Here's the spicy part though:
In other words, watch your wallets. The tab here could be very high. If everything goes extremely well, markets move upward, and the risky loans become far less risky, it's possible that taxpayers (that is, the Treasury) might actually make money. But if the bottom falls out, American taxpayers could be on the hook for trillions of dollars. What then? The federal debt soars. What then? Interest rates go out of sight. What then? Foreigners lend us less money. What then? We're cooked.
The Bailout of All Bailouts is a Bad Idea
Talk today about the Bailouts of All Bailouts eased market fears and generated a giant rally on the Street, but how realistic is it?
On Capitol Hill, Senator Charles Schumer suggested that government inject funds into financial companies in exchange for equity stakes and pledges to rewrite mortgages and make them more affordable. At the other end of Pennsylvania Avenue, Hank Paulson reportedly is considering an agency like the Resolution Trust Corporation, established during the savings and loan crisis of the late 1980s, to take bad debts off the balance sheets of financial institutions.
Problems are: (1) It's not likely to do all that much good because no one knows how much bad debt there is out there. Even if the government bought a lot of it, investors and lenders still couldn't be sure how much remained. After all, big banks have already written down hundreds of billions of bad debts, and that hasn't restored confidence in the Street. As the economy slows, bad debts will grow. Again, the problem isn't a liquidity or solvency crisis; it's a crisis of trust.
(2) However much bad debt there may be, that amount is surely far greater than the $394 billion of real estate, mortgages, and other assets that the old RTC bought from hundreds of failed savings-and-loans -- thereafter selling them off form whatever it could get for them. The Bailout of All Bailouts would therefore put taxpayers at far greater risk than they are even today, and require an unprecedented role for government in reselling assets. Another major step toward socialized capitalism.
A better idea would be for the Fed and Treasury to organize a giant workout of Wall Street -- essentially, a reorganization under bankruptcy, for whatever firms wanted to join in. Equity would be eliminated, along with most preferred stock, creditors would be paid off to the extent possible. And then the participants would start over with clean balance sheets that reflected new, agreed-upon rules for full disclosure, along with minimum capitalization. Everyone would know where they stood. Bad debts would be eliminated. Taxpayers wouldn't get left holding the bag. And there would be no "moral hazard" incentive for future financial wizards to take giant risks with other taxpayers' money.
Congress, the Fed, and the Administration shouldn't be giving more help to Wall Street. Policymakers should focus instead on people who really need a safety net right now -- workers who have lost or are about to lose their jobs, who need extended unemployment insurance and health insurance for themselves and their families; homeowners who have lost or are likely to lose their homes, who need additional help meeting mortgage payments and reorganizing their debts; and people who have lost or are in danger of losing their savings or pensions, who need better insurance against possible loss.
The only way Wall Street's meltdown doesn't spill over to Main Street is if policymakers begin to pay adequate attention to the people whose wallets really keep the economy going, and who merit more help than the Wall Street tycoons whose carelessness and negligence have put it in such jeopardy.
The Coming Bailout of All Bailouts Bill: A Better Alternative
If you think the Bailout of All Bailouts (whose details will be worked out over the coming week) won't saddle American taxpayers with billions, if not trillions, of risky obligations, you don't know politics -- especially in an election year when members of Congress are eager to get home to campaign; when the incumbent lame-duck president (who was he?) has all but vanished, leaving his hapless Treasury Secretary, a former investment banker, to take the lead and the heat; when voters are in high anxiety over the economy and Wall Street is melting down; when the executives of every financial powerhouse in America have staked lots of money on campaigns in both parties and have indundated Washington with lobbyists.
In other words, watch your wallets. The tab here could be very high. If everything goes extremely well, markets move upward, and the risky loans become far less risky, it's possible that taxpayers (that is, the Treasury) might actually make money. But if the bottom falls out, American taxpayers could be on the hook for trillions of dollars. What then? The federal debt soars. What then? Interest rates go out of sight. What then? Foreigners lend us less money. What then? We're cooked.
Some Democrats will try to make the best of the emerging Bailout of All Bailouts Bill, seeking to tack a stimulus package on it. In my view, they'd be better advised to hold out for a different approach.
Paulson is right that it makes sense to allow the big banks to wipe their balance sheets clean of as many bad loans as they can identify, and put them into a special agency that then sells them for as much as possible. The agency would bundle or unbundle the risky loans, slice and dice them as needed, with the goal of getting the most for them on world markets by creating a market for them.
But there's no reason taxpayers need to be involved in this.
Whether you call it a reorganization under bankruptcy or just a hellova fire sale, the process should resemble chapter 11 under bankruptcy. Any big financial institution that wants to clear its books can opt in. But the price for opting in is this: Investors in these institutions lose the value of their equity. Executives lose the value of their options, and their pay (and the pay of their directors) is sharply limited. All the money from the fire sale goes to making creditors as whole as possible.
Meanwhile, policymakers work on a new set of regulations to ensure transparency on Wall Street -- governing disclosures, minimum capital requirements, avoidance of conflicts of interest, and better ensurance against stock manipulation -- so that, once the bad debts are off the books, the new numbers can be trusted.
I repeat: This isn't a crisis of solvency or liquidity; it's a crisis of trust.
