Friday, September 19, 2008

The Mother of All Bailouts

I don't have much time to blog today, but the big economy news is that, despite yesterday's late Wall Street surge... the economy is still in deep doody.

The current thinking on what the bailout would look like is this:
"What we are working on now is an approach to deal with systemic risks and stresses in our capital markets,” said Henry M. Paulson Jr., the Treasury secretary. “And we talked about a comprehensive approach that would require legislation to deal with the illiquid assets on financial institutions’ balance sheets,” he added.

One model for the proposal could be the Resolution Trust Corporation, which bought up and eventually sold hundreds of billions of dollars’ worth of real estate in the 1990s from failed savings-and-loan companies. In this case, however, the government is expected to take over only distressed assets, not entire institutions. And it is not clear that a new agency would be created to manage and dispose of the assets, or whether the Federal Reserve or Treasury Department would do so.

So some sort of entity buys up all the bad mortgages that banks are holding, perhaps renegotiates to make them more affordable, and then sells them back off at some later date. On its surface, this seems preferable to lurching from one government takeover to the next with no real plan... but it also means that nobody gets punished for bad investments except the US taxpayer... and will it even stabilize the market?

Robert Reich doesn't think so, and cries foul about the consequences to the American people:
However much bad debt there may be, that amount is surely far greater than the $394 billion of real estate, mortgages, and other assets that the old RTC bought from hundreds of failed savings-and-loans -- thereafter selling them off form whatever it could get for them. The Bailout of All Bailouts would therefore put taxpayers at far greater risk than they are even today, and require an unprecedented role for government in reselling assets. Another major step toward socialized capitalism.

A better idea would be for the Fed and Treasury to organize a giant workout of Wall Street -- essentially, a reorganization under bankruptcy, for whatever firms wanted to join in. Equity would be eliminated, along with most preferred stock, creditors would be paid off to the extent possible. And then the participants would start over with clean balance sheets that reflected new, agreed-upon rules for full disclosure, along with minimum capitalization. Everyone would know where they stood. Bad debts would be eliminated. Taxpayers wouldn't get left holding the bag. And there would be no "moral hazard" incentive for future financial wizards to take giant risks with other taxpayers' money.

I certainly like the idea of the companies responsible paying more of a price, but it strikes me as unfeasible to get Wall Street to agree to this... though when the alternative seems to be complete socialization of our economy, maybe it's possible?