Hoping Paulson's Plan Works Is Not a Plan 18 comments
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I really hate to disagree with Kevin Drum. He's thoughtful, moderate, level-headed, smart. He's the kind of guy who is, on balance, usually right. So, it makes me nervous to read his recent post, Pass the Effin Bill.
I don't know if the financial universe will blow apart if Asian markets open Sunday night and there is no bailout in sight. I do know that the TED spread may not be telling us what we think it is, that the current proposal has almost nothing to do with the stressed out corporate paper market except via the catch-all term "confidence", and that the timing of bank failures is largely at the discretion of the FDIC. I accept the principle that it is worth bearing significant costs to insure against even uncertain catastrophes, but other than cries of inchoate pain from anything labeled financial, I have yet to hear a compelling tale of why we should be confident that this expensive ounce of prevention will actually work. Hope is not a plan, and neither is discomfort.
Of course, the people advocating the Paulson Plan have the capacity to create pain that might be perfectly avoidable. Yes, that's cynical. But that's honestly where I am. Not only do I not have confidence in the solvency of the banking system, I don't even have confidence that important players in both the public and private sectors wouldn't use the tools at their disposal to create a little pain, until they bully the public into giving what they want. I know, I know, give me my tinfoil hat. But, if you believe the advocates of the Paulson Plan, major financial institutions would be insolvent if they marked their assets to current (um, "fire sale") market bids. That's not what their balance sheets say. If it's true, investors and the public at large have been lied to for months by the leaders of the institutions to which we are expected to trust our life's savings. And they want us to help cover that up. So, I'm cynical.
Anyway, for better or for worse, I was finally moved to get political and write my representatives in Congress. I hope this was the right thing to do. For whatever it's worth, here's what I wrote:
September 27, 2008
To: Representative Ben Chandler
Senator Jim Bunning
Senator Mitch McConnell
Re: the “bail-out” (Fax transmission, 3 pages including this page.)
Like many voters, I feel helpless and angry as an astonishing bail-out of our corrupt and obsolete financial industry wends its way through the Congress. I am a new resident of Kentucky, have lived here for just over a year. The three of you are now my voice in Washington.
I am a doctoral student in finance at the University of Kentucky. I am not the world’s foremost expert in anything, but I am making the study of financial markets my vocation.
The legislation submitted by Secretary Paulson last weekend, if passed, would have been an astonishing arrogation of unchecked power. I fear for the United States of America that the proposal was even considered by the Congress, and described as “a good foundation” by Senator Schumer. After his crass attempt to assume near dictatorial power, I have lost my trust in Secretary Paulson. I believe this financial industry insider must be kept on a very tight leash for the few months he has left to help his friends and former colleagues on Wall Street.
I do, however, believe that we face a financial emergency, and that the Congress could play a constructive role in resolving the crisis in a manner that protects taxpayers and the general public and ensures that those responsible for our financial collapse bear most of the costs. I think there are two workable paths, one fully public and one fully private. I am open to both approaches. But I am adamantly opposed to a "public / private hybrid" solution, because frankly, I don’t think even our most well-intentioned public officials can avoid being milked and hoodwinked by the world’s greatest dealmakers. Either the Federal government should take over failing institutions, as it has taken over the insurance giant AIG, or the barrier between the public purse and the private banks should be made impermeable. The first thing that any legislative proposal should do is remove the gun that bankers currently hold to the head of our nation: the threat of disorderly bankruptcies. All systemically important financial firms should be subject to a controlled procedure in the event of insolvency, and should only have access to ordinary Chapter 11 reorganization or Chapter 7 liquidation after regulators have vouchsafed that such a filing would not imperil the nation’s financial system. Similarly, a petition by a creditor for involuntary bankruptcy should trigger the same regulatory review.
The Congress should choose either a private sector or public sector approach to managing the failure of systemically important firms. A private sector approach should follow the principles outlined by University of Chicago Professor Luigi Zingales. [See http://faculty.chicagogsb.edu/luigi.zingales/Why_Paulson_is_wrong.pdf] All of our financial firms are "asset rich" — they have plenty of money, it’s just that they have too much debt. They can be rendered liquid and solvent by requiring some creditors to accept equity in the firms in exchange for their debt claims. This is a perfectly fair outcome: People who lent these highly leveraged companies money knew or ought to have known they were taking a risk, and capitalism requires that lenders every bit as much as stockholders take responsibility for the soundness of the firms in which they invest. Unless these firms are quite profoundly insolvent, most creditors should take only a small haircut on the value of their debt, and could profit over time if the firms recover. Even the thorny issue of derivatives and other contingent liabilities can be addressed in this fashion: Firms that undergo a “fast-track reorganization” would be given the right to pay these obligations in the form of $1 par value preferred stock (the structure of which would have to be defined by Congress). Counterparties to derivatives transactions would undoubtedly prefer cold cash to company stock, but at least these contracts wouldn’t become fully worthless, as they would have under ordinary bankruptcy. Since counterparties would take only a haircut rather than a total loss, debt-to-equity conversions would help minimize the likelihood of cascading defaults on derivative contracts, the dreaded "CDS meltdown".
A public sector approach the problem would be to let the controlled failure of AIG serve as a model for systemically important financial firms. The banks that are today failing took on huge and foolish risks. (That "everyone was doing it" is a schoolboy’s excuse, not acceptable from people entrusted to manage trillions of other people’s money.) If as a consequence of their poor decisions, they now need money from the Federal government, we should demand that the taxpayer take effective ownership of the firm in exchange for the support. Regulators could then ensure a reorganization that promotes systemic stability while minimizing taxpayer costs, following which firms could be reprivatized in small, conservatively financed pieces that would no longer be "too big to fail".
Both the private sector and the public sector approaches presented here are workable, protect taxpayers’ interests, and avoid rewarding malefactors of great wealth with gargantuan public subsidies. The hybrid approach at the core of the Paulson Plan will result either in a serious cost to the taxpayers, or in future inflation as the Federal balance sheet is stretched to the breaking point and people lose confidence in US Treasury securities. (With a high enough rate of inflation, the Treasury can definitely turn a paper profit on any trash it buys from Wall Street, but that paper won’t be worth much. We could avoid a lot of foreclosures if we devalued the dollar by 50%.)
I am an independent voter. At the Presidential level, the Republican Party has already lost my vote. The last eight years have been catastrophic for the country, and accountability demands a change of party in the White House. At the Congressional level, however, my vote is up for grabs. Frankly, your response to the current financial crisis is my litmus test issue.
If there is any way I can be of service as you work through these difficult issues, I would be very honored to help. I thank you for your time and consideration.
Sincerely,
Steve Waldman
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A good number of the average workers are now out of jobs and out of house or if still employed struggling to pay the mortgage if they bought within the last few years.
To add insult to the "injury" sustained the last 8 years they are now being asked to pay up and shut up to the tune of $700,000,000,000 (with another $500,000,000,000 in the wings, according to billionaire Bill Gross) and bail out the capitalist elites responsible for the current mortgage mess and its amplification, many times over, by elites private and unregulated financial derivative games; now aptly characterized, by Warren Buffet, no less, as "weapons of mass destruction"...
So, one can understand why the masses are a little bit upset and "up in arms", as it were.
If you want to bring politics into it-who is trying to slow it down?
And for good reason I may add.
I know that liquidity is important (see Bernanke's 1983 essay on the root causes of the Great Depression), but there is an equal evil here that no one seems to want to address: housing prices continue to fall significantly!
Our financial "engineers" promoted the absurd notion that you could create prosperity out of a mountain of debt.
As long as new debt was being created it worked fine.
Unfortunately that mountain of debt was built on the backs of the American Consumer and we are TAPPED OUT.
This "bailout" is an end game ploy to compell us to take on more debt which is a confiscation of our future earnings, using the force of law.
They get the money right now and the taxpayer gets a deeper hole and an intergenerational transfer of wealth.
Does anyone see the FLAW?
Remeber, this is a Ponzi scheme, it only functions as long as new debt is being created. This merely prolongs a scheme that will inevitably fail.
Bondholders and shareholders of these failing banks should be completely wiped out, they understood the risks they invested in and they should be vanquished. I honestly don't care if the collapses take down the Federal Reserve system. There should be no assumption of their risks by the taxpayer. Period.
No Bailout, No Way, No How...Let them burn!
So naturally the majority of people are against the bailout bill, including me in principle, because it looks - to me and everyone else - like they are trying to keep The Ponzi Scheme alive and reward the Leveraged Debt Industry players.
However, I think the govt is trying to pass this politically toxic bill to prevent something much worse from happening this fall, which could be politically much more toxic than this bill.
Here's something that is true of just about everyone with a bank account: I don't know the real exposure of my bank to these derivatized securities because it is obvious that the ratings agencies either have not been 100% truthful, or things change very fast when so much leverage is involved, or both. I suspect that this truth is dawning on many others about now, which is why there couId be alot more pain in the banking industry, very soon.
But especially if this bailout bill fails.
The mind boggles at such misplaced blame.
The Dems run Congress. The Dems protected fannie in 2005 when Republicans wanted better oversight. Obama is in deep with Raines and Johnson and got more Fannie Mae money than anyone except Chris Dodd, who was #1 recipient. Fannie Mae incited the subprime lending boom and bust.
Meanwhile the Dems are the majority in Congress and have managed to destroy trust and confidence in Govts handling of the economy through repeated attacks on CEOs, on business ('big oil' etc), tax hikes, regulation attempts/sprees, and wild meddling.
In this bailout bill alone, they wants a budget-busting diversion of money to ACORN, a 'destroy-mortgage-cont... clause on bankruptcy, unions on corporate boards, and Govt ownership of banks.
Socialist is no longer a hyperbolic term for these guys.
What a sad and sorry spectacle. The Dems cause a problem, the Repubs get the blame, the Dems gain more power and cause more problems - rinse and repeat. We had FDR, we had LBJ and now we will get BHO, the third Liberal Reich.
I would like all reader to not fill up there cars and put gas into your tank daily, 5 gallons
Why, if we can get 2/3rds of all drives to do this where will the gasoline and oil companys stor all that extra gasoline
someone can do the math thanks
100 cars 20 gallon tank = 200 x 20,000 car = 4,000,000 gallons of gas @ 3.89 per gallon you do the math
now if we can just take five minutes per day and only put in what we use each day were will they stor the rest of that gas .
I would like to start this movment for six months
Please spreed the word, if we are lucky american will at least have better control on gasoline stortages.
we will be getting lower gas prices or the oil companys will spend more money in storage, I think we will have a win win
so please help send this to 20 of your friends and ask them to sent it to 20 more till we hit 20mil
add anything you can to help suport this
Thanks Victor