The Bailout: Liquidation and Subsidy

The Bush-Pelosi Bailout has two components: first, a liquidation (Secretary Paulson implied that this is the only purpose of the bailout), and a subsidy (CNBC has been focusing on the need for this portion). The liquidation is an attempt to replace the value of subprimes which cannot be sold at today’s prices with cash nominally worth the same, but much more liquid. The subsidy is an attempt to raise the value of those subprime mortgages, so that banks do not have to pay (“lost wealth because of”) their bad investments.

The politicians have been silent on this distinction, and most of the pro-bailout members of the chattering class have simply ignored it. Some more thoughts on the bailout, focusing especially on the subsidy:

The Corner on National Review Online
2) The Paulson-Democrat Wall Street Bailout will not work

· Banks are highly insolvent and the capital hole to be filled would not be filled by this plan – and any attempts to do so under this plan would drive up the cost of the “toxic asset” purchases (see next point)

· The supposed “profit” or “minimal cost to the taxpayer” is predicated on buying toxic assets low and selling them high – yet that inherently conflicts with the price point necessary to inject sufficient capital

· But even when prices are bid up (because Treasury is incentivized to do so to make it work), there is no guarantee banks will use the money to then lend if they are still insolvent and facing a likely recession

· This bill does nothing to deal with the over $60 trillion in largely unregulated Credit Default Swaps that are wreaking havoc with the financial system

· The plan is operationally questionable – with little clarity about dealing with the pitfalls of price-fixing, how a “reverse auction” won’t be easily manipulated to allow prices to get bid up, and other problems


The plan has no restrictions on buying up assets from foreign banks – banks who aren’t active lenders in U.S. markets directly and whose leverage is far greater (40x) than even American traditional investment banks (25x), whose leverage is greater than American commercial banks (10-15x).

· Moreover, many of these foreign banks are currently being or are soon to be nationalized. Therefore, the US government would be buying toxic assets at above market prices to support foreign governments.

Now, it may be wise to spend 700 billion something to help the economy. Universal health care for ten years, two complete interstate maglev systems, or using some of the money to eminent domain the subprimes at domain prices, while using the rest to pay down the debt (that is, not increase the debt). This is a serious issue, and we need an honest debate on it to come up with ideas.