The Ashford Zone Blog

BERNAKE, PAULSON URGE SPEEDY BAILOUT reads the headline right now at MSNBC.

Speedy.  Gotta do it.  Right NOW.

But why?  I find myself influenced by today’s NYT op-ed:

With all due respect to Mr. Paulson, who is widely regarded as a smart and fine man, we need to slow this process down. We got into this mess by handing out mortgages like lollipops to people who paid too little attention to the fine print, who in many cases didn’t understand it or didn’t care about it.

And the people who always pretended to know better, who should have known better, the mortgage hucksters and the gilt-edged, high-rolling, helicopter-flying Wall Street financiers, kept pushing this bad paper higher and higher up the pyramid without looking at the fine print themselves, not bothering to understand it, until all the crap came raining down on the rest of us.

Yes, the system came perilously close to collapse last week and needs to be stabilized as quickly as possible. But we don’t know yet that King Henry’s fiat, his $700 billion solution, is the best solution. Like the complex mortgage-based instruments at the heart of this debacle, nobody has a real grasp yet of the vast implications of Mr. Paulson’s remedy.

Obviously, we need to move fast.  But not so fast that we make a bad situation worse.  And certainly not so fast that we reward those who precipitated this mess in the first place.  When you consider that the people who got us into this mess are largely the people who are now advocating a "no strings attached" bailout, you should err on the side of caution.  Expedited caution.

UPDATE:  Matt Yglesius wonders why Paulson needs all $700 billion this week, since he can’t possibly spend that much even by the end of October.  So why not give him some, monitor how it goes, have a second stimulus later, etc…..

(1)  Good post from Ezra Klein explaining five things wrong with it

(2)  Isn’t it amusing how conservative Republicans are suddenly indignant about overreaching executive branch power with no oversight?

(3)  Japan and Europe tell us they won’t go along with our bailouts corporate welfare, and refuse to make their taxpayers finance the corporate mistakes. And Angela Merkel asks an interesting question: if this is so important to do now, why did the Bush Administration refuse to discuss increased financial regulation last year at the G7?

Look, we all know what is going on.  Paulson is proposing a system wherein profits go to investors, but losses become socialized.  That is NOT what Adam Smith envisioned.  It’s not even capitalism.

Read "Why Paulson is wrong," a two page essay being circulated by Luigi Zingales, the Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago. An excerpt:

When a profitable company is hit by a very large liability, as was the case in 1985 when Texaco lost a $12 billion court case against Pennzoil, the solution is not to have the government buy its assets at inflated prices: the solution is Chapter 11. In Chapter 11, companies with a solid underlying business generally swap debt for equity…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 the 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.

What’s the alternative?  Well, what do we normally do when companies go belly-up?  They file for Chapter 11.

The problem is that going through bankruptcy court takes time.  A looong time.  And the economy doesn’t have that kind of time.

But so what?  Zingales argues that we simply "ram" a restructuring program down the throats of these investment banks.  The government basically forgives the debt — wipes it out — in return for some equity in the companies.  In effect, the government would own parts of these companies as a whole, rather than buying the "toxic" assets of those companies.  And pretty soon (one hopes) the government will recoup its investment (because the debt-to-equity ratio of these companies will go down).  This was done before, in the 1930’s.

The benefit?  Well, it means the taxpayers won’t be burdened with $700 billion in a bailout.  Not that much.

Why isn’t anyone proposing this?  Because Wall Street lobbyists have the hearts and minds of the people in Washington, including Paulson.  Under Zingales’ plan, Wall Street will actually bear a portion of the pain.  And they don’t want that.  The common taxpayer, you and I, don’t have a voice.

UPDATE:  It looks like the Dodd proposal is pretty close to the equity-for-debt "bailout" that Zingales envisioned.  It also has provisions limiting top executive pay and bonuses.

The latest update is that Paulson is looking to spend $1.8 trillion to bailout and essentially socialize the investment banking industry.

Just to give you an idea about how much money that is, here’s some comparisons, from the 2007 Bush budget.

* Veterans’ benefits at $73 billion
* Education was $90 billion
* Interest on US debt was $244 billion
* Medicare $395 billion
* Defense was $548 billion
* Social Security was $586 billion

Those are billions, not trillions.

In total, the 2007 federal budget was a total of $2.8 trillion.   And now we’re adding another $1.8 trillion.

Where will it come from?  Well, taxes of course.  Either that, or we will increase the deficit tremendously.

Below is a Statement of Principles for the Treasury Proposal from Senator Barack Obama:

• No blank check. If we grant the Treasury broad authority to address the immediate crisis, we must insist on independent accountability and oversight. Given the breach of trust we have seen and the magnitude of the taxpayer money involved, there can be no blank check.

• Rescue requires mutual responsibility. As taxpayers are asked to take extraordinary steps to protect our financial system, it is only appropriate to expect those institutions that benefit to help protect American homeowners and the American economy. We cannot underwrite continued irresponsibility, where CEOs cash in and our regulators look the other way. We cannot abet and reward the unconscionable practices that triggered this crisis. We have to end them.

• Taxpayers should be protected. This should not be a handout to Wall Street. It should be structured in a way that maximizes the ability of taxpayers to recoup their investment. Going forward, we need to make sure that the institutions that benefit from financial insurance also bear the cost of that insurance.

• Help homeowners stay in their homes. This crisis started with homeowners and they bear the brunt of the nearly unprecedented collapse in housing prices. We cannot have a plan for Wall Street banks that does not help homeowners stay in their homes and help distressed communities.

• A global response. As I said on Friday, this is a global financial crisis and it requires a global solution. The United States must lead, but we must also insist that other nations, who have a huge stake in the outcome, join us in helping to secure the financial markets.

• Main Street, not just Wall Street. The American people need to know that we feel as great a sense of urgency about the emergency on Main Street as we do the emergency on Wall Street. That is why I call on Senator McCain, President Bush, Republicans and Democrats to join me in supporting an emergency economic plan for working families – a plan that would help folks cope with rising gas and food prices, save one million jobs through rebuilding our schools and roads, help states and cities avoid painful budget cuts and tax increases, help homeowners stay in their homes, and provide retooling assistance to help ensure that the fuel-efficient cars of the future are built in America.

• Build a regulatory structure for the 21st Century. While there is not time in a week to remake our regulatory structure to prevent abuses in the future, we should commit ourselves to the kind of reforms I have been advocating for several years. We need new rules of the road for the 21st Century economy, together with the means and willingness to enforce them.

It all sounds good, but Bush is already saying he WON’T support legislation to limit excessive CEO pay, he WON’T bailout homeonwers…

But at least this country is unified on one thing.  In a recent survey, ZERO percent said that the economy was getting better.  When was the last time a survey like that ended up with a zero percent?

Also, in another question, ZERO percent said that their household financial situation is better.

What should Wall Street give up in order to get the blank check from the government (i.e. us, the taxpayers)?  Robert Reich has some ideas I like:

1. The government (i.e. taxpayers) gets an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.

2. Wall Street executives and directors of Wall Street firms relinquish their current stock options and this year’s other forms of compensation, and agree to future compensation linked to a rolling five-year average of firm profitability. Why should taxpayers feather their already amply-feathered nests?

3. All Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers. Why should taxpayers finance Wall Street’s outsized political power – especially when that power is being exercised to get favorable terms from taxpayers?

4. Wall Street firms agree to comply with new regulations over disclosure, capital requirements, conflicts of interest, and market manipulation. The regulations will emerge in ninety days from a bi-partisan working group, to be convened immediately. After all, inadequate regulation and lack of oversight got us into this mess.

5. Wall Street agrees to give bankruptcy judges the authority to modify the terms of primary mortgages, so homeowners have a fighting chance to keep their homes. Why should distressed homeowners lose their homes when Wall Streeters receive taxpayer money that helps them keep their fancy ones?

Chances of any of these happening?  Zero.

Whhhheeeeeeeeeeeeeeeeeeeeeeee!