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.