Tuesday, September 23, 2008

More on the bailout

I guess the lesson to all of this is that when the government asks for cart blanche to play with $700 billion, it's tough to get either side of the political spectrum to support it. Both Democrats and Republicans sound very skeptical of the Paulson plan, and the markets even fell today due to uncertainty over its implementation, a far cry from the jubilance of Friday's rally.

Ezra Klein quotes an essay by Luigi Zingales from the University of Chicago that quite succinctly sums up the injustice and hypocrisy of it all:

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.

Capitalism? What's that?

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.

The problem that I see with all of this is that it is, at best, a short term solution. Removing all this debt from the equation may give a boost to the ailing financial market, but without correcting the root causes of this crisis (credit bubble, lack of regulations and protections for homeowners) history is likely to repeat itself. Moral hazard rears its ugly head again; if the industry knows that the government is waiting to bail them out whenever they fuck things up this bad, what's to stop them from doing it again?

That's assuming they'll even be in a position to do so. That bad debt isn't going anywhere; it's just being plucked from one basket into another. Time will tell, but most of that $700 billion (that could be better spent on health care, education, or alternative energy) is probably going to go down the tubes. The assets are likely worthless.

But the equity of these banks are not. Zingales argues that the banks should be filing Chapter 11 bankruptcy and "reorganizing" their debts (essentially swapping debt for equity), a move that is not without precedent (in fact, much of the airline industry has filed for Chapter 11 over the past few years). But that would mean Wall Street loses. Not such a radical concept for those that truly believe in the free market, but they are a rare species indeed.

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