Buy The Companies, Not the Assets
Doug Elmendorf, senior fellow in economic studies at the Brookings Institution is not, I take it, a Communist of some sort. But he says that instead of buying financial institutions’ bad assets, we should be buying the institutions:
An alternative to the government buying certain types of debt from financial institutions is for the government to make equity investments in a wide cross-section of such institutions. For concreteness, suppose that the government offered to make an equity investment in every firm regulated by a federal or state banking regulator equal to 10 percent of the market value of the company as of September 1st in exchange for a 10 percent equity stake in the company. (The 10 percent figure is illustrative. As with the first approach, a judgment about the appropriate total amount of government funds would need to be made.)
He goes on to observe that objections can be raised to this. But it has several important advantages over what Paulson is proposing. Most importantly, the government would “own the upside” of the bailout. In other words, if the plan worked and confidence was restored in these institutions, the value of the taxpayers’ investments would go up. If the plan failed the public would lose a ton of money, but obviously with any plan if you fail bad things are going to happen. Under Paulson’s plan, by contrast, the public has very little upside.
The other big advantage is that the equity proposal leaves the government bailing out everyone equally. Under Paulson’s plan, as I understand it, you would be giving more help to financial institutions that had made bigger fuckups.
Now in typical Brooking style, Elmendorf is being calm and judicious about this in his tone. Judicious to a fault I would say. He’s acting like this is just a decision that’s going to be made on the merits, so what’s needed is a calm and judicious tone. But there are big interests at stake here. Buying the assets is much less favorable to the taxpayers but much more favorable to well-connected financiers. That, rather than an argument over the merits, is what seems to be crucially at stake here.
28 Responses to “Buy The Companies, Not the Assets”
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September 20th, 2008 at 4:52 pm
1) Raise the $2 Trillion for the bailout from the Superrich. Then its their problem, not ours.
September 20th, 2008 at 5:00 pm
Matt, The problem is that investing in companies that don’t necessarily need the help is something that’s going to upset the stockholders of those corporations because it dilutes their shares.
September 20th, 2008 at 5:03 pm
Don,
Congratulations on a particularly dumb and worthless comment!
Please feel free to share more — no matter how little you have to contribute to the ostensible discussion!
And, hey, isn’t it time for you to make a tedious autobiographical interjection? It’s been at least a few hours since the last, right?
September 20th, 2008 at 5:07 pm
Michael, they’re asking for a one trillion dollar handout. It sounds like they need the help.
I’m going to assume that the stockholders would also be upset if their shares suddenly became worthless.
September 20th, 2008 at 5:15 pm
There is no alternative plan. This is it. Paulson told them do it or it’s Armageddon. And so it shall come to pass.
Some alt explainations of why it has happend say it’s economic terrorism or a bear raid by the Friends of Hank. (FOH)
http://wallstreetexaminer.com/bl…/winter/? p=1918
There are elements of truth to this but the crisis is real and took years to develop. I’ll say since 1980 with bigger and bigger pushes towards the disaster in steps at key points like 87, 91,95, 98 and then the biggest push of all since Bush came on board. Espcially since 02 after the tech stock crash and 9/11 when Greenspan The Street created, with knowledge aforethought, the mortgage/real estate bubble.
The key to wealth and power isn’t in controlling events, it’s in being prepared for them. When history is written on the era some will see conspiracy. I’ll stick with a conspiracy of human nature. The history of bubbles is well known and well understood. They are social phenomenon that occur in cycles.
Nefarious Dubai investors or the Friends of Hank didn’t cause the mess although they might have helped the push over the edge and are ready to cash in, if they can.
I said here in March this, this being the financial debacle, was going to be the biggest social/economic/political thing in the lifetimes of most people,ever. It isn’t there yet but it’s getting closer.
September 20th, 2008 at 5:39 pm
“Buying the assets is much less favorable to the taxpayers but much more favorable to well-connected financiers.”
Whether this is true or not depends on whether the assets are bought above, below, or at true value. The problem now is that nobody knows what “true” value is in this market.
September 20th, 2008 at 5:41 pm
Christopher’s last name: Cox.
September 20th, 2008 at 6:29 pm
You say that under the Paulson plan, the public has very little upside. That depends crucially on how much the government pays for the assets. As maynardGkeynes rightly points out, we just don’t know what those assets are really worth right now. I suspect, though, that at the moment the market has over-reacted and undervalued them, just as it once overvalued them. If so, there should be room to buy the assets at a price that steadies the market now, but still allows for a profit as the government gradually sells them over time. Will that actually happen? Who knows, but I don’t think you can rule it out as things stand (although I haven’t seen much discussion yet as to how Paulson plans to price the assets).
September 20th, 2008 at 7:16 pm
There can be no effective bailout of the financial sector without a bailout of distressed homeowners.
The problem is not just under-capitalization. The assets themselves need to be restructured. Besides undercap, the other huge problem is nobody knows what the assets are worth because they don’t really have a worth in any traditional sense. This paper is so toxic it can’t be traded nor can it really be compared to other kinds of securities. More significantly, the worth of these assets depends a lot on whether the solution we apply includes massive loan restructuring for borrowers. These assets could be accurately valued if they were transformed into securities that were based on traditional mortgage products instead of a bunch of exploding ARM, negative amortizing, option payment, teaser-rated shit. That means almost all subprime mortgage-backed securities need to be restructured or refinanced. Borrowers need to have their loan obligations modified on a case-by-case basis to turn them into performing assets. But private holders are too entrenched in trying to avoid looking weak and acknowledging gigantic losses to transform toxic paper into an asset that can actually perform and have some kind of objective value. Or perhaps they lack the capacity or economies of scale in their loss mitigation departments to process them. Whatever the reason, the private sector has shown that it cannot respond as needed. Government is the best option for doing these restructurings on such a massive, coordinated scale. Treasury has to buy these or the rot is not going away.
September 20th, 2008 at 7:57 pm
The British government is doing something like this with Northern Rock, offsetting debt repayments from the Bank of England’s emergency loans with an equity stake.
Anyway, we know what’s going to happen: Boehner and McConnell will whine over ‘loading the bill’, Bush will threaten a veto, and the Democrats will cave and give Hank his blank check. Massive wealth transfer ahoy!
September 20th, 2008 at 8:30 pm
I will bet that the shareholders will be largely wiped out with this deal.
September 20th, 2008 at 8:30 pm
The shareholders will be wiped out with this deal. Just wait.
September 20th, 2008 at 8:54 pm
Twice last week Charlie Rose had on Hank Greenberg, who built AIG and ran it for 30 years or so. He and his people wanted to set up a bridging loan, far short of the government’s $85 billion final solution, but they couldn’t get a seat at the table. Charlie Rose kept saying he didn’t understand why. I think Friday’s theatrics clear-up the mystery: Paulson needed a Reichstag fire to stampede the pols into the biggest raid on the U.S. Treasury in history, and AIG was it. Think about it. The ‘rescue’ IS the crime.
This thing is melting, which is why they’re so eager to ram it through. Anybody notice the part where they make it non-reviewable by the courts? What does that tell you? I just emailed my senator and congressman, and told them to stop it. I suggest y’all do the same.
September 20th, 2008 at 9:01 pm
If I understand it correctly, the government buying a stake in these companies partly stabilizes them because it (i) provides instant liquidity and (ii) is in effect backing up the institutions using its status as an “unfailable” institution. This is to the benefit of the companies and, one assumes if voluntarily undertaken, the shareholders. Why does this deal not automatically come with a premium? That is, to have the government buy a 10% stake why should this cost the government 10% of the share-price value when we could easily stipulate that this should be (say) 9%? If we wish generally for being bailed out by the government to be something that is worse for shareholders than good management but better than collapse then we should make it a bad but not too bad deal for the companies. The tax payers have various asymmetric advantages through the government (their triple A rating and ability to raise money at very low rates), and it seems fair that if we are being asked to back-stop a series of bad decisions we should charge a premium for it.
September 21st, 2008 at 12:07 am
The problem is that buying equity doesn’t solve the real issue. The underlying issue is that banks, etc., can’t be certain who is credit worthy and who is not. The system relies on easily available public credit, because the Fed doesn’t have nearly enough money to be able to loan all the funds that the financial institutions used to loan each other. The Fed is going to need extreme help from the Treasury to come up with the funds for the loan buyout. There’s no way for the US government to come up with the amount of money to replicate the scope of the credit market. Buying equity in the firms would only add a small fraction of the funds that freeing up the credit market will.
There are real limits to the power of the federal government.
September 21st, 2008 at 7:04 am
If the problem is foreclosures, why not bail out the mortgage borrowers instead of the lenders. The money divided amongst homeowners would do much more for the economy while saving the institutions.
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