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Kevin Drum Wants You for the Bailout, But Consider This First

Kevin urges readers to call members of Congress and tell them to vote for the $700 billion bailout bill. In an earlier posting, he explained why he favors the plan. But before readers pick up the phone, they might want to read what Mother Jones contributor Nomi Prims says about the bailout. Or what Mother Jones contributor James Galbraith has to say. Or what economist Dean Baker has to say.

Baker notes,

Almost every economist I know rejects the Paulson approach and argues instead for directly injecting capital into the banks. The taxpayers give them the money and then we own some, or all, of the bank. (That's what Warren Buffet did with Goldman Sachs.)

This isn't about begging for a sliver of equity as a concession for a $700 billion bailout, this is about constructing a bank rescue the way that business people would do it. We have an interest in a well-operating financial system. There is zero public interest in giving away taxpayer dollars to the Wall Street banks and their executives.

If Secretary Paulson constructed a package that was centered around buying direct equity stakes in the banks, he could quickly garner large majority support in both houses. Better yet, Congress could just construct its own package centered on buying equity stakes and send it to President Bush. If he balks, we can just threaten him with stories about the Great Depression.

Or these would-be angry callers could ponder Nobel laureate Joseph Stiglitz's view:

To be sure, the rescue plan that was just defeated was far better than what the Bush administration originally proposed. But its basic approach remained critically flawed. First, it relied – once again – on trickle-down economics: somehow, throwing enough money at Wall Street would trickle down to Main Street, helping ordinary workers and homeowners. Trickle-down economics almost never works, and it is no more likely to work this time.

Moreover, the plan assumed that the fundamental problem was one of confidence. That is no doubt part of the problem; but the underlying problem is that financial markets made some very bad loans. There was a housing bubble, and loans were made on the basis of inflated prices....

We could do more with less money. The holes in financial institutions' balance sheets should be filled in a transparent way. The Scandinavian countries showed the way two decades ago. Warren Buffet showed another way, in providing equity to Goldman Sachs. By issuing preferred shares with warrants (options), one reduces the public's downside risk and ensures that they participate in some of the upside potential.

This approach is not only proven, but it also provides both the incentives and wherewithal needed for lending to resume. It avoids the hopeless task of trying to value millions of complex mortgages and the even more complex financial products in which they are embedded, and it deals with the "lemons" problem – the government gets stuck with the worst or most overpriced assets. Finally, it can be done far more quickly.

By the way, a letter signed by 400 economists says, "We ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action."

Everyone should read Kevin and consider his argument. But before anyone dials a member of Congress to complain about the bailout bill's failure, he or she should also think about other options and not join the rush to judgment.

Comments

"think about other options and not join the rush to judgment."

There must be better options than rushing anything.

When they are rushing to do something for the sake of just doing something it always turns out badly.

If this really is about the financial health of our country and all our people (maybe even the planet) - how can it be not important enough to get it right?

Thanks

Posted by: capt on 09/30/08 at 10:05 AM Respond

The Wall Street bail-out is the mother of all Ponze schemes . . . Reagan trickle-down on steroids

Posted by: Bruce Mashburn on 09/30/08 at 11:06 AM Respond

Thanks, David Corn. I've been amazed at how passionately Kevin Drum feels about something that I think stinks. It's good to be reminded that someone else at MoJo is citing sound, professional arguments for a stay on this matter.
Capt, we agree yet again. This is huge - it can and should be pondered and perfected.

Posted by: Paul Miller on 09/30/08 at 3:45 PM Respond

NEW YORK, Oct 1 (Reuters) - "Investor George Soros said on Wednesday the the U.S. Treasury's original $700 billion bailout plan would have done little to address the credit crisis, suggesting instead the government take a direct stake in financial firms.
Global credit markets are in their worst slump in generations as bank lending grinds to a halt on persistent fears about the extent of financial institutions' exposure to the downtrodden mortgage sector.
Soros said the U.S. Treasury, rather than using federal dollars to buy up toxic mortgage bonds, would be better off making a direct equity investment in the banks. This in turn would spur reluctant private investors to step in again.
"The fact that the plan was rejected in Congress provides an opportunity to amend it to make it more effective," Soros told Reuters in an interview. "The way to do it is to focus on recapitalizing the banks by injecting equity and actually encouraging existing shareholders to provide that equity."
Soros said under such conditions, he himself would take an interest in buying up financial shares.
This approach worked during Scandinavia's own banking crisis in the early 1990s, Soros noted."

You Yanks should follow us Vikings.

Posted by: Lars, the Viking on 10/01/08 at 5:17 PM Respond