Tuesday, September 30, 2008

BUB Three

I’ve changed my mind about the Paulson bailout plan - and the Democrats’ permutation and the Republicans’ alternative - a half-dozen times in the last eleven days. Here’s where I stand now.

If we’re going to give money to people who made stupid decisions, I’d still rather give it directly to the homeowners with the bad mortgages than to the big firms with the bad mortgage-based assets. The only change I’d make to my original Bottom-Up Bailout proposal is that only primary residences will be eligible for the plan. If you put yourself in debt up to your neck to buy a vacation home or to flip houses hoping for a quick buck, you’re on your own.

Barring that, there are two alternatives to the Paulson Plan floating around that sound interesting to me. One is Mort Zuckerman’s
suggestion that the government invest in perpetual preferred shares in the companies that need bailing out. As I understand it, perpetual preferred shares have no voting rights but are first in line for dividends and take precedence over common shares in case of bankruptcy. What I don’t know about this plan is which companies the government would invest in: any companies that wanted in; only companies that are really troubled; or only companies that the government decided were sound enough to get back on their feet with a little help. If the investment was restricted to only certain companies there’s a lot of room for political maneuvering and preferential treatment. It’s worth noting, however, that that’s at least as big a problem with the Paulson Plan since no one seems to be willing to specify which assets will be bought from which companies at what prices.

Another interesting idea is what Peter Robinson at The Corner refers to as “Plan B”:

the use of the FDIC to backstop commercial banks, on which (as quite distinct from investment banks) our system of payments and credits actually depends. The broad outlines of such a plan—increasing the deposit insurance level while giving the FDIC additional discretion to help wobbly banks—are in very little dispute.

As with the Zuckerman Plan and the Paulson Plan, the “discretion” part of “additional discretion to help wobbly banks” means someone has to choose which institutions live, which die, and which get dismembered and sold off.

One final thing to keep in mind when considering the Paulson Plan. We’re now hearing more and more about how the $700 Billion is an investment or even a “loan” because once the government buys the mortgage-based assets, it will hold them until the real estate market stabilizes then sell them and recoup some or all of the original investment - perhaps even make a profit. As Mort Zuckerman pointed out on the McLaughlin group this past weekend, we don’t know when or where the real estate market will stabilize; no one knows what value - if any - these assets have now or will have in the future; and he expects the real estate market to drop by another 15 to 20 percent. (I cannot find a link to this.) Similarly, Jeffrey Miron says:

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

This less than rosy view of how much of our $700 Billion we’d get back doesn’t necessarily mean we shouldn’t follow the Paulson Plan. It just means that if we do we should accept we may never see our money again. Think of it like money you invest in your ne’er-do-well brother-in-law’s combination video rental store and laundromat: it’s possible his success will finance your retirement but you shouldn’t stop socking money away in your 401(k).



Updated October 24, 2008, with links to my subsequent BUB posts

Since I keep adding BUB posts, I updated this on December 13, 2008, to put all BUB posts in their own category. That way they can easily be found without my having to keep updating all the existing ones each time I add a new one.

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