Sould we trust Hank?

Some highlights from the Emergency Economic Stabilization Act of 2008, the current draft of the Bush-Pelosi bailout:

Calculated Risk: Draft: Emergency Economic Stabilization Act of 2008
Here are some parts on pricing mechanism:

(d) PROGRAM GUIDELINES.—Before the earlier of the end of the 2-business-day period beginning on the date of the first purchase of troubled assets pursuant to the authority under this section or the end of the 45-day period beginning on the date of enactment of this Act, the Secretary shall publish program guidelines, including the following:
(1) Mechanisms for purchasing troubled assets.
(2) Methods for pricing and valuing troubled assets.
(3) Procedures for selecting asset managers.
(4) Criteria for identifying troubled assets for purchase.

So it’s all up to the Secretary to establish the rules. Same with Warrants – it’s up to the Secretary to negotiate.

Treasury Secretary Hank Paulson is of course the Ken Lay of Goldman-Sachs — the CEO who bailed out shortly before the whole thing imploded. Hank was closer to our President than Kenny Boy, however, so while Enron went bankrupt, Goldman-Sachs was bailed out in the nick of time and now we’re going to trust one of the men who built this mess to solve it.

15 thoughts on “Sould we trust Hank?”

  1. You give Paulson too much credit.

    Central planners have definite objectives, and detail plans for meeting them.

    Hank’s is to give the people who get us into the mess a lot of money and power, and hope for the best.

  2. It’s better then just giving banks $$$$ for complex securities that ccant be valued.

    It sill puts the banks bond holders ahead of taxpayers.

    I would prefer Secured Loans [1] or Superbonds [2] as the centerpiece.

    I don’t know why nobody is talking about lowering capital requirements for bank lending for now to create instant liquidity. [3]

    I still need to comment on the public choice stuff too.

    [1]

    http://purpleslog.wordpress.com/2008/09/30/on-the-bailout-part-4-what-i-think-should-be-done-short-term/

    [2]
    http://purpleslog.wordpress.com/2008/10/11/on-the-bailout-part-17-the-superbonds-alternative/

    [3] http://econlog.econlib.org/archives/2008/09/reduce_bank_cap_1.html

  3. Purpleslog,

    I read the post on your blog, and liked it!

    One of the things we’re dealing with here is preventing our bail-outs from becoming rewards for bad behaviors. Stockholders are owners of companies who elect the board: they had the most to win through gambling, and it is because of their actions that the companies are so weak. The advantage of the Soros plan is that it effectively inflates away shareholder value.

    Bondholders are relatively innocent, as they (in theory, at least) have no sway over a board, do not elect officers, and act solely in response to publicly available information. To the extent that shareholders elected a corrupt or incompetent set of executive, bondholders are victims as well. Thus, the danger of secured loans is that it inflates away the value of the bondholders, while not harming the value of the shareholders.

  4. Generally my take on Public Choice is…

    Bureaucrats and politicians (in the public sector or inside corporate bureaucracies) have an incentive problem. They do not have a price system to guide them. They do not have a benificial profit motive. They do not fear for the loss of their job for reasons of failure (e.g. Peter Principle, incumbency re-election rates). These actors lack good incentives.

    So,they tend to uses metrics like size of budget, number of reports, personal affluence, perceived power of position, accumulation of perks,and personal status as the guiding incentives. They are not primariliy motivated by the success of the others or the organization as a whole.

    Really public choice economics is just looking at decision-making from the point of view of economics keeping in mind the driving incentives are different.

    The design of any government or internal bureaucracy should purposefully try to minimize the effects of these bad incentives and include counter-balancing incentives (to create a negative-feedback loop).

    Some things that come to mind:

    – Funding of robust and aggressive Auditors and Inspector General offices to root out graft and corruption and abuse

    – Term Limits, Job rotations, automatic cutting of low-performers

    – Open records, transparency of records and actions, sunshine, ridcule of abuse (name names)

    – single-subject legislation (harder to hide stuff); no conference report hidden earmarks

    – all legislation and project should have “expire on” dates, requiring purposeful renewal for continuation

    – decentralization / federalism / spinoffs

  5. “Thus, the danger of secured loans is that it inflates away the value of the bondholders, while not harming the value of the shareholders.”

    Point taken.

    it is hard to balance the protection of the taxpayers with not rewarding shareholder.

    I suppose a process where by if bank examiners determine the bank has negative shareholder equity, then the rapid takeover of the bank occurs (wiping that equity) turing over the bank to the bondholders would work.

    Also, while bondholders are “innocent”, they do take on some risk for return for their returns. I don’t see why the should come before taxpayers. So perhaps the the thing to do is some combo of Secure Loans (protect taxpayers) with Warrants (dilute shareholder equity) along with rapid takeover of negative shareholder equity banks would work.

    I hope the feds don’t by actual common stock, that would be the worse idea. Politician will want policy says soon enough through that ownership.

    All of these plans (secured loans, superbonds, warrants, preferred stock) are better then by MBS and other complex securities from the banks.

  6. I hope the feds don’t by actual common stock, that would be the worse idea. Politician will want policy says soon enough through that ownership.

    Absolutely agreed. And there’s another reason to oppose Fed common stock, too:

    The federal government is not competent to handle its financial interests.

    That is, the federal government would not exercise its voting rights to maximize profit to obtain some specific lists of objectives. Rather, the federal government’s priorities can be expected to vary wildly every few years. From the point of view of preventing loss of wealth, the federal government should have as little say as possible in how its investments are handled.

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