Last week, Prof. Steven Ramirez from Loyola University Chicago contacted me to help him spread his analysis of A Law Professor's View of the Bailout.
Today, he has further thoughts on the events of the last week, along with his analysis of the Paulson-Bush bailout Bill that the Senate will vote on tonight.
Prof. Ramirez's analysis is below the fold, published with his permission.
The Paulson approach is still at the core of the recently rejected House Bailout Bill and it still bails out the wrong people, in the wrong way, using the wrong logic. It must be killed in its entirety so that an appropriate bailout can go forward.
The US Senate is poised to vote on the Paulson-Bush Bailout Bill (.PDF) tonight. That Bill is a fraud and seems specifically designed to stuff billions in the pockets of the very CEOs responsible for this fiasco rather than help the economy.
I spent most of Sunday reading the House bailout bill that was rejected on Monday. Apparently few in the media spent any time reading the text of the bill because the talking heads packaged the bill in a way that was radically different from reality.
For example, the media consistently suggested that the Bush Administration would have only $350,000,000,000.00 to start with and would need congressional approval for the other $350,000,000,000.00. Under Section 115, however, the congress must override a presidential veto to stop the second installment—meaning a vote of 2/3 of each chamber must vote against its disbursement. The game is rigged strongly in favor of the entire $700 billion being spent once the bill is enacted and no media outlet that I have found discusses that fact. The Senate Bill retains this exact language. The bottom line is once the Bill is passed Paulson has $700 billion to spend with only the thinnest of limitations.
Similarly, the bill supposedly limits executive compensation. In reality, Section 111 empowers Secretary Paulson to set standards on executive compensation, and he has been a vehement opponent of any limitations at all. In addition, the standards do not apply at all to any company getting less than $300,000,000.00 in assistance, and then apply only to "new" employment agreements. Even in a situation where the government purchases trash assets directly from a company the standards are too vague to assure any real limit on executive compensation. The Senate has not addressed this problem.
So, without getting into the rest of the gory details, suffice it to say that bill was not portrayed accurately to the public. But perhaps the grandest fraud is that the Paulson approach is the only approach.
Early on, Paulson and Bernanke stated the Paulson bailout is the only possible bailout. That is false. A recent IMF study (.PDF) in fact assesses bank crises throughout history and across the world. It demonstrates that there many different ways to proceed with a bail out.
According to NYU economist Nouriel Roubini (the top economist on this entire subprime fiasco) the Paulson bailout is a "disgrace and a rip-off" compared to alternatives. More specifically: "the Treasury plan is. . .a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer." Worse he states "the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown." So, it seems like we pay a ton of money for "nothing" under the House Bill.
The beneficiaries of this bailout will be the shareholders of the firms that caused this mess and the directors and officers that manage those firms. Their firms will be recapitalized with a giant slug of taxpayer funds and the managers who trashed the global financial system will remain in control. Under the Paulson plan the most inept managers in the history of capitalism get a new $700 billion of our money to mismanage.
There have been many bank crises world wide. There are many different ways to resolve a crisis. Almost always current shareholders and managers must also pay up. Sweden apparently made money from a banking system rescue by taking ownership of problem banks.
The Treasury should take the Warren Buffet approach. The government should inject capital to save the financial system, which certainly needs saving. In return we should take a preferred shareholder position and negotiate for preferred dividends, suspend common shareholder dividends, and obtain preferred voting rights to oust the most reckless managers and boards. The risk to the taxpayer is minimized and the costs to current shareholders and mangers are significant.
As Nouriel Roubini and Paul Krugman each recognize this approach also has the benefit of injecting pure capital, which is the basis of all financial lending.
The difference is simply this: the Paulson plan rescues reckless bankers at great cost to the taxpayer and a government preferred share purchase program rescues the financial system with a much smaller risk to the taxpayer.
Submitted by: Professor Steven Ramirez
Loyola University Chicago
Oct. 1, 2008