As James Galbraith points out in today’s Washington Post (hat tip reader Marshall), the Paulson bailout plan wasn’t necessary, and any rescue could have been handled by expanding existing programs:
Now that all five big investment banks — Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs and Morgan Stanley — have disappeared or morphed into regular banks, a question arises.
The point of the bailout is to buy assets that are illiquid but not worthless. But regular banks hold assets like that all the time. They’re called “loans.”
With banks, runs occur only when depositors panic, because they fear the loan book is bad. Deposit insurance takes care of that. So why not eliminate the pointless $100,000 cap on federal deposit insurance and go take inventory? If a bank is solvent, money market funds would flow in, eliminating the need to insure those separately. If it isn’t, the FDIC has the bridge bank facility to take care of that.
Next, put half a trillion dollars into the Federal Deposit Insurance Corp. fund — a cosmetic gesture — and as much money into that agency and the FBI as is needed for examiners, auditors and investigators. Keep $200 billion or more in reserve, so the Treasury can recapitalize banks by buying preferred shares if necessary — as Warren Buffett did this week with Goldman Sachs. Review the situation in three months, when Congress comes back. Hedge funds should be left on their own. You can’t save everyone, and those investors aren’t poor.
With this solution, the systemic financial threat should go away. Does that mean the economy would quickly recover? No. Sadly, it does not. Two vast economic problems will confront the next president immediately. First, the underlying housing crisis….The second great crisis is in state and local government.
Of course, such a straightforward program would have eliminated the opportunity to further enrich Wall Street by paying fees to various advisors and subcontractors for buying assets from financial firms.
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I do not see any mention of the pricing formula or strategy? This is huge. If they buy at a reasonable discount and take equity in return, the potential losses might be mitigated although by the looks of this updated plan, it is still very likely to fail and result in hude losses as there is no concrete pricing strategy. As for helping homeowners via changing judges’ authority to modify loans and also other plans being discussed such as a freeze on foreclosures or balance paydowns (freezing foreclosures and reducing balances not part of bailout i realize) the only thing this will do is increase mortgage rates and reduce credit. How is it that the hard working, prudent people of America (and by extension the World) who pay their mortgages on time, live within their means, and are better at managing their money have to pay higher taxes, higher mortages rates in the future, and suffer from collapsing home prices due to the stupidity of Government (fuelling rise of houses through FRE/FNM and FHA, , etc), the Fed, the Banks’s execs who set credit policy, and the many borrowers who were reckless and stupid with their money ? That is the real tragedy here. In fact, most of this intervention (markets not really free to begin with) provides an incentive to default on your mortgage and / or walk away, spend like crazy, and be reckless. Things will only recover when house prices reach their market led “fair” value which is what the average buyer will afford. Add in a good job market. So it is likely we will continue to see governments and friends of certain top government people continue to implement programs to take money from the innocent (savers/depositors/private shareholders) via taxation and inflation in order to transfer it to those who have been gaming the system and engaging in stupdid behaviour (bank execs / counterparties and bondholders). Must be helpful to have a lobbyist or two working on your behalf, or better yet, make huge campaign donations and have the politician in your pcoket. The end is near for the debt based, fiat money foundation that is the American and world economy. Say hi to deflation and then at some point high inflation or a combo of both, so that in 3-4 years, most average citizens will be poor. Citizens must keep up the fight.
JO
There are only two choices, accept that houses were overpriced and cram down the debt or take them through foreclosure to auction for true price discovery. Or inflate until the value catches up with the nominal price.
The Paulson plan is fantasy. A short term stop gap, hoping that the economy will come back and the houses will be worth what they’re mortgages say they are. But this is in effect denying that there was a bubble, or planning to re-inflate it.
This is going to hurt.
‘The point of the bailout is to buy assets that are illiquid but not worthless. But regular banks hold assets like that all the time. They’re called “loans.”‘
PRECISELY!
* claps palm to forehead *
Why didn’t I think of that?
Galbraith’s plan makes a lot more sense than Paulson’s, with one caveat. Unlimited 100% deposit insurance produces huge moral hazard.
There’s this misconception that deposit insurance means “no one should lose a penny.” Nonsense. Your homeowner’s insurance has a deductible. So does your auto insurance. And probably your health insurance as well.
Deductible, percentage haircut, whatever. These measures restore the incentive for prudence, without risking systemic collapse. 100% insurance up to a too-small ceiling is badly designed, and needs to be changed. Unlimited insurance, but with a deductible or haircut, is the ticket. Hell, allow private underwriters (AIG) to compete with FDIC. Result: caveat depositor (como siempre), but the system survives … and thrives.
— Juan Falcone
@ Juan, the British deposit insurance system used to have “a deductible or haircut” and that was abandoned after the run on Northern Rock last year. Mind you, I think much of the problem in Britain was that most savers were pretty ignorant about deposit insurance because we hadn’t had a bank run since 1866.
Another good idea. Amazing how many different approaches have surfaced on blogs this week that are succinct and involve a lot less risk to the taxpayer. They are not being entertained because Paulson has a one track mind.
During the hearings this week when Shelby asked him what other solutions have been considered, he didn’t have an answer!! Unbelievably, couldn’t even make one up!
Since he was head of Goldman from 1999-2006, he was in charge while a lot of this crap was created. He is not capable of thinking in simple straightforward terms that gets to the heart of the problem without a gazillion dollars that he is in control of. He is by nature going to make things complex (to help his buddies on the street) so they can’t be understood and he can’t be pinned down
He is the wrong leader at the wrong time. This week would have been better utilized had he brought a distinquished group of bankers, economist, hedgies to camp david for the week and hammered out something that was less infuriating to everyone (instead of wiggling in front of committee’s). Of course would have been better if they’d done it 18 months ago.
>> the FBI as is needed for examiners, auditors and investigators.
I'm not sure, because The G-Men have been no where to be found for 8 years…ever since Enron!
My take: this is the biggest heist in history and based on a charade. Bush blames the average guy who borrowed too much for a house and can’t pay. But estimated values of mortgages in arrears is only $150 billion. The real reason for this “bailout” is to save the banks from their credit derivative nightmare — of which there is $400 trillion on their books all based on a Ponzi scheme and the American taxpayer is at the bottom. Face it, our political class — Republicans and Democrats — is lying to us. We’ve been had.
did you seen that the banks banged the discount window for a record 262 billion this week and a significant portion was ‘investment banks?’
I know of only two remaining at least as of this week while they are in the waiting period.
FDIC wouldn’t do these two much good at this point.
http://tinyurl.com/3zhelw
Galbraith’s plan is far, far better as well as simpler than the Paulson Sellout, and would leave the government in the driver’s seat. —Of course that’s why the financial industry can’t come up with this kind of thing to stovepipe to Paulson and Frank.
I would completely support Galbraith’s plan.
The Japanese Dude that said Paulson was thinking like a GS CEO and not like the head of the US Treasury was completely correct.
I am massively impressed with James Galbraith. He should be obeyed by every person in congress.
The WSJ article should be compulsory reading for all of them.
“Buffett is getting paid 10% to hold what is essentially an option to buy $5 billion worth of Goldman with essentially little to no equity risk given the terms of the deal. That’s not an “investment.” That’s just an endorsement deal.”
http://www.minyanville.com/articles/GS-buffett-BRK-X-congress-goldman/index/a/19154/p/1