Thursday, October 2, 2008

I am upset

We have just witnessed another example why the political process is broken in the United States. There is complete disregard of policy advice from people who understand the issues, staggering amounts of money is thrown at problems with policies that are ill-conceived from the start, are amended to make them worse, and then hastily packaged with other poor policies to "sweeten the deal".

In a nutshell, here is what is wrong: If the government buys the toxic assets, it will face a very serious adverse selection and buyer's remorse problem: it will only get the worst ones, and at a price well above the market. The idea to have a reverse auction on a good that is not homogeneous is also ludicrous. If the government can recoup 20 cents on the dollar for those toxic assets, it will be lucky. Remember that those assets will be pushed from people with little competence (banks) to incompetent ones (government).

There are other solutions. My favorite one is the Swedish one: have the government take equity positions, thus recapitalizing, force write-offs of bad assets, dilute shareholder value (shareholders are supposed to carry risk, remember), and then sell the stake once things are back to normal. This keeps incentives in the proper place, as banks continue to service the loans. The cost to tax payers was relatively minor when a similar situation happened in Sweden in 1992. Americans may not like this idea of partial nationalization, though. Alternatively, let those who are sitting on plenty of cash recapitalize, like in the Middle East or in Asia. UBS did this earlier in the year twice, as it was not expecting a bailout.

Another one is to get all problematic institutions through bankruptcy court. No tax payer money is involved (well, a little, to pay the courts) and it force the bad assets to be written off, and all can start afresh.

But stop scaremongering and claiming something needs to be done immediately and hastily. We have seen with the Iraq war and the Patriot Act how this can go wrong.

4 comments:

VIlfredo said...

I am also upset. One could also add that Washington is once more pushing this myth that this measure will pay for itself. Bullocks.

T-Bone said...

I'm not quite sure what the problem is. As I understand it, the problem is that credit is not available for even solid businesses and people with good credit. I don't understand why.

If people are just not investing in some banks because they are at risk of collapsing, there must be banks that aren't at risk. I have money to invest, and there's business out there that needs a loan. One bank as an intermediary should do the trick.


Or is the issue that:

1: The banks in trouble are in danger of collapse because investors are pulling out because of the risk.

2: Collapsing will cause a lot of unnecessary economic pain even beyond the bank and its shareholders if they had to liquidize.

3: If only the investors would not panic and would stay invested, the banks would recover on their own, but keeping investors in may require easing their risks through a bailout.



Because if the issue is only about protecting shareholders, a bailout seems wrong on it's face. But if it's about an economic domino effect for others through no fault of their own... Then that is the only scenario that even starts to make sense to me. Am I way off?

Independent Accountant said...

I am amazed. We are not that far apart here. I suggested Uncle Sam buy subordinated debt in the companies looking for bailouts. Rate: prime plus 8%, take it or leave it. They don't like it, file bankruptcy.

Bruce Wilder said...

"stop scaremongering and claiming something needs to be done immediately and hastily"

I, of course, agree that the policies proposed are not very logical or sensible.

But, I would be interested in why you think panic is not justified. The situation seems dire to me. And, unsuitable policy responses don't reassure me. But, you, apparently, are not frightened. Why?