl's right that it shouldn't be Paulson, the financial markets are, after all, a confidence game and that game was in the middle of completely blowing up last week. It still may be. Just looking at how we regulate banks, as suggested in the article, is far from enough.

Doug

[MikeP]

I have said many times that my knowledge of financial matters is miniscule. I frankly don't understand it at all. It's as if there is a missing part of my brain when this comes up. It doesn't compute at all.

I have listened on the news, etc to all the talk and I am still totally mystified as to why I should care or how this affects me at all. I am NOT saying that it doesn't, just that I don't see how it does.

Is there perhaps a few sentences in plain english that can help me understand how all this affects everyone? Certainly, I understand that if someone loses their job, they may not be able to make payments on things they purchased. But I don't have the impression that most people are losing their jobs. There's "less money available." What does that mean? If it simply means that based on my credit I can't get a loan for a new Lexus and have to buy an Accord instead I'd be annoyed but it's hardly a problem.

An attractive talking head on the news last night said this is worse than the great depression. How? I wasn't around then but based on what I've read of history, and my parent's description, this doesn't appear to me to even be remotely on the scale/impact of that.

Again, I am NOT trying to be sarcastic or anything. I REALLY don't understand all the drama.

[Boatsb]

Passages help me with the math here. I guess each taxpayer will only owe around 5.8Billion. If the dollar tanks that should be easier to pay off since each dollar is worth less right?

[Passages]

Oh goodness no - That would be alot. It works out to only $5833 per taxpayer.

Please do the right thing and add the $5.8k to your 2008 Fed tax return so this does not have to drag out.

Your bank will thank you, I'm sure.

[Genesis]

The $700 billion will NOT address the root cause of the problem and thus won't fix it. It will NOT restore confidence.

[Passages]

The $700 billion will NOT address the root cause of the problem and thus won't fix it. It will NOT restore confidence.

OK, pick a number. Whatever it is it won't be pretty.

[Boatsb]

Jim did I scare you? I love the "new math"

basically the 6K per taxpayer is not the biggest part of it. It's the fact that this would be the beginning of many more and oh by the way the companies that need bailing out have already hidden the profits from the years before so we cant have them bail themselves out.

If I remember it right it reads "the right to life liberty and the pursuit of happiness" Property was specifically removed. You do not have the right to own a home. Work for the privilege. Make smart decisions and you will reap the fruits of your labor. 2% down on an interest only variable rate loan is not a smart decision. Making loans to people who cant afford them is not a smart decision. The government bailing out the people who made bad decisions is not a smart decision. Let those who made the decisions pay the price.

[Traveler 45C]

Take a look at this....

http://www.msnbc.msn.com/id/26866149/