Making the Case for the Bailout (Updated)

In an op-ed in the Washington Post this morning William H. Gross, CEO of the investment management company PIMCO, makes the case for the Paulson-Bernanke proposal to bail out ailing mortgage holders:

The extreme measures are extended government guarantees and the formation of an RTC-like holding company housed within the Treasury. Critics call this a bailout of Wall Street; in fact, it is anything but. I estimate the average price of distressed mortgages that pass from “troubled financial institutions” to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent. Calls for appropriate oversight of this auction process are more than justified.

That’s the case against the opponents of the proposal that’s on the table. It’s followed by a little understandable self-promotion:

There are disinterested firms, some not even based on Wall Street, with the expertise to evaluate these complicated pools of mortgages and other assets to assure taxpayers that their money is being wisely invested.

of which I assume PIMCO is one. That doesn’t mean we should discount what Mr. Gross has to say but it’s something to keep in mind. He concludes:

The Treasury proposal will not be a bailout of Wall Street but a rescue of Main Street, as lending capacity and confidence is restored to our banks and the delicate balance between production and finance is given a chance to work its magic. Democratic Party earmarks mandating forbearance on home mortgage foreclosures will be critical as well. If this program is successful, however, it is obvious that the free market and Wild West capitalism of recent decades will be forever changed. Future economic textbooks are likely to teach that while capitalism is the most dynamic and productive system ever conceived, it is most efficient over the long term when there is another delicate balance — between private incentive and government oversight.

No argument here.

Making the case for the Paulson-Bernanke proposal doesn’t require it either to be perfect nor to be better than any conceivable proposal, just that it be better than doing nothing at all in the near term and better than other proposals on the table. That certainly seems to be the case to me.

Update

Economist Mark Thoma:

Maybe we can absorb such a shock with our vaunted flexibility, some people want to find out and teach the financial industry a lesson, but me, I’m not taking that chance. People’s livelihoods are at stake. A massive credit meltdown is nothing to mess around with. Period. I want action that protects people from the consequences of credit drying up, and we were perilously close to that in the wake of the Lehman failure.

We need to make sure the bailout doesn’t turn into a massive giveaway to financial institutions, no doubt about that, but I am not about to risk the jobs of so many people through inaction, and I’m convinced there are scenarios where the downturn could be very, very painful for the typical household.

So this isn’t a question of if we should act, it’s a question of how we avoid a giveaway. On that front, I’m not as convinced as Gross is that the plan, as I understand it, will lead to the gains he predicts. That is part of what the current objections to the plan is about, addressing these types of concerns.

The plan doesn’t have to be completed tomorrow, there’s time to get the details right, but we can’t waste time either. Tensions are building and they explode without warning. Nobody knows for sure how how much time we have until the next problem erupts, and what kind of chain reaction might result.