“Treasury Secretary Paulson proposes a sort of Resolution Trust Corporation (RTC) that will buy out (with taxpayers' money) the distressed assets of the financial sector. But, at what price? ....
The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich—at the taxpayers' expense. If this subsidy is large enough, it will succeed in stopping the crisis. But, again, at what price? The answer: Billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses. ....
As during the Great Depression and in many debt restructurings, it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for- equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture. But if it is so simple, why no expert has mentioned it?
The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers' expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few. Since the many (we, the taxpayers) are dispersed, we cannot put up a good fight in Capitol Hill; while the financial industry is well represented at all the levels. It is enough to say that for 6 of the last 13 years, the Secretary of Treasury was a Goldman Sachs alumnus.
But, as financial experts, this silence is also our responsibility. Just as it is difficult to find a doctor willing to testify against another doctor in a malpractice suit, no matter how egregious the case, finance experts in both political parties are too friendly to the industry they study and work in.”
Luigi Zingales, "Why Paulson is Wrong", undated 2-page paper.
http://faculty.chicagogsb.edu/luigi.zingales/Why_Paulson_is_wrong.pdf
Luigi Zingales is Professor of Entrepreneurship and Finance at the Graduate School of Business, University of Chicago. Zingales has a BA in economics from Universita Bocconi in Italy and a PhD in economics from MIT. He is co-author, with Raghuram G. Rajan, of Saving Capitalism from Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity (Princeton University Press, 2004).
I have no idea whether Treasury Secretary Paulson’s bailout of the banks is a good idea or not. I suspect not, simply because all bailouts are a bad idea, especially bailouts done in a crisis when no one has the time to think about what they are doing. His response to the situation is exactly what one would expect from Washington: Let’s pass a law, and don’t ask me about the details of the law because the devil is in the details and anyway I don’t know what the details are. We’ll work it out as we go along. Anyway, we’ll include a lot of spending items in the bill, and you’re bound to like some of them. Focus on the “candy” and forget about the costs.
I would simply say this approach will only make matters worse. We are in a deep financial crisis precisely because in the past we have been reckless in our expansion and use of credit. So, how does the Administration intend to deal with the situation: Ever more credit to get increasingly doggy debt off the books of the banks that brought us to this state of affairs so they can continue to do exactly what they did in the past. And, how does the Congress intend to deal with the situation: Ever more spending and ever greater deficits to try and “rescue” all the people who are sinking under the weight of the debts they have accumulated in the past by shifting a mountain of debt to the taxpayer.
One cannot help but fear that the road they have taken will not be helpful. The magnitude of the adjustment required to restore some semblance of balance between saving and investment in this country was large before this debacle. Now it is becoming even wider as a result of (misguided?) efforts to attain temporary calm in what is a raging storm. Both Presidential candidates did the best they could to ignore the looming deficits dooming the proposals they have hawked to voters in the election campaigns. The spending proposals of one side and the tax relief proposals of the other, propped up as policy corpses awaiting burial after the election, are now not just dead but irrelevant to the future of the country.
We shall see if one or the other of the candidates actually produces a program that actually deals with an economy encumbered with too much debt and a government on a track to financial bankruptcy.
Thanks to Larry Willmore and Tyler Cowen for the pointer.
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