I always thought it was funny when friends who worked in banking would refer to a risky bet on the market as a "huge position." Now I'm less amused, but huge positions are exactly what the problem was in the market. A big reason that there are no longer any independent investment banks is that the SEC eased its rules in 2005 to let just five of them borrow money at a 30 or 40-1 ratio of debts to assets (the typical spread is 10 or 12-1). Those five are now either collapsed or, in the case of Goldman Sachs and Morgan Stanley, have become bank holding companies, submitting to additional regulation in order to accept deposits that would provide them with a base of solid capital. Their decision represents a voluntary return to the mechanisms of the New Deal.
But now the federal government wants to take a huge position, offering $700 billion to companies to buy their bad assets. This isn't a good plan, as you can see from these commentators -- I recommend this essay as well [PDF]. The government's offer to buy up bad assets at what will effectively be higher than market value while obtaining no value for taxpayers is ridiculous. It's a bad bet -- unless Congress demands that companies go into bankruptcy when selling their bad assets, or ensures the government a share of future profits through a capital injection, as Paul Krugman argues. Making this bill fair in the face of Bush administration and public pressure for a quick solution will be a big test for the Democratic leadership in the House and Senate.
Now the big joke is asking for bailouts of your own. But your position isn't huge enough; the new rule is "the more you screw up, the less you pay." Only when you become irresponsible on a grand scale do you get to walk away from your mistakes without paying the price. Some friends of mine think the people responsible for this mess should go to jail, but there are probably all too many of them. They should not, however, be allowed to walk away without paying the market price for their poor business decisions.
--Tim Fernholz
