Financial Times' Martin Wolf does not believe the bailout is necessary nor efficient. Action is needed, but not at taxpayers' expense
The fundamental problem with the Paulson scheme, as proposed, is then that it
is neither a necessary nor an efficient solution. It is not necessary, because
the Federal Reserve is able to manage illiquidity through its many
lender-of-last resort operations. It is not efficient, because it can only deal
with insolvency by buying bad assets at far above their true value, thereby
guaranteeing big losses for taxpayers and providing an open-ended bail-out to
the most irresponsible investors.
Wolf suggests that the banks need to feel a little pain so that they work to get their houses in order.
The simplest way to recapitalise institutions is by forcing them to raise
equity and halt dividends. If that did not work, there could be forced
conversions of debt into equity. The attraction of debt-equity swaps is that
they would create losses for creditors, which are essential for the long-run
health of any financial system.
Such a move would not cost one cent of taxpayers' money. What a concept! But the banks would not find it attractive. Well, how attractive is bankruptcy?
The advantage of these schemes is that they would require not a penny of public
money. Their drawback is that they would be disruptive and highly unpopular:
banking institutions would have to be valued, whereupon undercapitalised
entities would have to adopt one of the ways to improve their capital
positions.
Too much pain for the banks? Well, how about a little equity stake then in exchange for the taxpayers' money?
If, as seems plausible, a scheme that imposes such pain on the financial sector
would be rejected out of hand, the next best alternative would be injection of
preference shares by the government into decapitalised institutions, on the
lines proposed by Charles Calomiris of Columbia University. This would be a
bail-out, but one that constrained the behaviour of beneficiaries, not least on
payment of dividends. That would make it far better than dropping benefits on
the unworthy, via mass purchases of overpriced toxic paper.
Wolf goes on to stress the need for independent oversight of any bailout fund should it come to that. And for the need for social justice in assisting distressed homeowners on Main Street.
Also objectionable, though more in design than in the fundamentals, were the unchecked powers for the Treasury. Such a fund should be operated professionally, under independent oversight.
Finally, if the US government is to bail out incompetent investors it should
surely also provide more help to the poor and often ill-informed borrowers.
This wise man goes on to conclude that whatever is done, it needs to be done right and that may take a little more time than a week's review and a vote by Friday. Let's hope the Democrats have the intestinal fortitude to realize the bed they are making is one they will have to sleep in, hopefully right next to President Obama. Let's get it right!
What is needed, still more, is a clear and effective way of deleveraging and recapitalising the financial sector, ideally without using taxpayer funds. If such funds are to be used, they must also be injected in as carefully targeted and controlled a way as possible. Comprehensive action is essential, as Mr Paulson has decided. But let the US take the time to make that comprehensive action right.
Source (free registration required)