The Opposition Grows

Posted by: Michael Mandel on September 21

Opposition is growing to the Paulson plan. Much of it makes sense:

Luigi Zingales from the U of Chicago Business School writes:

The decisions that will be made this weekend matter not just to the prospects of the U.S. economy in the year to come; they will shape the type of capitalism we will live in for the next fifty years. Do we want to live in a system where profits are private, but losses are socialized? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalized and prudent behavior rewarded?
For somebody like me who believes strongly in the free market system, the most serious risk of the current situation is that the interest of few financiers will undermine the fundamental workings of the
capitalist system. The time has come to save capitalism from the capitalists.

Paul Krugman writes

… the plan does nothing to address the lack of capital unless the Treasury overpays for assets. And if that’s the real plan, Congress has every right to balk.
So what should be done? Well, let’s think about how, until Paulson hit the panic button, the private sector was supposed to work this out: financial firms were supposed to recapitalize, bringing in outside investors to bulk up their capital base. That is, the private sector was supposed to cut off the problem at stage 2.
It now appears that isn’t happening, and public intervention is needed. But in that case, shouldn’t the public intervention also be at stage 2 — that is, shouldn’t it take the form of public injections of capital, in return for a stake in the upside?
Let’s not be railroaded into accepting an enormously expensive plan that doesn’t seem to address the real problem.

Robert Kuttner writes:

Paulson’s storyline is that the credit markets are frozen, and unless Congress passes a “clean bill” — his way — disaster lies ahead. He spent a busy Sunday morning on the talk shows ducking questions on what would happen if Congress didn’t act — and what might still happen if it did.
One senior Congressional Democrat told me, “They have a gun to our heads.” Paulson behaved as if he held all the cards, but in fact the Democrats have a lot of cards, too. The question is whether they have the nerve to challenge major flaws in Paulson’s plan as a condition of enacting it.

Yves Smith at Naked Capitalism writes:

The US needs to wean itself of unsustainable overconsumption, and since consumption has come to depend on growth in indebtedness, a reversal, however painful, is necessary. Our excesses have been so great that there is no way out of this that does not lead to a general fall in living standards (note that the officialdom in the UK is willing to say that, but since perpetual prosperity is a God-given right in America, admitting we will be getting poorer is verboten). Thus, a sharp contraction in lending seems inevitable; the trick is to prevent it from crossing the tipping point into a vicious, accelerating downward spiral.

But regardless, there has been broad agreement that private capital will not enter the mortgage/housing market until investors have confidence that a bottom is nigh. The Treasury program, by quite deliberately propping up asset prices, will delay finding a market clearing level and thus attenuate the financial crisis.

James Hamilton at Econobrowser writes:

I do not see that a clear vision of exactly what is expected and required, in the way of modified capital standards and risk management procedures, for any institution that receives federal assistance is a key part of any of the proposals. And it should be.

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Reader Comments

W. Raymond Mills

September 21, 2008 08:04 PM

Until it is clear that all alternatives to spending $700 billion have been investigated and shown to be impractical, the Congress should refuse the offer to provide $700 billion, regardless of what else is proposed as sweetners.

Begin with the first question...Do we have any alternative? Paulson has not shown that he has explored other options.

For example, the immediate problem is the recurrent write-downs that firms are required to take because they own contracts that are not selling or if sold, at great discounts.

This is silly. These firms could hold these contracts indefinitely, if they were not required to mark-to-market.

I would like to see a through investigation of how these write-downs could be prevented.

Joe Cushing

September 22, 2008 02:19 AM

W. Raymond Mills makes a good point. Only a small portion of mortgages have gone into default. Even if the homes lost 35% of their value and had no equity before the loss; taking a 35% hit on 5% of one class of your assets in a year should not make a catastrophe. I think we are seeing a run on the bank. I think panic is the major culprit here. Whoever is holding these MBSs in the end is going to be rich.

Tom Gerber

September 22, 2008 10:22 AM

An appropriate name for this bailout is "Paulson's Payoff," because he is paying off his Wall Street friends at taxpayer expense.

ajay

September 22, 2008 10:32 AM

The only comment I have to make is no one is addressing the core problem which is the asset devaluation. I dont know why everyone is turning a blind eye to it. Will this rescue stop the depreciation of the asset values if no then how much money are you going to need to keep the banks afloat? As the asset value drops further the banks will need more capital than the 700 billion $. Also a 20% decline is asset value which is very likely will make the 5.7 trillion dollars worth mortgages Fannie & Freddie own looase atleast 1 trillion dollars. Who will account for that?

tg

September 22, 2008 10:36 AM

We were in the market to buy a house (we sold one a couple of months ago). After the last couple of weeks we've decided to stay renting for awhile and when we do buy, we are going to be buying a much smaller house than we would have.

I don't understand the argument how this will help the residential real estate market. We've gone from being a prospective buyer to sitting on the fence for at least a year.

tk

September 22, 2008 10:38 AM

Paulson's proposal is : give me 700 billion dollars, leave the rest up to me, I know what I'm doing, and don't hold me responsible now or ever for what I am about to do.

Congress must not give in to such ludicrous demand by a Wall Street insider who is looking after his own kind. Congress is obligated to think, speak, and act for the tax payor.

TP

September 22, 2008 11:47 AM

Does this not seem a little strange to anyone else? We borrowed wildly from foreign investors in order to have cheap capitol which was used as loans to people and corporations that didn't qualify for assets well out of their reach. Now that some of those loans have begun to fail we are going to borrow again from the same foreign investors to by back those loans. Aren't we paying twice for the same investments?

In a side note, what is going to happen to investment in actual innovative but risky companies now that there are no more investment banks? Will innovation dry up for a few years or more? Without being able to use leverage the risk/reward proposal for some of these businesses will become much less appealing.

This crisis needs more than a couple of days to figure out. We're moving too fast.

Jeff

September 22, 2008 11:49 AM

This is the most incredible abuse of Wall Street insiders in collusion with politicians are about to change the way we live our lives... I agree with Luigi.."Do we want to live in a system where profits are private, but losses are socialized? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalized and prudent behavior rewarded?"

How can we trust the likes of Chris Dodd, whose sweetheart mortgage from Countrywide and hundreds of thousands in campaign money from Fannie Mae to do the right thing for the taxpayer?

Let's not forget that the Financial Modernization Bill of 1999 signed into law by President Clinton; and voted for 90-8 by the Senate (Harry Reid and Joe Biden both FOR) began this whole process of accelerated deregulation.

John

September 22, 2008 11:52 AM

Yves Smith is the only one who has it right. Kids who graduate from HS and who are NOT necessarily producing anything tangible are immediately expecting a 3000 SF house, SUVs and a boat in the driveway, flat-screen TVs and brushed-stainless appliances, etc. -- all purchased on credit. Work. Save (set some aside for the long-run). Then buy.

maggie lee

September 22, 2008 12:09 PM

As a Canadian, I find it incredulous that the US taxpayers (never mind law-makers) would hand out a blank cheque (never mind the initial $700 billion - increasingly it seems Paulson wants no limit to it) to a single public official (unelected) to spend as he likes to save a single sector, with no gauranteed results, with no due diligence and hey, do not limit executives' pay AND to do this real fast. Would I give $7 to my son to help his friend on such terms ? No.

Ray

September 22, 2008 12:58 PM

The bailout plan doesn't address the fundamental problem: the country had a negative saving rate against the investment rate over the past decade. Injecting liquidity will only cause inflation. Inflation will hurt the average american but benefit the bankers.

jack

September 22, 2008 01:27 PM

When the WTC collapsed near my home a few years ago, we were in the middle of another election: NYC mayoral contest. Bloomberg was trailing Mark Greene. Then when the damage to the NY economy became clear to all, Bloomberg surged, won and has delivered on his promise. Similarly, I think the game changed last week. The only way to fix this is for a leader to swim against the current, piss people off - taxpayers and elected officials alike - which of the two people on the ticket, it's McCain. But he should quickly recognize the severity of the situation, move Palin somewhere else on his team, and announce Bloomberg as VP. Desperate times, desperate measures. I think it would show leadership. And if there's anyone who can make sense of this recovery it's Mayor Mike.

GLL

September 22, 2008 02:03 PM

Paulson is the insider's insider. He is ethically conflicted having been the former CEO of Goldman Sachs and is actually fighting congress on limiting the CEO payouts to those responsible for nuking our economy. It is hard to understand why they are even being allowed their golden parachutes under the current circumstances, but Paulson wants to make sure they get their money as part of the deal. It is clear he is more concerned about saving his buddies than our country. He needs to be removed from the decision process, not given unlimited power and a blank check to hand over to the people responsible for this train wreck. It is time to hold people accountable or we can kiss the free market good bye. What future investor wants to deal with a country that makes the rules up on the fly?

i pay tax

September 22, 2008 02:29 PM

why are we so afraid of a little pain early? americans are so financially retarded. i propose we put surgeons in the treasury, they will start slicing and dicing away all the problems. SCALPEL!

Repair roads and bridges

September 22, 2008 04:00 PM

Instead of giving these crooks a blank check of taxpayers money, why can't we use this $700 Billion to build our roads, bridges etc. which will create more jobs and wealth for the country. Also, if you need money for the bailout of these financial institutions, take them from the same folks (Ex CEOs, current CEOS & all other inhumans) who gained a lot by creating this mess.

Rick Aster

September 23, 2008 12:18 AM

If the bailout passes it is the biggest disaster ever to hit the U.S. economy and perhaps the biggest in U.S. politics. It could be the end of the Republican party from what I am hearing. And the Democratic party too.

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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