An Inadequate Case for the Bailout

For over a year I have discussed the collapse of the U.S. real estate market and the havoc that I believed it would cause to the larger economy. Sadly, most in Washington paid little or no attention to the problem until it became a catastrophe. Now the Chimperator's crew have proposed a huge bailout which has as its main features (1) no accountability on the part of the Secretary of the Treasury, (2) no punishment for those in the investment banking and mortgage industries who recklessly caused the mess, and (3) no help for the average homeowner or business owner who has been swept up into the maelstrom. Moreover, the $2.5 billion in the bonus pool for Lehman Brothers, now in bankruptcy, and golden parchutes of CEO's of failed firms, are nothing short of obscene. The New York Times has a good editorial that lays out why the current administration proposal does not fit the bill for what is needed. Here are some highlights:

*

Under skeptical questioning in the Senate Banking Committee on Tuesday, Treasury Secretary Henry Paulson and the Federal Reserve chairman, Ben Bernanke, gave no ground in defense of their $700 billion proposal to bail out the financial system. They also gave little reason to believe that their proposal would protect taxpayers from huge losses.

*

Rather than rushing to approve the $700 billion bailout, lawmakers need to examine alternatives. They should look for one that ideally would let taxpayers share in the gains from any postbailout revival, along with the bankers and private investors who will make money if the bailout succeeds. Several ideas have been advanced that Congress should examine.

*

Prominent among them is a plan to make a direct investment of taxpayer dollars into financial firms, rather than buying up their bad assets. With that money, the firms could absorb the losses that they are bound to take as their investments go sour and avert failure and panic. Once the firms begin to recover, taxpayers would earn a return.

*

Another proposal, advanced by Senator Christopher Dodd, would buy up bad assets, as proposed by the administration, but would give the government the option to acquire stock in the firms receiving help. The danger is that private investors, fearful of seeing their ownership stakes diluted if the government becomes a shareholder, might be reluctant to invest money. That would deprive the firms of investments they need to recover.

*

One thing is certain. If taxpayers do not share in the potential profits from a bailout, someone else will. On Tuesday, the Federal Reserve announced that it was relaxing rules that require investors who take large stakes in banks to submit to longstanding regulations on transparency and managerial control. Private equity firms have pushed for the changes because they would like to become big investors in beaten-down banks but do not want to be regulated.

*

Relaxing the rules invites more of the same type of opacity and risk-taking into banking that caused many of today’s financial problems. Politically, the Fed’s timing could not have been worse. Taxpayers are being asked to buy up banks’ junky assets, with little expectation of return. At the same time, private equity firms are being invited to make what are likely to be highly profitable investments in the same banks. That’s not a plan that lawmakers and voters can support. Congress has more work to do.