Note to Self: Potential Dealbreakers:

For political viability and rough equity, the financial rescue plan requires:

• Pay reform
  • Cancellation of current golden parachutes
  • Look backs in the future--pay over $1M conditioned on the long-term profitability of the enterprise over more than a decade
• Substantial upside for the government
  • Immediate substantial equity dilution via warrants for companies that put any substantial share of their assets to the Treasury
• Congressional approval of terms
• Personnel: I wouldn't vote for anything that could give a McCain-appointed Treasury Secretary this much authority. I don't think I know Paulson well enough to trust him with this much authority. (I would trust Bernanke.)

Comments

[dd]

You did not mention pricing of assets (unless it is covered in the point regarding approval of terms), the most difficult aspect of the proposed transactions. Any thoughts?

Also, what about mandating further disclosure of assets owned as a condition to doing a deal?

[dd]

Let me add cancellation of dividends on common and pre-existing preferred to my first post. Is there any reason not to insist on this, as was done in the Fannie and AIG cases?

[T Griffin]

I could not agree more about the Treasury getting equity warrants.

What is wrong with the current system that banks can give the Fed collateral and get cash against that collateral with the risk that if collateral falls apart the banks have a problem not the government? No above market price paid by the government and hence no subsidy? No transfer of risk from the banks to the government?

There is no requirement in any scheme that all risk move to the government-- the banks should continue to have plenty of risk for anything transferred and the government should see the upside of any risk it takes. The way to make sure that the banks behave themselves is with equity warrants that kick in if the debt deteriorates in quality.

The toxic paper should move to the government at a discount determined by the current market and the banks should pay an equity dilution price if the paper gets worse.

In essence, the government buys the loans in a form which has the nature of a bond (which it should) and if things go wrong then warrants should allow the government to stick the loss to the bank as equity dilution. The bank has the incentive to behave in the desired manner. Any financier would stucture the notes right now to include warrants that would create a cram down of equity if the valuation gets worse.

As an aside, what we do not want is banks buying paper that is particularly odious from foreign banks, hedge funds (or others not covered by the scheme) and then selling it on to the Treasury. No paper bought by a bank after last week should be part of this at a minimum.

Banks should not be allowed to create massive negative externalities (i.e, systemic risk) that they are not forced to internalize. The systemic risk we suffer now is like pollution emitted by a lead smelter in the middle of a big city.

[dd]

Let me add cancellation of dividends on common and pre-existing preferred to my first post. Is there any reason not to insist on this, as was done in the Fannie and AIG cases?

[The fastest growing municipality was Las Vegas]

IBs were run for the benefit of top management thought publicly traded companies. While the masters of the universe played with OPM, less than half of the company wide profits were distributed to the shareholders.

I would trust a to-be-proposed outside panel of economists who were right as the taxpayers' honest brokers to serve as their representatives, Shiller, Roubini, Stiglitz, perhaps the management of Annaly Capital Management to manage the socialized shit pile, and market-wise Buffett, headed by Volcker.

Bernanke is an inflation specialist. He dithered his first year in the head central planner seat. There were opposing views that were more right than wrong, but they were ignored. Perhaps this is granite reality, "Of course, the idea of a candidate telling voters that they will suffer if he is elected runs counter to every political instinct." No one in Washington DC can be mobilized till the tsunami reaches shore.

[The fastest growing municipality was Las Vegas]

This is concrete. Naomi Klein on the Bill Maher show via Crooks & Liars, "The reason why this bubble was allowed to inflate was not that the American people demanded it, it was spectacularly profitable for Wall Street. Just in bonuses last year, they handed out 33 billion dollars in bonuses… The problem is we have crybaby capitalism where when the times are good they are preaching deregulation and when the times are bad they want the bail-outs."

Paulson is a genius, Via that Swedish socialist site Eschaton, "Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency." No, Paulson is not trustworthy.

Bernanke has been moving from the Ivy League, prep schools for the Industray that Lost More Money than It Ever Made and the central planning bureau in Washington, DC. No, I can not trust Bernanke unless the thinking is his last hundred decisions have been disastrously wrong so he's due for a right one.

[The fastest growing municipality was Las Vegas]

Please, people catch up with the units. It is not "billions," "hundreds of billions" just captures it. Use trillions, hopefully only one or two. Seven hundred billion is just step one.

[The fastest growing municipality was Las Vegas]

Wow, who forecasted that we would march into a south Asian nation and collapse just like the Soviet Union?

Somehow our central planners are deemed worthy by some to keep their seats.

[Steve LaBonne]

Trust Bernanke? I wouldn't trust a committee composed of Jesus, Buddha and Zarathushtra with the kind of no-accountability blank check envisioned by the draft legislation.

[who gave Roubini the magic 8 ball?]

The first couple of Sec of the Treasuries picked by Bush were complete nonentities. All I remember is the overly paid CEO from Reading Railroad. Suddenly Paulson shows up just in time for big shitpile to start spreading pestilence.

No Deal

This is a proposal from the Bush Administration, unless you're Rip van Ruben you know by now how well that works.

No Deal is the New Deal

[MobiusKlein]

How much is the USA on hook for the AIG insurance policies on mortgages?

It seems that once we own the insurance company that pays off on the busted properties, buying them outright seems like it is a push.

Or do those policies pay off at some lesser fraction?

[who gave Roubini the magic 8 ball?]

Palson's opening negotiating tactic seeking down payment on his mega-trillion blank check is exactly Cheney's move to scare us into war in Iraq, also blank check government, complete end run around the regulating institution, the UN.

[Paul Yarbles]

DeLong: "I wouldn't vote for anything that could give a McCain-appointed Treasury Secretary this much authority. I don't think I know Paulson well enough to trust him with this much authority. (I would trust Bernanke.)"

DeLong, have you lost your mind? Read this again:

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

http://blogs.wsj.com/economics/2008/09/20/treasurys-financial-bailout-proposal-to-congress/

I would oppose this even if Jesus Christ himself was the Secretary. You don't give one guy this much power. Especially if it's one of the guys that f**ked everything up in the first place. Do we really need Mr. Goldman Sachs being the economic dictator of the country?

I suggest you either check yourself into the nearest psychiatric hospital or, if you don't have the time to do that, read this piece by Dean Baker:

http://tpmcafe.talkingpointsmemo.com/2008/09/20/progressive_conditions_for_a_b/

[bakho]

AIG not only writes insurance policies on mortgages, they also write insurance policies on stock holdings.

Congress should demand a seat at the table (or perhaps form a commission) to control that much money. The potential for corruption (intended and unintended) is too great.

[who gave Roubini the magic 8 ball?]

Congress has been approving this debacle from the beginning. Lieberman? Schumer? They're owned by the innovative finance industry. Look at the neighboring state New Jersey's SWF investment in Lehman Bros Co.

Proposed honest brokers rated in order, Volcker, Buffett, Roubini, Stiglitz, Jim Grant. This list is short.

One weekend Roubini said Goldmine Sachs was too on death's list and the following week we have another Bush administration blank check.

[who gave Roubini the magic 8 ball?]

Will this be on our grave stone? Krugman, "their track record to date does not lead to the automatic conclusion that they know what they’re doing."

[who gave Roubini the magic 8 ball?]

Paulson has spent more time consulting with the Chinese than he wants to spend negotiating with Congress.

[Craig]

The real issue is credibility and how to restore it. No doubt important stopgap measures can prop up our financial system in the coming weeks but the real issue is that George W. Bush has undermined our economy with reckless spending, excessive tax cuts, two wars that seem to assume infinite resources, cronyism, further deregulation and a general failure to provide sufficient oversight. The mortgage derivatives that are a major source of the problem should never have existed.

Despite any stopgap measures, the financial credibility of the United States will continue to deteriorate until Bush leaves office. If McCain is elected, our financial credibility will continue to slide. Electing Barack Obama may give us a temporary reprieve and perhaps time to repair the damage but only if Obama is aggressive, makes clear how deep the problem is and the Democrats in Congress show enough backbone to get rid of the deadwood on Wall Street and get us out from under our financial obligations to the war in Iraq. I fear the biggest problem Obama and the Democrats may face, however, is obstruction from Republicans over issues such as alternative energy, global warming and the creation of jobs, all issues that have been ignored for too long.

One last point. I went to my local newsstand which carries about 20 newspapers and a hundred magazines. From what I could see, you would think our current crisis is simply a minor bump in the road. Not good. Not good at all.

[insane times]

Would all of you worry warts relax. This plan is brilliant and I'm all for it. Paulson is a genius. You minions should not question this. Of course it will work and taxpayers will make a ton of money with Paulsen running the show. Who are we to doubt. Indeed.

[Roger Thomson]

Why not distribute $20,000 to every adult American under 65? The money will eventually "trickle down" to American bankers. This would only cost $3.6 trillion, which is only a bit more than 5 of Paulson's $700 billion print runs for his friends. The ensuing inflation will end the downward spiral in house prices!

And if you think this plan is ridiculous, you're not grasping what Treasurer Paulson is up to.

[Robert Waldmann]

"political viability" you wish. It is clear that the Republicans can scare the Democrats into anything (and that in areas less obscure than what the hell have banks been doing).

I'd say not gonna happen. However, it is key that Democrats (and in particular Obama) establish a position that a rescue is necessary, but it shouldn't be a give-away and that the people who have obtained great wealth destroying our financial system ought to pay.

I'd say, the deal should include a clause that says no deal unless the top 5 officers of the bank kick in some of their personal wealth. I don't think they can refuse without resigning or violating their fiduciary responsibility to their shareholders. The US can't just take their money, but it can refuse to deal with their bank.

I think Dean Baker or someone says "no dividends for x years if you participate" I'd add no compensation over $ x either. Plus capital requirements for all, money market account balances become savings account balances, bankruptcy judge can rewrite mortgage. Repeal bankruptcy reform. US get's equity stake (ah you have it).

Also remember carried interest ? Seems like time to tax it. Not to mention a special AMT surtax on incomes over $1,000,000 to help pay for the bailout and well lots of fun stuff (say 50% no deductions (on top of current taxes(and they have to wear dunce caps))).

Enough to make Phil Graham whine (actually doesn't take much).

Anyway, not gonna happen.

But good to tell people what would have been done if the bankers co-conspirators didn't control the executive.

[bigTom]

Whatever happens don't commit to anything until experts have examined the proposal for devious hidden agendas. These guys have access to lots of well thoughtout plans for slipping in innocent sounding stuff, which advances some devious rightwing agenda. Be very very afraid of this, and carefull!

[do not let the pony finders inside the gates]

I can't remember the names of the Bush Administration's first two zombies as sec of the treasury. I can only remember one was the over paid ceo of Reading Railroad. How did Paulson get in this position in time? That was certainly an exceptional pick compared to the first two; it's like getting CIA information and acting personally but not telling the public.

['As You Know' Bob]

"...pay over $1M..."

Nope. They now work for the American public. Obviously, the federal civil service salary schedule should now apply.

[Michael Cain]

"Whatever happens don't commit to anything until experts have examined the proposal for devious hidden agendas."

Which set of experts? The one that insists this is a liquidity crisis? Or the ones who suspect it might be a solvency crisis? I am far less concerned about "hidden" agendas than I am about the one that sits out in plain sight: that the government is going to spend taxpayer money and grossly overpay for the assets. I have no faith that Paulson and his staff (or Bernanke and his, for that matter), can accurately judge the value of this stuff.

[David Ricardo]

Why not distribute $20,000 to every adult American ?
Didn´t "Helicopter Ben" suggested something similar in the past ? Print money cause inflation make debts easier to pay.

David Ricardo

[harlynman]

Questions

If the government received about 80% of AIG equity in exchange for an $85 billion loan, is Paulson suggesting taxpayers receive nothing from bailed out banks?

If bailed companies stocks rise, should shareholders and debt investors, including those who created the mess, reap profits from taxpayer intervention?

Should banks pay shareholder dividends with taxpayer dollars?

If Treasury decides that fair prices are higher than market prices
what should be the consequences for shareholders and debt investors
if taxpayers effectively give financial firms money?

If hedge funds and foreign firms are not eligible to participate, what prevents them from selling or exchanging near worthless securities to eligible US banks to offload on to US taxpayers?
Is legislation stating “Decisions by the Secretary…are non-reviewable…
and may not be reviewed by any court of law or any administrative agency,”
constitutional?

Does bailing out the Banks & Wall Street revitalize the housing market, simulate consumer spending or increase Government Revenue?

If the S&L bailout cost taxpayers $125 billion
and the original estimates were somewhere between $30-50 billion
how much could a financial institution bailout cost
if initial estimates are $700 billion to 1.2 trillion?

Should the USA’s debt rating be AAA?

[bakho]

The Paulson proposal looks like every other proposal from the Bush administration. Use a crisis and threat of serious consequences to force unpalatable legislation through Congress. The proposed solution is short on fixing the problem but long on giving money to Bush supporters. With Bush, the policy is political. The policy may or may not be a solution.

Congress needs to convene its own experts and write its own plan.

[ob]

A thought about the opportunity cost of this plan:

I've been looking around at the commentary on the financial blogs about this bailout and it all seems rather narrowly focussed on questions about the eventual full cost, on the moral hazard issues, and on accountability. There is no discussion of opportunity cost associated with a USD 700 billion government expense. Two premises ought to be kept in mind. One, the ultimate point of the action is not to stabilise the credit market; this is just a means to the further aim of limiting the effect of the credit crisis on the real economy - consumption and investment - of the US. Banks going bust is a problem insofar as it causes the credit markets to dry up, thus limiting the opportunities for debt both for companies and consumers, causing a negative feed-back loop as consumption and investment dries up, leading to depression. Two, the way the plan is structured - buying up bad assets rather than capital infusions in the banks - makes it likely that the full sum of 700 billion will be eventually be written off as a loss (see the comments of Calculated Risk and Angry Bear).

So from this perspective, we can ask ourselves what the opportunity cost is of blowing USD 700 Billion on bailing out banks. Is this the most efficient way of limiting the effect of the credit crisis on the real economy?

Take a simple alternative - give the 700 Billion back to the tax-payer. This would involve USD 7000 per household, or if targeted somewhat more efficiently at those hardest hit, USD 14000 per household under the median wage. This would raise consumption and investment, help households pay off their credit card and mortgage debt, and cushion the blow for those hit by foreclosure and unemployment. Moreover, consumers' improved ability to pay off their debts would improve the performance of the various problematic credit instruments - CDO's, MBS's, etc - and thus improve the liquidity in the secondary credit markets.

So what is the objection to this alternative?
1. Is it grossly unfair? Yes, it is a grossly unfair redistribution from the affluent to the less affluent, but no less unfair than the reverse distribution proposed by the Paulson plan.
2. Is there a moral hazard risk? Yes, the consumer who has unwisely taken on too much debt will feel encouraged in this behavior. But, again, the Paulson plan encourages and vindicates the irresponsible behavior of other participants of the economy - banks. And arguably the moral hazard in the proposed consumer bailout is less of a problem. Because the hard-hit banking sector will have learned the lesson of the credit crisis and thus forbid consumers from overextending themselves in future.
3. Won't many banks go bankrupt? Yes, insolvent banks will go bankrupt. That is the point of a free-market economy - punishing bad investment.
4. Won't the implosion of the banking-sector cause a depression-inducing shrinking of the money-supply? Unlikely, the infusion of USD 700 bn will ensure an expansion of the money-supply.
5. Won't the implosion of the banking sector cause further government expense in the form of federal deposit insurance, etc? Certainly, but find me one economist who thinks that the Paulson plan is the end-game in credit-crunch related government lay-outs.
6. Won't this be massively inflationary? No. The kind of inflation that is problematic involves a self-reinforcing wage-price spiral, and a one-time infusion does not a spiral make.
7. Isn't this massive consumer bailout plan utterly insane? Yes, but it just puts into perspective how insane the massive Paulson plan is. And the whole justification for the Paulson plan is that these are insane times, calling for insane action.

There are other alternatives. This is just one example. But the question ought to be 'what would you do with 700 billion dollars to help the US economy?', not 'what color wrapping paper do we use for a 700 billion dollar gift to the banks?'

best,
OB

[hooligan]

We are approaching the eye of the storm.The assets dont care if they are financed by the government or a hedge fund and the returns on assets cant be increased unless there is creation/injection of profit/equity. The second eye wall is of course, as in nature, much more destructive and in this case it is the long term impact and second round effects on the broader economy. This use of capital guarantees (leaving aside the pentagons 500 billion a year and the funded or unfunded capital demands of medicare and medicaid) here for the financials, surely means less capital (guarantees) elsewhere, or the effect of conventional wisodom leading to the direct or indirect pursuit of the japanese model from 1991. Too big to fail = zero rates so NPL cant be distinguished until banks have rebuilt balance sheets through panifully slow profit growth. I worry that it is the allocation of scarce resource (tax payers future capital) that hasn't been thought through and that the problem couldbe fixed by supporting the broader economy with this capital over the long term. The last shoe to drop does not exist in the financials sector it rests in the size of the dole queue and the subsequent quality of life for tax payers. Of course follwoing the japanese model means overt or covert accpetance that government debt to gdp ratios of 160-200% are acceptable. That is a bigger question entirely, after all, this is another moral hazard ignored by most. Interest costs on national debt, preclude any expansion in spending on any other sector and in fact mean that if the overall economy grows the interest on debt (opportunuty cost) becomes unbearable at the government level. I/e interest rates go up to match the return on the economy (nominal gdp). Perhaps the Japanese model will work and the new laws will follow it (called something else of course). But i think the Japanese experience still proves salutory. Japans stock market peak was 1991. it is still 70% below 39,000. The Dow peaked at 14,000, so is it headed for 4,000 over the next 15 years because thenet effect is that the US is, by default, following that model? Oh, one final thing, is it legal to put in a clause in the bill that says all action is outside the us legal system?

[Bill Callahan]

Professor, your deal-killers are fine, but from the perspective of my dining room table in Cleveland a few need to be added...

1) If a bank wants access to the bailout, foreclosures stop now.

2) If a bank wants access to the bailout, bulk sales and auctions of REO properties stop now.

3) The governmment or bailout agency must get management authority over the actual mortgages underlying any RMBS or derivative it acquires.

4) The legislation must spell out principles guiding this management including a) minimizing foreclosures through aggressive restructuring, principal writedowns to real value, etc., and b) significant control of REO sales by local communities.

http://www.callahansclevelanddiary.com/?p=672

[pieta]

Why would you trust Bernanke? I am asking that seriously. I mean, everyone in the financial sector, govt and industry, apparently ignored this, and how could they ignore it? Greenspan (whose fault it partly is, yes) was a whole lot more vocal in warnings the last three weeks than Bernanke.

What did Bernanke do that makes you think he can deal with this honestly and effectively? I generally defer to your judgement, because I think over the years you have shown pretty good judgement, but we do need some support for that endorsement, as it seems counter-intuitive at best.

Especially now we hear that lobbyists are apparently flocking round and getting a good listen in the House.

[Pat]

There should be a provision that no firm accepting this deal can pay its executives or employees any more than a GS-15 (around $125k).

[harold]

"Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."

It strikes me that this is neither legal nor constitutional, whether they pass it or not.

[Norm Goodman]

If everyone understood that the plan, as described by Paulson, would terminate or drastically reduce Medicare (already on life-support), then the response by Congrees might be more thoughtful.

As things stand, this is a rush to judgment that will have a far reaching impact on our society and the public's perception of 'full faith and credit.'

[Norm Goodman]

If everyone understood that the plan, as described by Paulson, would terminate or drastically reduce Medicare (already on life-support), then the response by Congrees might be more thoughtful.

As things stand, this is a rush to judgment that will have a far reaching impact on our society and the public's perception of 'full faith and credit.'