"The government plans to bail out the banking sector by buying up to $700bn (for now) of 'impaired assets' … but at what price? Pay too little, and the banks will not have sufficient capital to remain solvent; pay too much, and the wealth of the American taxpayer will be unilaterally handed to the banks and their shareholders."
Stick with this for a minute -- it's finance-speak and I'm no more familiar with it than you are. What important is that Simon Johnson, economist at MIT, has a bail-out solution that makes damned good sense sense if you agree that a bail-out of some kind would be a good move. It's light years ahead of, say, John McCain -- who appears to be ducking out (bailing out?) of Friday's Ole Miss scary oral exam.
Start with Warren Buffett who's nobody's fool. He didn't just throw $5 billion at Goldman Sachs yesterday as a patriotic capitalist gesture. Buffett bought $5 billion's worth of preferred shares. Preferred shares are shares which guarantee equity if the company you're investing in goes belly-up. The ordinary shareholders get any crumbs left over after preferred shareholders get their full meal. Buffett gives Goldman Sachs some real help at a bad time, but he isn't giving them charity. The taxpayers shouldn't hand out charity to these bankers either.
Simon Johnson, the MIT economist, suggests in effect that the the US government's bail-out should consist of buying special-issue preferred shares in the faltering banks. That way the US taxpayer makes out like Warren Buffett -- not a bad deal -- while genuinely helping out the banks. But that way the US taxpayer doesn't wind up playing the patsy.
But that's not all. First the Feds should step in and buy some of the bad debts at fair market value (FMV). Johnson writes in the Financial Times:
"Given the need to (a) take these 'toxic' assets off the hands of the banks and (b) make sure that they get more money than they would get on the open market, the answer is to separate the two parts of the transaction. In the first step, Treasury would pay FMV for the securities; in the second step, after assessing the bank’s resulting condition, Treasury would do a capital injection by buying newly issued preferred shares.
"In order to determine FMV in the first step for a given tranche of securities, a portion of the debt could be auctioned to the private sector. Any debt bought by the private sector will have no further recourse to the government, i.e., it is 'bailout free'. Properly designed, this auction will indicate ... the fair market value in a free market. The government would then acquire the securities not bought by the private sector, at the price established in the auction [emphasis added]. With their MBS [mortgage-backed securities] gone, it will be easier to assess banks’ solvency and determine the appropriate terms for a government recapitalization.
"By explicitly identifying the FMV of the assets and distinguishing the asset purchase from the capital injection, this mechanism provides transparency to the operations of the proposed fund and limits the risk of overpayment. More fundamentally, it provides the much-needed assurance that the overall plan is fair to the American taxpayer and not simply a handout to the banking sector."
Sounds like a plan to me.
Jamie Galbraith also makes the kind of sense we're not seeing in Washington. Amazing how intelligent people can be when they're not twisted by greed, as everyone from Bush to Paulson to John McCain, Harry Reid, Boehner, Pelosi and colleagues are.
"The point of the bailout is to buy assets that are illiquid but not worthless. But regular banks hold assets like that all the time. They're called 'loans'.
"With banks, runs occur only when depositors panic, because they fear the loan book is bad. Deposit insurance takes care of that. So why not eliminate the pointless $100,000 cap on federal deposit insurance and go take inventory? If a bank is solvent, money market funds would flow in, eliminating the need to insure those separately. If it isn't, the FDIC has the bridge bank facility to take care of that.
"Next, put half a trillion dollars into the Federal Deposit Insurance Corp. fund -- a cosmetic gesture -- and as much money into that agency and the FBI as is needed for examiners, auditors and investigators. Keep $200 billion or more in reserve, so the Treasury can recapitalize banks by buying preferred shares if necessary -- as Warren Buffett did this week with Goldman Sachs. Review the situation in three months, when Congress comes back. Hedge funds should be left on their own. You can't save everyone, and those investors aren't poor."
That doesn't "fix" the economy. We have to do that. But it stops global panic.
