Despite the incendiary title of his article in today’s New York Times, Issue Is Payback, Not Bailout, the point that David Leonhardt makes is precisely the right one:
Yet in just a few days’ time, members of Congress have to figure out how to improve the bare-bones $700 billion plan submitted by Henry Paulson, the Treasury secretary, and ultimately whether to vote for it.
Their best shot at success depends on keeping the debate tightly focused on the questions that matter most. There are really only two: What steps are most likely to solve the immediate crisis? And how can the long-term cost to taxpayers be minimized?
Everything else — reducing executive pay on Wall Street, changing the bankruptcy laws, somehow slowing the descent of home prices — is either a detail or a distraction.
The financial crisis isn’t one of liquidity but one of confidence. The ceiling suggested yesterday by New York Sen. Charles Schumer will have the effect of reducing the level of confidence raised by a bailout plan.
I have no idea whether a bailout plan is necessary at all and, I suspect, neither does anyone else although the worried look on Ben Bernanke’s face suggests it may well be. Nor do I know whether the bailout plan as requested will be effective and, once again, I suspect that nobody else does either. I wish somebody would give the specifics and connect the dots so I could actually arrive at a reasoned conclusion. Perhaps nobody knows and it’s just fear talking. Perhaps giving the details would aggravate the situation.
I think that Congress should either add a few additional provisions for oversight and other modifications but largely pass the requested measure as is on a timely basis or vote it down outright. Otherwise they’re simply meddling while preserving plausible deniability.
IMO that’s the real root cause of the mess: a lack of willingness to take the responsibility that one was hired to take.
I would hope that, if a bailout really is necessary and Congress delays past the time when the needed bailout could have been effective or Congress modifies the bailout so that it doesn’t have the required effect (most of which is to instill confidence), that Congress would get the blame. Unfortunately, that’s a forlorn hope because of Congress’s diluted responsibility. Nearly everybody already hates Congress but likes his or her own Congressman.
I started from a position that it is so important to keep the credit market from failing that this is a worthwhile plan, at least in outline. I like some of the qualifiers the Democrats are proposing (capping executive pay in exchange for the bailout, acquiring ownership (as long as there’s a requirement to liquidate it in a set amount of time) as part of the bailout), which is kind of odd for me; I generally don’t agree with many of the Democrats’ economic ideas. (I do expect that next year we’ll see a bill that will make SOx look tame, requiring companies to value their risk (how, exactly?) and show that on their balance sheets; I tremble at the thought.)
But the more I think about it, the more concerned and annoyed I’m getting. Let’s start with the most crass analysis: what is in it for me.
I would pay about $20,000 or more (I am actually a net income tax payer by a large margin) in additional taxes, if I’m lucky. It might be worse, because there is still a chance that Congress would choose to fund this through acquisition of debt, which means that I and my children will pay far more than that. Moreover, we haven’t yet gotten to the “lard it up with extras” phase of the bill, and on this big of a bill, you just know that’s going to happen. Emergencies be damned, there’s an election to be won by buying people off. In exchange for this rather heft payment (which, frankly, would be very, very painful), what do I get? Can I (or any generic consumer) go into bankruptcy to avoid the payment? No. Will I get debt relief? No. Were I still paying a mortgage, would I get relief? No. As a renter, would I get relief? No. So where is the money going? As far as I can tell, it would protect pension funds and 401Ks (little to no help to me) by protecting their current value of shares in the banking industry. It would go to foreign lenders holding bonds. It would go to the companies’ direct shareholders, most notably and largely including those who got us into this (secondary) mess by making excessively risky bets on securities they didn’t understand without sufficient capital to insure against losses.
OK, so what about a more altruistic analysis: what’s in it for the economy in general? Is it a good idea to do this in order to preserve market stability, particularly in credit? Well, what are we really talking about here? If we do not do this bailout, those companies that have excessive positions in mortgage-backed securities (particularly those securities with an excess of exposure to Freddie and Fannie mortgages) will take large capital losses. They will have to eat these losses, which will happen in a number of ways. First, their share price will drop precipitously, making them buyout targets for other large companies that were more circumspect. Well, no harm no foul there; who cares if they get bought at fire sale prices? Second, they would stop lending money hand over fist, shrinking the economy overall and probably kicking us into recession. Well, guess what, that’s what we get for getting into such a bubble in the first place; a recession is an economic shakeout that culls the economic losers, strengthening the winners and opening up new routes for future capital investment in new companies and new ideas. In that sense, the bailout would ease the down slope, but would actually cause net long term harm over and above the direct cost of the bailout itself. Third, these companies would stop underwriting risky home loans, and demand more transparency in future securities. This is a flat out positive good.
Any way I come at this, the bailout looks like a terrible idea. What would I propose instead? How about this: let the market crash, and we take our lumps. It would be over pretty fast, within a year or two, and it would be far cheaper and more efficacious to use a fraction of that money to protect individuals from losing their homes and livelihoods as the weaker companies go down. In fact, we already have mechanisms in place for most of that, so no new bureaucracy or government powers would even have to come into being to make it happen. Too hard to stomach for politicians in an election year? OK, how about this alternative:
The “bailout” would be that a new GSE would be formed, that would take over Freddie, Fannie, AIG (do you realize we, the taxpayers, now own an 80% shared in AIG!?!) and any other companies that are collapsing because of this. But they would take them over: the companies would be declared bankrupt and bought for (say) 10 cents on the dollar, and their assets liquidated to pay their debts. Golden parachutes would be last on the list of items to be paid out. There would be a time line for liquidating the company, and any assets still present at the end of the time would be auctioned to the highest bidder (heck, put ’em on eBay) and any liabilities would be retired by the treasury. If the shareholders don’t like 10 cents on the dollar, they can find another buyer or tough it out. It would be a mechanism to ease the crisis, and give failing companies a way out that does not result in no returns to their shareholders, while simultaneously not growing government or rewarding the people who failed us on this. Moreover, by giving the government a mandate to liquidate Freddie and Fannie as failed enterprises, maybe it will get the Congress to think before, in the future, they demand that private or semi-private institutions enact social policies with private profits and socialized risks. Eh, who am I kidding?
Really, I don’t think that any good is going to come of this, and I fear much harm will result instead.
My analysis parallels yours pretty closely, Jeff, and I’m a net taxpayer, too. There’s one difference: I’m older and I’m concerned that the crash would be deeper and longer than you’re suggesting, possibly lasting as long as my productive life.
Jeff, I’m assuming the cost of no bailout is that more than one financial firm will enter bankruptcy, either liquidation or reorganization. Given the nature of the assets and liabilities these firms will be in bankruptcy for at least five years, perhaps more. Other companies that owe or are owed money will be forced into bankruptcy as well. We’ve had airlines and other companies continue to function through bankruptcy, but I’m not sure about the financial sector. They are not selling a tangible commodity or service, but a lot of time they are simply selling institutional trust. So I believe the harm could be deep and sustained until confidence is restored and new institutions are created.
Sidenote: I understand the problem with “golden parachutes,” but the executive pay agreements I have seen provide for these payments as a condition of accepting employment. The executives have already “earned” the golden parachute by accepting the job and showing up for the first day of work. My assumption is that the executives have a property right to their golden parachute that the government can’t do anything about without compensating the executives.
Megan McCardle has asked the same question about executive pay, and from my perusal of the comments, I think my above assumption was correct. I also think the government can’t condition payouts on some sort of “first in line” treatment in any subsequent bankruptcy. There are prior secured debtors that have property rights as well. Eric Posner is asking similar constitutional questions about another Dodd provision.
The benefit of the Paulson plan is its simplicity. The government has limited ability to retroactively reform these financial institutions. That ship has sailed and its passage should be noted for future laws.
The whole point, though, (to PD Shaw’s first comment) is that this should be a very painful alternative to soldiering on or doing a traditional sale or bankruptcy arrangement. It should be a last resort. It shouldn’t be easy on the executives to approve. Yes, I realize that they would have to give up a property right they had acquired (and which better be on the books as a liability!), but that would be part of the cost of taking the money: save your company and screw yourself along with the general taxpayers, or decide your company can afford to ride this out or use existing mechanisms.
I’m not sure why you believe, Dave, that this would be so prolonged. I can see a 2 year recession or, if we get really stupid, even a five-year depression, but I cannot see us being in the 20-year cycle that Japan ended up in unless we lose all sense whatsoever. The market is huge, and the problem is relatively small, apparently, in relation to the overall credit market. It seems to be confined to a very small part of the credit market (rapidly churning mortgage-backed securities based on bundling fractional shares of mortgages of different risk categories), rather than a general credit problem.
This is not an area where I have great strength, though, and I’d be very happy to hear why I’m wrong.
For the last eight years the engine driving the economy has been either the housing sector along with the financial companies that are in trouble now or the government and its handmaiden industries.
I don’t see the government as a viable driving engine if for no other reason than that it didn’t work for the Soviet Union.
Technology has been in the doldrums and I see little hope for recovery. Further, I think that engineering is likely to follow manufacturing overseas for structural reasons.
This isn’t something that has risen up overnight and I doubt it will vanish overnight, either.