Bail-Out Becomes Buy-In?

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paulson bailout.jpg
I spoke to former World Bank Chief Economist and Initiative for Policy Dialogue President Joseph Stiglitz on Saturday by phone, and he shared with me many of the same points that he does in this excellent article, “A Better Bailout,” on how we needed to structure a financial markets action plan.
He shared a number of concerns with me about the administration’s approach to the financial crisis — but the biggest concern he had was that Paulson was trying to stick the U.S. taxpayer with all of the consequences of Wall Street’s recklessness and give financial firms squeaky clean portfolios that they could then float up — again taking huge financial gains for themselves.
From his piece:

The administration is once again holding a gun at our head, saying, “My way or the highway.” We have been bamboozled before by this tactic. We should not let it happen to us again. There are alternatives. Warren Buffet showed the way, in providing equity to Goldman Sachs.
The Scandinavian countries showed the way, almost two decades ago. By issuing preferred shares with warrants (options), one reduces the public’s downside risk and insures that they participate in some of the upside potential. This approach is not only proven, it provides both incentives and wherewithal to resume lending. It furthermore avoids the hopeless task of trying to value millions of complex mortgages and even more complex products in which they are embedded, and it deals with the “lemons” problem – the government getting stuck with the worst or most overpriced assets.
Finally, we need to impose a special financial sector tax to pay for the bailouts conducted so far. We also need to create a reserve fund so that poor taxpayers won’t have to be called upon again to finance Wall Street’s foolishness.
If we design the right bailout, it won’t lead to an increase in our long-term debt – we might even make a profit. But if we implement the wrong strategy, there is a serious risk that our national debt – already overburdened from a failed war and eight years of fiscal profligacy – will soar, and future living standards will be compromised.
The president seemed to think that his new shell game will arrest the decline in house prices, and we won’t be faced holding a lot of bad mortgages. I hope he’s right, but I wouldn’t count on it: it’s not what most housing experts say. The president’s economic credentials are hardly stellar. Our national debt has already climbed from $5.7 trillion to over $9 trillion in eight years, and the deficits for 2008 and 2009 – not including the bailouts – are expected to reach new heights. There is no such thing as a free war – and no such thing as a free bailout. The bill will be paid, in one way or another.
Perhaps by the time this article is published, the administration and Congress will have reached an agreement. No politician wants to be accused of being responsible for the next Great Depression by blocking key legislation. By all accounts, the compromise will be far better than the bill originally proposed by Paulson but still far short of what I have outlined should be done.
No one expects them to address the underlying causes of the problem: the spirit of excessive deregulation that the Bush Administration so promoted. Almost surely, there will be plenty of work to be done by the next president and the next Congress. It would be better if we got it right the first time, but that is expecting too much of this president and his administration.

The bailout proposal which House Speaker Nancy Pelosi is calling a “buy-in” plan is better than the first Paulson plan.
I haven’t reviewed all of the details, but I do know that the U.S. government receives warrants in the firms in which it is supporting, which allows participation in the upside that these firms will get by the U.S. accepting the risk of the toxic mortgage portfolios held by financial institutions. CEOs that get bailed-out have compensation caps of $500,000. It’s strange to think that is a healthy number — but on a relative basis I guess it is.
Here are some of the provisions of the plan and a summary in pdf form. (section by section analysis and separately, a summary)
I haven’t been able to deduce whether the “encouragement” of the U.S. to financial institutions and mortgage holders to keep people in their homes during this mess is only encouragement — or whether there is some hard edge to this. Others may want to comment on this aspect.
I feel that Wesley Clark was right when he told me that we have to stop the deterioration of neighborhoods that has come with the rampant foreclosures — and have to give families who are the victims in this crisis as much time as the banks and financial institutions to stabilize and see if their “own life portfolios” can float upward with time.
— Steve Clemons

Comments

25 comments on “Bail-Out Becomes Buy-In?

  1. Carroll says:

    Posted by rich Sep 29, 10:51PM – Link
    Bill Kavanaugh,
    Another on the Swedes’
    >>>>>>>>>>>>>>>>>>>>>>>>
    That would work except for one thing…our government and 90% of the people in it are as corrupt and as incompetent as these WS firms.

    Reply

  2. Carroll says:

    Posted by rich Sep 29, 10:51PM – Link
    Bill Kavanaugh,
    Another on the Swedes’
    >>>>>>>>>>>>>>>>>>>>>>>>
    That would work except for one thing…our government and 90% of the people in it are as corrupt and as incompetent as these WS firms.

    Reply

  3. rich says:

    Bill Kavanaugh,
    Another on the Swedes’ dealt with their criticism from the NYTs:
    http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html?_r=1&dbk&oref=slogin
    >>
    September 23, 2008
    Stopping a Financial Crisis, the Swedish Way
    By CARTER DOUGHERTY
    Standing shoulder-to-shoulder with the opposition center-left, Mr. Bildt’s conservative government announced that the Swedish state would guarantee all bank deposits and creditors of the nation’s 114 banks. Sweden formed a new agency to supervise institutions that needed recapitalization, and another that sold off the assets, mainly real estate, that the banks held as collateral.
    Sweden told its banks to write down their losses promptly before coming to the state for recapitalization. Facing its own problem later in the decade, Japan made the mistake of dragging this process out, delaying a solution for years.
    Then came the imperative to bleed shareholders first. Mr. Lundgren recalls a conversation with Peter Wallenberg, at the time chairman of SEB, Sweden’s largest bank. Mr. Wallenberg, the scion of the country’s most famous family and steward of large chunks of its economy, heard that there would be no sacred cows.
    The Wallenbergs turned around and arranged a recapitalization on their own, obviating the need for a bailout. SEB turned a profit the following year, 1993.
    “For every krona we put into the bank, we wanted the same influence,” Mr. Lundgren said. “That ensured that we did not have to go into certain banks at all.”
    By the end of the crisis, the Swedish government had seized a vast portion of the banking sector, and the agency had mostly fulfilled its hard-nosed mandate to drain share capital before injecting cash. When markets stabilized, the Swedish state then reaped the benefits by taking the banks public again.
    More money may yet come into official coffers. The government still owns 19.9 percent of Nordea, a Stockholm bank that was fully nationalized and is now a highly regarded giant in Scandinavia and the Baltic Sea region.
    The politics of Sweden’s crisis management were similarly tough-minded, though much quieter.
    Soon after the plan was announced, the Swedish government found that international confidence returned more quickly than expected, easing pressure on its currency and bringing money back into the country.
    <<

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  4. Bill Kavanagh says:

    The Swedish experience seems to be a worthwhile guide to
    navigating out of the failed bailout plan. If it’s possible to focus on
    how the Swedes saved their own market and not on words like
    nationalization, perhaps there’s a political prayer of it being
    accepted.
    Probably not, but it makes too much sense not to consider it. A
    recent article in the IHT discussed how it worked in 1992 when
    they had the very similar real estate bubble pop…
    Here’s a reference: http://billsrants.typepad.com/my_weblog/2008/09/swedish-
    experience-outlined.html

    Reply

  5. WigWag says:

    Well, Kathleen, it might not be long before the only thing we can afford to eat is bananas. Without a bailout in the next few days, we could easily see a run on the banks that’s like nothing we’ve seen since 1929.
    With short term credit drying up, banks won’t be able to borrow enough for normal operations. A massive bank run is an entirely forseeable consequence of this.
    And FDIC insurance won’t help. The FDIC has $50 billion in assets. In a serious bank run, that would evaporate in a few days. That $50 billion insures trillions in deposits. Where will the money come from to pay depositors?
    The answer is the printing press. But the US treasury can’t change the laws of physics or mathematics. They printed money willy nilly in Weimer Germany too. How did that work out?

    Reply

  6. Kathleen says:

    WigWag..Bananna Republic…for sure…I’ve been thinking this for months now and even bought myself some yellow pants with big green bannana leafs on them….Seriously…I wanted to make sure my drag was politically correct……

    Reply

  7. WigWag says:

    This is what Paul Krugman has to say:
    September 29, 2008, 3:02 pm
    “OK, we are a banana republic, House votes no. Rex Nutting has the best line: House to Wall Street: Drop Dead. He also correctly places the blame and/or credit with House Republicans. For reasons I’ve already explained, I don’t think the Dem leadership was in a position to craft a bill that would have achieved overwhelming Democratic support, so make or break was whether enough GOPers would sign on. They didn’t.
    I assume Pelosi calls a new vote; but if it fails, then what? I guess write a bill that is actually, you know, a good plan, and try to pass it — though politically it might not make sense to try until after the election.
    For now, I’m just going to quote myself:
    So what we now have is non-functional government in the face of a major crisis, because Congress includes a quorum of crazies and nobody trusts the White House an inch.
    As a friend said last night, we’ve become a banana republic with nukes.”

    Reply

  8. leo says:

    IBG-YBG: “I’ll be gone, you’ll be gone” — sell crap derivatives then get out fast and rich.

    Reply

  9. Mr.Murder says:

    Some of us told you this was where we would be when Paulson was promoted. The paper lion of our economy based upon revenue negative tax cuts for billionaires has shown what empty item was driving it this entire time.
    Real estate companies here love the no collateral loans. Move one idiot household into the neighborhood, people start moving out as their kids get jumped after school , other houses get vandalized or broken into.
    Thank God that Barack sees these types as just deserving a true chance instead of the one they just threw away, taking entire neighborhgood down in the process….

    Reply

  10. Linda says:

    Hi,Erich,
    I was just being practical and realistic about the whole thing.
    Nobody can understand a 106 page bill and all its implications without months of analysis and hearings–and nobody does–not staffers pulling all nighters to write it–nor surely members of Congress who will approve it.
    But it’s probably still better than three-pages that would have made Secretary of the Treasury the economy czar.
    There is much more important policy work in the implemention of any legislation, especially in the writing of the regulations that implement it. For a bill of this size, that takes a year or so to do right, with lots of lobbyists on all sides actively involved.
    So what we realistically have is a stopgap measure to assure the world markets and hopefully (one of my hopes) stop the bleeding. It’s just a tourniquet, and for the next four months only Bush Administration is licensed to apply tourniquet.
    We should know within a couple weeks, even before the election, if the bleeding can be stopped.
    And I don’t think the rest of the details matter that much because the implementation will take many months, if not years. So then the election is still the most important thing. And I still can only hope that Obama is elected.
    And I mentioned the transition because I think the next President has to name his Secretary of Treasury, HUD, and others doing oversight immediately and have them working informally in transition with the Bush lame ducks–like having Stigliz, Galbraith, Buffet–and better minds involved well before Thanksgiving.
    So for me it’s just Reinhold Niebuhr’s Serenity Prayer: ” God grant me the serenity
    to accept the things I cannot change;
    courage to change the things I can;
    and wisdom to know the difference.”
    So right now all I can do is repeat my endless mantra of urging others to donate and volunteer for Democrats because that is something we call can do to bring about change.
    I hope that this Thanksgiving I can be thankful that some more sane, intelligent, thoughtful, etc. people will be in charge next year.

    Reply

  11. Kathleen says:

    erichwwk…heavy duty analysis…thank you….it is indeed all about incumbency…
    I’ve stopped contributing to the DNC because I feel, as a taxpayer, that in addition to paying their salaries, we are expected to volunteer and contribute to elected officials keeping their jobs… it does virtually nothing for me but insult my intelligence. I only contribute to candidates who support impeachment, accountability and high ethical standards of official conduct. For Demz to refuse to hold impeachment hearings, in the face of such incompetence and mendacity is to me, tantamount to saying we abolish all ehtical standards….but keep sending money…we neeeed you….suckers.
    Good luck with that, guys….I’m for a “you’re on your own, gov’t”…keep your job without my help…..Don;t call me, I’ll call you….when I want something from you….hold your breath…it’s good for your soul..

    Reply

  12. PissedOffAmerican says:

    “What the hell are are we doing here?”
    Getting royally and totally screwed, sans any lubricant.
    Kathleen, have you noticed the scummiest of the scummy are beginning to roost here? Dondero really stinks the place up, doesn’t he?

    Reply

  13. Kathleen says:

    Why does this bailout say “not more than $700 billion at any one time”? Does that mean up to $700 billion can be obtained more than one time? What the hell are are we doing here?

    Reply

  14. erichwwk says:

    Linda writes:
    “I don’t think the details of the plan Congress will pass really matter that much”
    If you mean, we are essentially a lawless nation, governed by the whims of a ruling elite, i agree.
    If you mean a government whose primary function is to redistribute wealth from those that produce it to those that merely appropriate it, (and Joe Siglitz) couldn’t disagree more.
    In response to Steve, my sense is we essentially have 100 pages of lipstick on the pig. Stiglitz won his Nobel Prize for his work on asymmetry in markets- if there was ever a case in which this applied, this bailout is it.
    A $500,000 cap on compensation is something substantive???? Get real. The “stick” is a CAP on DEDUCFTIONS; This is merely half of the current cap, which already has proven ineffective and worthless.
    So the housing folks got thrown a bone, in that the Sect. of the Treasury “MAY” help out; surely Steve knows the difference between “SHALL” and “MAY” in appropriation language.
    I am just flabbergasted at how many of the commenters “hope” something good comes of this.
    Have we sunk so low that “hope” is considered a meaningful substitute for analysis and intelligent discussion?
    Warren Buffet once said “in every poker game there is one sucker, for whose holdings all the other players compete. And if you don’t know who the sucker is, it’s probably you.”
    What this Bill proposes to do is to launder and make legitimate the previous transfer of wealth (theft) from the investment bank community by creating fictitious wealth by an accounting sleight of hand. As politicians (and DC pundits) are dependent on handouts from this ruling elite, they refuse to slap the hand that feeds them. As Andrew Bacevich writes in his latest book “The Limits of Power”, Congress is essentially incompetent and capable only of perpetuating its incumbency. THAT is essentially its ONLY purpose.
    As an aside, the list of economists signing on to the Univ. of Chicago (yes they have some of the best, despite being now known primarily for the silly privatization ideology) letter signees has grown to 400.
    I URGE all readers to read the Stiglitz piece Steve cites with care.
    This proposal is the Paulson’s (Goldman Sachs) equivalent of the Rice and Cheney mushroom cloud.
    Let’s hope we learn from being the suckers in a $3Trillion Ponzi scheme, and substitute intelligent thought for hope. This meltdown is hardly unexpected. Even Warren Buffet warned about it in his 2002 shareholders speech.

    Reply

  15. PissedOffAmerican says:

    Well, while our eyes were on this carnival of posturing, a huge defense spending bill was sent to the President for his signature.
    What is this fiasco missile defense system costing us? (Not only monetarily, but in terms of resurrecting the cold war and an arms race?)
    And how come no one is expressing any curiousity as to the two trillion missing DOD dollars that Dov Zakhiem presided over?
    And surely continuing to send billions of dollars to Israel to finance their genocidal programs isn’t a wise expenditure at this time.
    But we will continue these expenditures, and more that make even less sense. Does anyone really think these looters on Wall Street, or the rich and self serving pieces of shit in Congress really have a clue what economic hardship is like?

    Reply

  16. DonS says:

    On getting out of Iraq, Obama hasn’t made noises at all about “rapid divestment.”
    However, he has talked about adjustmet to his domestic goal due to the bailout costs. So why not adjustments to the foreign policy portfolio, including Iraq, Iran, etc? Couln’t be better timed from that standpoint. He’s already taken heat by saying he would to to other leaders. What’s to stop him getting really serious about changing America’s profile in the world?
    Don’t tell me. Its the terrorists!!! (and th3e lobbyists)

    Reply

  17. carol says:

    Although this bailout is really very annoying I suppose they have to do something!!!!
    I just hope the American people will get something back out of this.
    Yet another reason to get rid of this useless Republican party who have been the major part of this crisis all along.
    John McCain is not the White Knight that has saved the day….he has been a MAJOR PLAYER in this financial crisis to start with!!!!

    Reply

  18. fdeblauwe says:

    I was intrigued about the “popularity” of the leading people
    involved in the proposed bailout bill so I did a face-off at my Word
    Face-Off blog: Paulson, Bernanle, Pelosi, Reid, Frank, Boehner,
    McConnell, Baucus… even Bush, Obama and McCain. The resulting
    trend graphs are very interesting:
    http://wordfaceoff.blogspot.com/2008/09/nancy-pelosi-vs-
    henry-paulson-vs-barney.html.

    Reply

  19. ptw says:

    Try this …
    [http://ca.youtube.com/watch?v=oAADyc6t4nY]

    Reply

  20. ptw says:

    Most troubling …

    Reply

  21. Linda says:

    It would be delightful to have Stiglitz, Galbraith, etc. replacing Friedman and U of Chicago economists as dominant next year and to contemplate who will be Secretary of the Treasury, Secretary of HUD, etc. in key positions in an Obama Administration–though I’m not ready to say yet that Obama will win.
    I don’t think the details of the plan Congress will pass really matter that much, i.e., Congress and the next Administration are going to have to adjust it a lot.
    Pass it and hopefully stabilize the markets, have the debates, and election–and then it’s going to be one of the most interesting transition periods we’ve ever seen.

    Reply

  22. Steve Clemons says:

    Dan — I completely agree. The charade that we can do it all is coming to a grinding halt.
    steve

    Reply

  23. Dan Kervick says:

    Once we have the bailout bill passed, surely we have the makings of a very compelling case that the Iraq war has become completely unaffordable, and we need to begin rapidly divesting ourselves of our extravagant commitments in Iraq, and stop piling up debt in a war that was unnecessary in the first place.

    Reply

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