There is utterly too much to comment on and opinions range quite widely, so I thought that I would provide interesting links:
- Bloomberg (HT: Barry Ritholtz):
Treasury Secretary Henry Paulson’s $700 billion proposal to stabilize the banking system may push the national debt to the highest level since 1954, threatening an erosion of foreign appetite for U.S. bonds.
The plan, which asks Congress for funds to buy devalued securities from financial institutions, would drive the debt above 70 percent of gross domestic product and the annual budget gap to an all-time high, possibly exceeding $1 trillion next year, economists estimated.
- Calculated Risk:
…many people are saying the government can only lose a portion of the $700 billion because there will be offsetting assets. This is true in the Fannie and Freddie conservatorship (the mortgage assets mostly offset the debt of Fannie and Freddie), but it is not true here. Although Paulson and Bernanke are talking about hold-to-maturity prices, they are also talking about both buying and selling securities. A little math will show that if you take a loss (say 30%) on each transaction, it doesn’t take many transaction to lose most of the entire $700 billion.
- Securitization, Liquidity, and Market Failure, Paul Davidson:
Keynes’s LPT can provide the explanation. LPT presumes that the economic future is
uncertain. Consequently, the classical ergodic axiom that is fundamental to any efficient market theory is not applicable to real world financial markets. Keynes’s analysis presumes that, in the real world of experience, the macroeconomic and financial systems are determined by a nonergodic stochastic system. In a nonergodic world, current or past probability distribution functions are not reliable guides to the probability of future outcomes [Davidson, 1982-3, 2007]. If future outcomes can not be reliably predicted on the basis of existing past and present data, then there is no actuarial basis for insurance companies to provide holders of these assets protection against unfavorable outcomes. Accordingly, it should not be surprising that insurance companies that have written policies to protect asset holders against possible unfavorable outcomes resulting from assets traded in these failing securitized markets find they have experienced billions of dollars more in losses than the companies had previously estimated. [Morgenson, 2008]. In a nonergodic world, it is impossible to actuarially estimate insurance payouts in the future.
- How About a Market?, Felix Salmon
- Credit Is Flowing, Sky Is Not Falling, Don’t Panic, Robert Higgs
- Why Paulson is Wrong, Luigi Zingales:
Do we want to live in a system where profits are private, but losses are socialized? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalized and prudent behavior rewarded? For somebody like me who believes strongly in the free market system, the most serious risk of the current situation is that the interest of few financiers will undermine the fundamental workings of the capitalist system. The time has come to save capitalism from the capitalists.
- The Paulson Sale, WSJ:
There is a better — and more transparent — way to put public capital into the banks while protecting taxpayers: through the Federal Deposit Insurance Corp. The FDIC has long had the power to handle failed banks. But in 1991, Congress passed the Federal Deposit Insurance Corporation Improvement Act (FDICIA) that limited the FDIC’s ability to provide assistance to struggling but still solvent banks.
The exception is when there is a risk to the entire financial system. In that case, the President, Treasury Secretary and two-thirds of the Fed board can authorize such open-bank aid. The current moment would seem to qualify. Yet the White House has so far refused to trigger this exception and let the FDIC work with the likes of Wachovia, Morgan Stanley, and others before they crash and burn.
Whether or not the Paulson plan passes, President Bush should sign the FDICIA waiver. This would allow Treasury and the FDIC to inject new capital into banks early enough to prevent failures; in return, the feds could impose some discipline in the form of management dismissals and preferred stock or warrants that would protect taxpayers when the banks recover. This also beats the Congressional idea of attaching taxpayer warrants to the Paulson plan, which will be much harder to administer to hundreds of banks as opposed to one at a time through the FDIC.
- What Would Hayek Say?, Peter Klein
- An Open Letter Opposing the Paulson Plan
- Where is the Credit Crunch?, Alex Tabarrok:
I look at the situation as follows. Banks are bridges between savers and investors. Some of these bridges have collapsed. But altogether too much attention is being placed on fixing the collapsed bridges. Instead we should be thinking about how to route more savings across the bridges that have not collapsed. Government lending may be one way of doing this but why lend to prop up the broken bridges? Instead, why not lend directly to the investors who are in need of funds? After all, if these investors exist and have valuable projects that’s where the money is! Let the broken bridges collapse, taking the shoddy builders with them. Instead focus on the finding and rescuing the victims of any credit crunch, the investors who need funds.
- Let’s Get the Bank Rescue Right, R. Glenn Hubbard, Hal Scott, and Luigi Zingales, WSJ op-ed:
Any solution should observe three guiding principles: It should (1) restore the stability of the financial system quickly and at the lowest possible cost to the taxpayer; (2) punish those who are responsible for losses; and (3) address the root cause of the crisis — the price collapse in the residential real-estate market. In doing so, the solution should respect the rule of law by spelling out the proposal in sufficient detail for the Congress and the electorate to pass judgment. To the extent possible, it should follow proven precedents.
The administration’s current proposal fails to meet these principles.