Monday, September 22, 2008

Deal or No Deal (U.S. Congressman Edition)

. Monday, September 22, 2008

Hate to make this place all-bailout, all-the-time, but that's the biggest issue of the day.

If I'm a U.S. Congressman, and I'm being asked to give $700bn to the Treasury Department with no string attached, I say "no deal" whether I'm a Republican or a Democrat. If I'm a Republican, I'm ideologically opposed to massive government programs with essentially no oversight. I'm concerned about the fact that the current Treasury Secretary will likely be replaced in five months, and will presumably be seeking a job on Wall Street at that time. The term "moral hazard" has been tossed around a lot in recent weeks; this plan, if enacted, would immediately go in the Guinness book. If I'm a Republican, I'm also worried that I don't know who the new Treasury Secretary is going to be in five months, he's probably going to be appointed by President Obama (still the favorite according to the betting markets), and if the Congress gives up power to the Treasury Department now it may not get to change its mind later. I'm also wary of the provisions which will be added by Congressional Democrats in exchange for their votes. I note that right-leaning economists are very skeptical of this plan, and not just the far-right libertarians.

If I'm a Democrat, I'm thinking that I'm generally not happy with the way the Bush administration has used the unilateral authority it's had in the past. I'm thinking about Iraq (and not just the decision to invade), a host of civil liberties issues, lack of transparency in general, and corporatist tendencies. I'm thinking about the fact that while McCain is still an underdog he still has a 48% chance of winning (per Intrade), and his most notable executive decision so far has been to appoint Palin as his running-mate, which doesn't give me much confidence about his ability to pick capable technocrats in his administration. I'm very worried about the lack of oversight, since in this proposal Treasury decisions are non-reviewable by the Congress or the courts, essentially making Sec. Paulson the Supreme Monarch of Wall Street, and am even more cynical about moral hazards than my Republican counterpart. I'm concerned that President Obama will be constrained in his ability to enact social spending programs in January if all the money is spent today. I note that left-leaning economists are almost united in opposition to this plan, and not just the far-left anticapitalists.

If I'm a non-partisan wonk, I wonder what the point of this is. If the broader problem is still liquidity, then the Fed can fight that on its own. It's true that Treasuries were actually trading negative for a moment or two last week, but they were still trading, so it doesn't yet look like the Fed is "pushing on a string". In other words, it doesn't yet appear that the Fed has used up all its bullets. Additionally, there is still private and foreign capital out there to be had; if it's become difficult to get that capital, then the Fed and/or Treasury can do some regulatory tweaking on the margins to improve the situation without nationalizing all the risky assets in the world*.

If the problem is solvency, then I'm questioning the wisdom of putting the solvency of the U.S. government at risk. If that's too much Chicken Little for you, then I'm wondering why the government should, without oversight or even a structure of decision-rules, be nationalizing investment losses while keeping investment gains private. We've all heard of corporate welfare, but this may take the cake. And yes, some pension funds and retirement accounts will go down with the ship. That sucks, but that's what we've got a safety net for. Maybe the $700bn would be better spent shoring up those safety nets rather than bailing out Wall Street?

for more from the right, see Mankiw, Cowen, and Naked Capitalist.

for more from the left, see Krugman and DeLong.

Nadav Manham defends the plan here. Let's say that I think his view is best-case, and we have no reason to think that we're in best-case territory here.

*Sebastian Mellaby channels some academics proposing other solutions:

Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles.

Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.

2 comments:

Sarah Bauerle said...

Shouldn't that be US CongressPERSON edition?

:)

Sarah Bauerle said...

One more thing -

The argument that the government should be buying bank stock instead of bank debt is flawed on several counts:
1. While there actually are share prices (as opposed to the debt that has no buyer and therefore no price), the ability to predict where these prices will go is severely undercut because the fundamentals of financial stocks are not really known (the risk wasn't measured properly, so the fundamentals looked good, which made fund managers buy up these stock). Buying the stock doesn't change the fundamentals, so buying equity doesn't necessarily bring other investors back.
2. If the Fed owns such high amounts of equity in these banks, when will it cash out? Would the Fed get voting rights? It seems equity ownership would lead to more systemic nationalization then just assuming bad debt.
3. People actually live on their dividend payments. Its not a good idea to draw-down principle, especially in a down and volatile market. What would happen to all those on fixed incomes? (And I'm talking about retirees, not trust fund babies) It would be one thing if Medicare actually provided adequate coverage, but many retirees depend upon their IRAs for real costs of living, not just cruises in the Caribbean.
4. Public offerings only work if there's a buyer. Buyers aren't coming unless the risk is reduced. The risk is reduced when the debts go away.

Bottom line - this mess is too big to ignore, the actions needed to clean up are unfair and costly, but we've been backed into a corner and realize that we're stuck with the bill. Maybe we'll learn our lesson and apply reasonable regulations to prevent a future crisis of risk assessment.

Deal or No Deal (U.S. Congressman Edition)
 

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