×
For a very clear explanation of the odd thinking behind the bailout proposal, read "Why Paulson is wrong," a two page essay being circulated by Luigi Zingales, the Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago. An excerpt:
When a profitable company is hit by a very large liability, as was the case in 1985 when Texaco lost a $12 billion court case against Pennzoil, the solution is not to have the government buy its assets at inflated prices: the solution is Chapter 11. In Chapter 11, companies with a solid underlying business generally swap debt for equity...If banks and financial institutions find it difficult to recapitalize (i.e., issue new equity) it is because the private sector is uncertain about the value of the assets they have in their portfolio and does not want to overpay. Would the government be better in valuing those assets? No. In a negotiation between a government official and banker with a bonus at risk, who will have more clout in determining the price? The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich—at the taxpayers’ expense. If this subsidy is large enough, it will succeed in stopping the crisis. But, again, at what price? The answer: Billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses.Chapter 11, of course, takes some time, and time is obviously of the essence. But as Zingale argues, there's ample precedent for government to simply ram a debt restructuring plan through the system. We did in the 30s, and the Courts upheld the move. More importantly, the market approved too. Stock and bond prices soared after the decision. So why aren't we doing this now? Well, as Zingales says, the problem isn't with the economics of such a solution. It's with the political economy of it. A debt-for-equity swap may solve the problem, but from Wall Street's perspective, it's certainly better to have the Treasury buy up assets for inflated prices. That way, the government will bear the losses, rather than Wall Street. If the government forgave the debt in return for some level of equity (or, basically, ownership), then it's pretty likely that the government would recoup its investment and Wall Street would bear the losses. Zingales again:
It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few. Since the many (we, the taxpayers) are dispersed, we cannot put up a good fight in Capitol Hill; while the financial industry is well represented at all the levels. It is enough to say that for 6 of the last 13 years, the Secretary of Treasury was a Goldman Sachs alumnus.It would've been one thing if Paulson had come to Congress and begged them to approve an emergency plan that erred on the side of protecting taxpayers. To come to Congress and err on the side of protecting his former colleagues from losses takes rather a lot of gall, but that's exactly what Paulson is trying to sneak in beneath the cover of emergency. By offering such a lopsided bailout proposal, it is Paulson, not his critics and not the Congress, who has put the speed of the response at risk.
