Solving the Illiquidity Problem Alone Won't Be Enough

I just sent this in response to a question about how the bailout is supposed to work:

I'd say it this way, there are two problems.

1. People are stuck holding securities they can't sell and can't borrow against. Since they borrow short and lend long, that's a killer. The problem is that there are hidden bombs in the asset portfolios, and nobody knows which securities will blow up. By trading for these frozen assets (some of which are perfectly fine) and replacing with safe, low risk or risk free assets, they ought to be able to borrow/sell again and credit will resume flowing.

That's an illiquidity problem. It's caused by toxic assets. The hidden ones freeze up the whole system since nobody wants to end up with them. Why give up cash unless the i-rate is really, really high, too high?

2. The other problem is solvency. Now, some people think that if you solve the illiquidity, it will allow the firms to borrow and recapitalize themselves.

Others think this will require additional injections of safe assets - say cash or bonds. Solving the illiquidity problem alone won't be enough.

I don't want to take chances, so I say (1) get rid of the toxic stuff, that helps the liquidity problems (2) add additional capital to help with solvency, this is extra insurance in case freeing up credit markets by solving the liquidity problem isn't enough by itself, and (3) give taxpayers a stake in all of this for their troubles. The exact form of that stake isn't as important as the fact that they have one.

Comments

[MarvinMBA:]

Let the junk bond holders rework the real estate and assets they acquired like everyone else that holds secure paper. Why bail them out? This is a raid of our very lives and existance and Congress is destroying the US if this giveaway deal to the holders of this paper proceeds. Marvin the Maven

2008 Sep 22 01:42 PM

[JasonC:]

Instead the dems have decided it is class warfare Christmas and are recklessly demanding every socialist measure they can think of as a condition for passage.

Which is so irresponsible I would not have considered it possible as recently as last week. What insufferable clowns, they couldn't run a hotdog stand let alone a country.

2008 Sep 22 01:44 PM

[JohnKing:]

The toxic stuff has to be exposed.

Who can buy something with a mystery value?

A bailout won't solve anything, Paulson will just assign value to protect his freedom (he was complicit in these instruments while running Goldman) and his buddies.

Allowing a financial predator like Paulson to run a "bail out" of his buddies is like assigning child care duties to a known pedophile.

2008 Sep 22 01:45 PM

[gabe borens...:]

This is a total economic nonsense.Solvency is not an issue for corporate America-liquidity is.Lack of liquidity effects business but it could be "deadly" to the American taxpayers.Lack of liquidity - more precisely the lack of functional financial system will bring economy to a standstill and cause an implosion (global) that would make the Great Depression look like a booming economy.
The Treasury's "stability" plan may appear like a hand out to Wall Street ,but in reality it is a radical approach to saving working Americans from an economic Armageddon.
Enough of this ridiculous criticism also eminating from the CNBC's yellow journalism reporters ,let's get behind this mega stabilization plan .The job you are saving is your own.
The financial plan as proposed will work and contribute to a record economic and market rebound
The nonsense we hear is reflective of the record open short interest .
We should have a moratorium on all of the short positions in all of the sectors.

2008 Sep 22 01:51 PM

[Broken:]

JasonC :
"Instead the dems have decided it is class warfare Christmas and are recklessly demanding every socialist measure they can think of as a condition for passage"

Heh.
"Reckless" measures like oversight of King Henry's bailout and "class warfare" like insisting that bailout money doesn't turn into golden parachutes? Communist Democrats!

But socializing bank losses for $1 trillion? Pure capitalism, baby!

2008 Sep 22 02:35 PM

[phdinsuntan...:]

buy PPF: Paulson Pension Fund

2008 Sep 22 02:55 PM

[mlyn:]

JasonC:

Both parties are responsible for this, but the Republicans via the neoconservative base, have wrecked this economy. The wrecking crew has been active since the 1970's when the U.S. went off the gold standard, was supported further in the 1980's when Reagan was in office, demoralized in the 1990's when Clinton was reigning but used social values and Monica to repeal the Glass-Steagall Act, and then the last eight years of the Bush-Cheney regime really, really killed transparency and acountability. (Elliot Spitzer also was taken down.)

The neoconservatives are taking the American public down the road of fear and fascism. Whether or not John McCain wanted this, he went to the "dark side" when he accepted the neoconservative condition of having Sarah Palin as his sidekick. All his advisors are lobbyists for Wall St.

2008 Sep 22 04:33 PM

[TinyTim:]

Do nothing and don't assign partisan blame.
I don't believe the sky will fall, just Wall St
Let the markets sort out the toxic elements.

2008 Sep 23 10:14 PM