Friday, September 26, 2008

Bailout Commentary

Commentary via Greg Mankiw's blog: Commentary on the Financial Mess

First, the Treasury should only buy troubled assets at fair market value. Second, the Treasury should be allowed to purchase, again at fair market value, new securities issued by financial institutions needing additional capital. Third, to ensure that asset purchases are made at fair market value, the Treasury should buy them through multibuyer competitive processes with appropriate incentives.
I'm not sure these big Wall Street banks are really necessary, and I'm not sure
we'd miss them much if they were gone.
The real estate boom in Japan ended around 1990, and it was assumed that the banks could handle the nonperforming loans on their books. The result of that assumption was more than a decade of stagnation, until measures were taken to reduce the nonperforming loans on the banks' books, recapitalize the banks and restore the flow of credit.

Any solution should observe three guiding principles: It should (1) restore the stability of the financial system quickly and at the lowest possible cost to the taxpayer; (2) punish those who are responsible for losses; and (3) address the root cause of the crisis -- the price collapse in the residential real-estate market. In doing so, the solution should respect the rule of law by spelling out the proposal in sufficient detail for the Congress and the electorate to pass judgment. To the extent possible, it should follow proven precedents.

The administration's current proposal fails to meet these principles. ... First, there is the central issue of how to price the assets. A second issue is ... why should losses (particularly in solvent institutions) be borne by taxpayers rather than the shareholders and debt holders? The final problem is potential cost.

On both questions, our bipartisan consensus is holding true to form. In a system that is chock-full of heavy regulation, they instantly blame the current collapse on the excesses of the free market, for which a still heavier dose of regulation supplies some supposed cure. That indictment contains few particulars. It typically rests on a populist broadside whose centerpiece is greed on Wall Street, but never on Main Street--where there are more voters.

How can the Treasury encourage private players to back up its purchases? The short answer is: Buy cheaply. If the government pays, say, 30 percent of what the loans were originally worth, any hedge fund that thinks they are really worth 40 percent will dive into the market. If the government pays 50 percent of what the loans were originally worth, that same hedge fund will stay on the sidelines -- or may even figure out a way of betting against the government.

... But there is a better way: Tackle the capital shortage directly.

Paulson may not like the idea of the government owning chunks of the financial system. But after the nationalization of Fannie, Freddie and AIG, it's too late to worry about that. Besides, if the U.S. government refuses to recapitalize the banking system, foreign governments may eventually do so. Sovereign wealth funds have already bought $35 billion worth of stakes in U.S. financial institutions.

Love it or hate it, the true cost of Treasury Secretary Hank Paulson's proposed rescue of the financial system is not the sticker price of $700 billion. Conceivably, the government could make money; with glum assumptions, the losses would probably be less than $250 billion. No one knows the correct answer -- not Paulson, not Federal Reserve Chairman Ben Bernanke nor anyone else -- but here's how to think about the problem.
  • And a last one, by Bill Gross of Pimco (the world's largest bond dealer)
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.
Commentary via the Big Picture blog

  • Analysis on the $700B bailout, with Chris Whalen, Institutional Risk Analytics and CNBC's Steve Liesman
Commentary via the Freakonomics blog

My concern about the bailout comes from the sudden shift in political discourse towards re-regulating the financial industry. Popular belief holds that if the government had better regulated the mortgage industry, the current crisis could have been avoided. At some level, this must be right: if the government outlawed mortgages altogether, there would be no one to default on a mortgage. But we must not risk throwing out the baby with the bathwater.

Financial institutions are important because they transform our savings into investment capital for productive firms. Without this bridge from lender to borrower, it would be much harder for firms to expand, purchase new machines, or invest in developing workers or new ideas. We must ensure that the new regulatory framework ensures that financial markets continue to generate these enormous productive gains. My reading of the accumulated research (which I will describe in greater detail) is that the worst excesses of previous regulatory efforts throttled these productive gains. We must not repeat these mistakes.

No comments: