Big Bailout Isn't a Slam Dunk

Posted by: Matthew Goldstein on September 21, 2008

Late last week investors cheered the news that the federal government was racing to put together a massive $700 billion bailout package for the financial system. A huge two-day rally in the stock market nearly wiped out all of last week’s declines and almost made investors forget Lehman’s bankruptcy filing, Merrill’s shotgun marriage with Bank of America and the government’s defacto takeover of insurance giant AIG.

But now that the Bush administration has finally presented its plan for saving Wall Street from its past mistakes, there are some serious questions legislators need to ask themselves before rushing to enact the measure.

For starters, the plan would give unprecedented power to the Treasury Department with few obvious checks and balances. Tresaury can just about hire any money manager it wants to oversee all the ailing mortgage-related debt the government—at taxpayer expense—plans to buy-up.

It’s totally up to Treasury to determine the prices it will pay for those assets. Pricing of assets is critical because it determines how much in further mark downs Wall Street will have to take and whether taxpayers can expect to make any money off this deal down the road. If the prices set for the assets are too high that could be a great deal for the Wall Street banks but mean taxpayers won’t be able to recoup much of a profit when the assets are later resold.

The brief three-page outline of the plan also doesn’t require the banks to give anything up. There’s no talk of forcing them to bring leverage levels down to a specific level—a move that would limit the ability of banks to again pile into risky assets. The measure also doesn’t require any corporate governance changes at the banks to make them more accountable or transparent in dislosing risk levels.

Finally, if the taxpayers are doing all this to keep the banks solvent, shouldn’t the executives who run these entities be required to give something back. During the hey day of the mortgage boom, top executives on Wall Street at Goldman Sachs, Lehman, Bear, Morgan Stanley, Merrill and other firms took home hundreds of millions in compensation. Sure, many of those executives lost a lot when the share prices of their companies plunged. But they also banked a lot of cash on the way.

If taxpayer are going to be asked to pay-up to solve the crisis, what about the Wall Street bankers who caused this awful mess?

Reader Comments

bondy

September 21, 2008 10:57 AM

We'll when it only costs the Government 50 cents to print a $50 dollar note, guess they can keep the ball in the air a bit longer. Its an awful mess that Mr Greenspan cohearst. The American tax payer is going to be on the hook for decades to come. You can only conclude that a $50 note will eventually reach its correct value... that is 50 cents.

Fred

September 21, 2008 12:13 PM

The 2 previous episodes of bailout from Paulson failed to curb the finanacial meltdown. What make you think this time he can fix the problem once and for all?? If he left too many loopholes on this bailout, I am so sure CEO's on the wall street will become the ultimate beneficiaries of Paulson's plan, at the taxpayers' expense

tom

September 21, 2008 1:37 PM

There should be a shared risk deal. Taxpayer has all the leverage, though Paulson does not want people to think that. He wants to make it painless for his friends on Wall Street.

Taxpayers should also have a lien on CEOs homes which will be liquidated if we lose any money.

A transaction tax should be put on these over-the-counter swap type transactions. This is fed into the kitty. That way foreign banks can also kick in.

Bob

September 21, 2008 1:50 PM

This whole things really gets me upset. I have been 30% in cash because it did not take much to see things where just plain wrong. I was 70% in stocks because things can stay wrong for a long time. So now these idiots are going to get rewarded! I think what they have done up to now is better. Sent half the companies to bankruptcy and the other half the government gets 80% of the company for backing the loans.

A better ratio would be 1/3 bankruptcy and 90% of the company.

Eben Calder

September 21, 2008 2:44 PM

This is a two year plan. But as Meredith Whitney and others are commenting, it's flawed on many levels. Initially, the housing market is still declining - and history suggests it may be only a little more than half-way to its ultimate bottom - which will be at 35% to 40% of the previous high value. We currently have no idea what the true cost will in fact be until this happens, and until we know not only how many bad loans cannot be serviced by consumers, but how many people who are still making payments, stuck in a $450,000 mortgage on a house worth $300,000, will simply give the keys back. The second fact is that taking toxic loans off the books of the banks will not help the banks unless the government pays "above" market value. After all, they'll be taking write downs of 50% or more (Merrill Lynch wrote down $30 billion by 78%), and they'll have no capital to lend until they find the capital to shore themselves up - and many may not be able to do that. And, if the Fed pays more than the assets are worth to try to assist the banks, they will have no market for the assets they have just purchased.

The bottom line is this is a panic reaction to an event that no one controls. They don't know anything - but they must try something.

Peter Christiansen

September 21, 2008 3:52 PM

What's the big hurry? This bailout, as presently written, will provide billions of dollars to help landlords who speculated in real estate (often via "liar loans") and flippers (also often via liar loans) but does nothing for renters who will not only have to continue paying exhorbitant rents but will also have to pay for the for the bailout of their land lord. Renter are screwed twice by this bailout.

Also, since the Republicans got us into this mess and are the pricipal beneficiaries of the bailout, why can't there be an amendment to eliminate the tax cuts for the millionaires that Bush and company enacted, and remove the limit on social security taxes that enables millionaires to escape paying their full share of the social security tax.

Peter Tremulis

September 21, 2008 5:17 PM

The time has come for a taxpayer revolt! The financial chronies have taken over the government and blackmailed the current crop of DC bureaucrats into doing whatever the financial chronies want. There will be no end to the bail outs as a blank check has been cut without any qualified government oversight. The inmates are running the asylum and have drafted 799 of thier closes friends to dine at the largest taxpayer buffet in history.

It's time for a third party to emerge and nominate a candidate to run against the Obama/McCain sharade. What is happening now is against all good sense. Paulson's guarantee is designed as he sees it and when he sees it and applying it with our tax dollars without consequences for those who ran thier corporate ships into the rocks. It's ludicris to think that Paulson should be given the power to be judge, jury and executioner or savior to his closest friends as he sees fit.

McCain's blast of Cox was right-on as the SEC removed the debt to equity limit of 12:1 for investment banks and Lehman and the other four investment banks promptly went to 30:1 all on thier own and pushed the avalanche of newly created debt onto an uneducated underclass driving the housing market first to bubble then to bust. If you give a man enough rope, he will hang himself. Let's not give Paulson enough rope to hang himself again and the taxpayers for a first time because of the recklessness of insiders in Washington DC and New York City.

This has gone quite far enough.

Peter Tremulis

September 21, 2008 5:18 PM

The time has come for a taxpayer revolt! The financial chronies have taken over the government and blackmailed the current crop of DC bureaucrats into doing whatever the financial chronies want. There will be no end to the bail outs as a blank check has been cut without any qualified government oversight. The inmates are running the asylum and have drafted 799 of thier closes friends to dine at the largest taxpayer buffet in history.

It's time for a third party to emerge and nominate a candidate to run against the Obama/McCain sharade. What is happening now is against all good sense. Paulson's guarantee is designed as he sees it and when he sees it and applying it with our tax dollars without consequences for those who ran thier corporate ships into the rocks. It's ludicris to think that Paulson should be given the power to be judge, jury and executioner or savior to his closest friends as he sees fit.

McCain's blast of Cox was right-on as the SEC removed the debt to equity limit of 12:1 for investment banks and Lehman and the other four investment banks promptly went to 30:1 all on thier own and pushed the avalanche of newly created debt onto an uneducated underclass driving the housing market first to bubble then to bust. If you give a man enough rope, he will hang himself. Let's not give Paulson enough rope to hang himself again and the taxpayers for a first time because of the recklessness of insiders in Washington DC and New York City.

This has gone quite far enough.

Stewart Prior

September 21, 2008 7:36 PM

My letter to the Senate regarding bailout:

Dear Senator,

I wish to to voice my concern regarding the proposed bailout of the financial institutions that have wreaked havoc both on myself, and the public at large by their avarice and lack of accountability. While the bankers were reaping record profits, and bonuses, they were pricing responsible individuals like myself out of the housing market by their reckless lending practices. I have always felt that living within my means was both prudent, and best for my family. I make a fairly decent salary, in fact, above the median income for most communities in Long Island where I reside.
Before I digress any further I would like to get to the crux of the matter.
First, there needs to be serious deliberation in the Senate before approval of any bailout package. I believe that if the situation is as dire as stated by Treasury, which truthfully, I do not believe, then a quick passage of this measure would show a lack of due diligence by Congress. Secondly, the bankers, and other financiers must be held accountable both criminally, if appropriate, as well as financially. Bankers must not be allowed to retain any profits directly related to the sale of their impaired assets. If, as banks balance sheets get stronger, which they will, they must then begin to re-assume some of the toxic debt they have bestowed upon the American public at par of their sale price. This should be a reprieve, not an exoneration of the bankers, and their inexcusable lack of fiduciary responsibility. Finally, any potential future profits must be given back to the public either by funding Social Security, Medicare, put towards universal health care, tuition grants etc. We should not practice socialism only when it comes to bailouts of corporations. We need to regain what is left of our moral compass in this country, as we appear to have become a nation that is lacking in any sense of self-responsibility, or consequence. We cannot continue selling the future of our nation for the benefit of the top one percent of the population. I look forward to your acknowledgement, and thoughts on this subject.

Word Carr

September 22, 2008 3:40 PM

Bailout is the wrong terminology. Seizure of all the mortgage assets of companies that took part in the fraud by the federal government is what should happen first.An evaluation of the value of the assets should then take place.Then severe penalties should be imposed, similar to that of the penalties of convicted drug smugglers on those that took part in the fraud.Third, rewrite all the mortgages contracts of those that live in the homes as their primary domicile, that are in default, in simple language that cannot be misunderstood.Next,structure a means by which private mortgage companies can buy these mortgages from from the government. Time is not a factor, the Fed can, and should make money on this mortgage restructure.

Karla Guzman

September 25, 2008 8:56 AM

The bailout plan is a step in the right direction that would prevent an unmanageable economic crisis. However, this plan should require more accountability from executives responsible for letting poor lending practices occur under their watch. The Government has yet to address a resolution for the ongoing foreclosures and what will happen to home owners in the risk of loosing their homes and the impact this will continue to have in the economy. Also, the Government and financial institutions do not seem to have plans to avoid future predatory lending practices and educate potential homeowners of the risks associated with different home loans. Addressing the root of the problem is important.

Karla Guzman

September 25, 2008 9:06 AM

The bailout plan is a step in the right direction that would prevent an unmanageable economic crisis. However, this plan should require more accountability from executives responsible for letting poor lending practices occur under their watch. The Government has yet to address a resolution for the ongoing foreclosures and what will happen to home owners in the risk of loosing their homes and the impact this will continue to have in the economy. Also, the Government and financial institutions do not seem to have plans to avoid future predatory lending practices and educate potential homeowners of the risks associated with different home loans. Addressing the root of the problem is important.

Karla Guzman

September 25, 2008 9:16 AM

The bailout plan is a step in the right direction that would prevent an unmanageable economic crisis. However, this plan should require more accountability from executives responsible for letting poor lending practices occur under their watch. The Government has yet to address a resolution for the ongoing foreclosures and what will happen to home owners in the risk of loosing their homes and the impact this will continue to have in the economy. Also, the Government and financial institutions do not seem to have plans to avoid future predatory lending practices and educate potential homeowners of the risks associated with different home loans. Addressing the root of the problem is important.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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