Mine is not a political blog. I have political views, but I try to keep them out of my writing here, because they aren’t relevant to my readers. This is a rare point where the two worlds collide, and I have to take a political stand.
Let me state this plainly at the beginning of my piece, so that you know where I am going: I am asking all of my readers, and all of the financial bloggers that read me to call their Congressmen, and ask them to oppose the Bailout Plan as currently structured. I am also asking the financial bloggers to ask their readers to do the same thing.
I don’t do things like this often, so understand that I think that this bailout plan is very ill-conceived. I also think that opposing the bailout should appeal to all, regardless of party affiliation.
Okay, now let me explain why, and propose an alternative. Some links to begin:
- Here is the proposed bill
- Here is a summary of the main points of the bill
- Here is a relatively neutral article from the Wall Street Journal on the issue.
- And another from Marketwatch
- Finally, a blog post from Paul Krugman, opposing the bill. (If Paul Krugman and I agree on something, there is something weird going on.)
As I stated in my last blog post:
The possibility of a new RTC could be a good or a bad idea. The main criterion is whether it is proactive or reactive. My answer my surprise many: reactive is good, proactive is bad.
What we don’t want to do is provide a place for companies to dump lousy assets at inflated prices. Instead, a new RTC should be a last resort place that the assets of failed companies go to until they are disposed of. Common and preferred equity should be wiped out, and bondholders should take haircuts. New loans should be senior to all old loans, similar to the situation with AIG.
Anyone going to the new RTC should feel pain, and a lot of it. It should be the last resort for companies that are failing. It should not try to keep companies alive, but merely conserve the value of assets, and prevent contagion. Remember, if the risk is not systemic, the government should not try to bail it out.
The current proposal is proactive. Proactive solutions are expensive, and do not fairly distribute the losses to those who caused them through their shoddy lending practices. The owners of bad assets should risk their equity before taxpayers put up one red cent. The government should not try to prevent financial failure, but prevent financial failure from spreading as a contagion. Common and preferred stockholders of failed institutions should be wiped out. Subordinated debtholders should take a haircut. But depositors and senior debtholders should be guaranteed, in order to protect other financial institutions that invest in those instruments, thus avoiding contagion effects.
Second, the proposed bill is vague, and offers the Treasury a “blank check” to do pretty much what it wants. Section 8 states: “Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.” Who are we kidding here? I don’t care how great the emergency may be, the other branches of government should be able to act as needed.
Third, there is nothing to assure that fair market value will be paid for assets. If an investment manager is hired, who could tell if he plays favorites or not? Clever investment firms will take advantage of the government and its agents, and only sell overpriced assets to the government.
Fourth, there is no easily identifiable upside for taxpayers here. If we bail out a firm, it should be painful, as it was for the GSEs and AIG, where most of the equity gets handed over to the government in exchange for a senior loan guarantee.
Fifth, though the name of the Resolution Trust Corporation has been invoked here, this is nothing like the RTC. The RTC only dealt with insolvent S&Ls. It did not try to keep existing S&Ls afloat.
This proposal is an expensive boondoggle and should be opposed by all. As one bit of evidence here, how many noticed that mortgage rates went up on the day the deal was announced? Here is a graph for Fannie 30-year fixed-rate mortgages (click to enlarge):
The announcement of a bailout may have caused mortgage credit spreads to shrink, but it caused Treasury yields to rise even more. The announcement was not a positive for the mortgage market, and my guess is that it will get worse from here.
Bring back the Resolution Trust Corporation, for real. Don’t do deals with solvent institutions. Let them figure out how to best maximize their financial positions on their own; after all, it was their great decisionmaking skills that got them into this.
But do do deals with insolvent companies. Take in their illiquid assets, reposition them, and auction them off once they are more saleable. To the extent that we bail out whole firms, make it so costly to the firms that it is clearly a last resort, as with Fannie, Freddie, and AIG.
I am willing to testify before Congress on this issue, not that I think that will happen. If anyone from Congress happens to read this and wants me to testify, please contact me here.
Finally, to any readers or financial bloggers that take me up on my request, I offer you a hearty thanks.