Ezra has a post on the new plan to convert the preferred shares in banks bought with TARP funds into common equity; he gets the policy debate right but fudges a little on the politics. First, what it all means:
This entails some new risk for the taxpayer. The preferred shares acted much like a loan. So long as the bank was solvent, we were pretty sure to be repaid. Equity isn't like that. If the bank limps along, and we want to cash out our equity at some point, we may well lose money on the deal. The point of dispute between folks like [Paul] Krugman and folks like [Felix] Salmon is whether you think the preferred shares that the government previously held were more like loans or more like equity. If the market was indeed treating them as equity, then this won't increase capitalization much. If it was treating them as the equivalent of bonds, as Salmon suggests, then it well might. The answer, in theory, will come clear soon enough.
One thing to note in the above is "so long as the bank was solvent, we were pretty sure to be repaid." Critics of this move like Krugman and others are convinced the banks are insolvent, so it seems an equity stake just takes us closer to seizing the banks for a government-mandated restructuring. Salmon's take seems to put this move in the perspective of the administration's continuing efforts to help the banks limp to solvency while avoiding both the high up-front costs of recievership and the needed task of radically restructuring the financial industry.
Back to Ezra's post. He writes that "when the story of all this is written, the amount of effort the administration expended finding clever ways to avoid Congress will play a starring role." This is backward. In this case, the administration isn't finding a clever way to avoid Congress; Congress is trying to avoid the huge expenses that would come with either a) taking insolvent banks into receivership or b) adding additional funding to the TARP. It's not as though Congress has a better idea about what to do in response to the financial crisis and the administration is avoiding it; almost all congressional attention to TARP has been focused on putting greater oversight on funds already allocated and questioning the current plan's efficacy. Nor is this a case of the administration trying to avoid the oversight mechanisms Congress is pushing. Instead, the dynamic at play here is such that, when the story of all this is written, the amount of effort the administration expended finding clever ways to extend their limited rescue funding -- perhaps at the expense of a quicker recovery -- will play a starring role.
-- Tim Fernholz
