Bail Out...Here Comes the Cave Again?

$700 billion. $.7 Trillion. It is a lot of money. It might be a little early but i suspect that this financial crisis will come to be one of the most important events in any presidential election. It will also have a major impact on America and the economy for the foreseeable future. Exactly how this bail out goes down will be crucial for everyone. From reading the reaction of people i trust around the net the current proposal looks like a major fail. Right now the proposal and its possible consequences are being reviewed in democratic offices and i cant think they like what they see.

There are several issues with the proposal in its current form. The biggest issue is that we are not getting anything for this. I mean that the tax payers are shouldering all the burden and receiving no potential upside. Krugman explains,

Here’s the thing: historically, financial system rescues have involved seizing the troubled institutions and guaranteeing their debts; only after that did the government try to repackage and sell their assets. The feds took over S&Ls first, protecting their depositors, then transferred their bad assets to the RTC. The Swedes took over troubled banks, again protecting their depositors, before transferring their assets to their equivalent institutions.

The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system — that is, convince creditors of troubled institutions that everything’s OK — simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem — which seems doubtful — or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.

And there’s no quid pro quo here — nothing that gives taxpayers a stake in the upside, nothing that ensures that the money is used to stabilize the system rather than reward the undeserving.

Do not reward the undeserving. That is the GOP line on every social program in existence. Cant help people who might not deserve it. With them, somehow it always ends up that no one deserves it. Now the roles are reversed as it is responsible liberals who want to make sure that the people who dont deserve it, the people in charge of the companies, are not rewarded by their massive failure.

Krugman is not the only economist who looks at this thing and gets major warning bells. Those bells are going off everywhere. Three other articles are available that think this is not the right way to go. One in the WaPo by Sebastian Mallaby, one by Douglas W. Elmendorf at the Brookings Institute, and one by Luigi Zingales and Robert C. Mc Cormack of the University of Chicago each are hounding on the point that this deal makes no sense for the tax payers.

The articles all say that we need to do this some way where the people who created this mess are not getting off free. Rajan and Zuniga,

The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few. Since the many (we, the taxpayers) are dispersed, we cannot put up a good fight in Capitol Hill; while the financial industry is well represented at all the levels. It is enough to say that for 6 of the last 13 years, the Secretary of Treasury was a Goldman Sachs alumnus. But, as financial experts, this silence is also our responsibility. Just as it is difficult to find a doctor willing to testify against another doctor in a malpractice suit, no matter how egregious the case, finance experts in both political parties are too friendly to the industry they study and work in.

The decisions that will be made this weekend matter not just to the prospects of the U.S. economy in the year to come; they will shape the type of capitalism we will live in for the next fifty years. Do we want to live in a system where profits are private, but losses are socialized? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalized and prudent behavior rewarded? For somebody like me who believes strongly in the free market system, the most serious risk of the current situation is that the interest of few financiers will undermine the fundamental workings of the capitalist system. The time has come to save capitalism from the capitalists.

That encapsulates it right there. These are people in the know and they think this deal sucks for america. I cant comment on how well their proposal to, "cram down a restructuring plan on creditors, where part of the debt is forgiven in exchange for some equity or some warrants". would work but it certainly makes more sense to a layman that the treasury plan does. The Elmendorf proposal is similar in that it focuses on a debt for equity swap as opposed to a straight buying of the debt.

An alternative to the government buying certain types of debt from financial institutions is for the government to make equity investments in a wide cross-section of such institutions. For concreteness, suppose that the government offered to make an equity investment in every firm regulated by a federal or state banking regulator equal to 10 percent of the market value of the company as of September 1st in exchange for a 10 percent equity stake in the company. (The 10 percent figure is illustrative. As with the first approach, a judgment about the appropriate total amount of government funds would need to be made.)

With this approach, the government would not need to determine the appropriate prices and quantities of individual mortgage-related securities, it would not be providing a greater reward to companies that have made the worst investments, and it would gain the opportunity for taxpayers to receive a higher return if the financial system recovers more strongly.

These proposals deal with the problem of the proposal of buying up the debts on its merits as an economic idea. They dont even address the other big problem that has been exposed with the proposal, unlimited power to the treasury secretary. Matt Yglesias summed it up,

To give the regulatory authorities who failed to prevent this crisis carte blanche to hand out money to the financial institutions who caused the crisis while doing nothing for ordinary people would be outrageous.

So the basic situation is that we have Bush and the GOP including John McCain who wants to create an institution to buy up the bad debt from the banks in just they way the economists oppose on one side. On the other side we have the dems and Obama and the economists. Obama has yet to make a strong statement for or against the proposal. Nancy Pelosi is on record with the insightful,

“Democrats will work with the administration to ensure that our response to events in the financial markets is swift, but we must insulate Main Street from Wall Street and keep people in their homes.”

Ms. Pelosi said Democrats would also insist on “enacting an economic recovery package that creates jobs and returns growth to our economy.”

I wrote a couple days ago that this occasion was the textbook occasion for the implementation of the shock doctrine. Either the dems could do it putting in place a policy that would reign in the excess and make sure that if the tax payers were asked to bear this burden they at least had the potential for some upside. I think this is still true. Opinions on the plan are in flux and the public has not been swayed one way or another on the the plan. Unfortunately the dems are now a step behind because the base proposal is gop style shock doctrine.

The public is not going to wait long for action on this thing. They understand that this could be very very bad and action needs to happen quickly. This puts the dems in a bad spot because the GOP will be taking every opportunity to claim they are playing politics with the relief effort. The dems have talked about taking on a lot of pork projects but imo that is a loser. fighting this battle on the merits of the proposal will be hard enough without handing the gop a weapon to use against the bill.

A fight is being set up here because the dems are going to have to work really hard to get this proposal to be anything other than a give away to the bankers. This gets me pretty worried because well, the dems have no spine. Even Obama has not shown a marked willingness to lead a battle on anything like this. He was not there when we needed him on fisa. Maybe this will turn out different.

What we really need is a concerted effort by everyone we can get to fight this an get something for the taxpayers. We need to get oversight, the elimination of golden parachutes and ridiculous ceo pay. this deal cannot stand as is.



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