House of Cards, part 3

Is the Paulson bailout plan the right way to go?

I’m increasingly thinking it’s not.  But let’s hear from some others:

Luigi Zingales, professor at University of Chicago, in his short paper “Why Paulson is Wrong”:

If banks and financial institutions find it difficult to recapitalize (i.e. issue new equity) it is because the private sector is uncertain about the value of the assets they have in their portfolio and does not want to overpay.  Would the government be better in valuing those assets? No. In a negotiation between a government official and banker with a bonus at risk, who will have more clout in determining the price?  The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich – at taxpayers’ expense.  If this subsidy is large enough, it will succeed in stopping the crisis.  But, again, at what price?  The answer: Billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses.

Zingales recommends a debt forgiveness plan which keeps the taxpayer out of the mess (and of course acknowledges that the financial folks far prefer a bailout!).

More points are made in this article, “Concerns about the Treasury Rescue Plan” by Douglas Elmendorf at Brookings.

First, the affected debt instruments are quite heterogeneous, which makes setting appropriate prices and quantities very difficult.

A second problem with buying troubled debt is that it provides the most help to the financial institutions that made what are, in retrospect, the worst investment decisions. Banks that stayed clear of this debt or sold such debt at cut-rate prices earlier this year in an effort to move beyond the crisis would receive no direct gain from such a program, while banks that made the biggest commitments to low-quality mortgages and have delayed dealing with their balance-sheet problems would be the biggest beneficiaries.

I’d suggest that we slow things down just a bit, rather than ramming a plan through Congress before anyone understands the ramifications…

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