Well, Here We Go
September 19th, 2008 . by economistmom
Have I been talking about reducing the federal budget deficit? Well, never mind. Secretary Paulson did not beat around “the bush” today about how this will impose a cost on all Americans (CNN-Money story):
Paulson said that federal action would target the mortgage-related “illiquid assets” that are burdening the finance industry.
“The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy,” said Paulson. “This troubled asset relief program must be properly designed and sufficiently large to have maximum impact.”
The new program would cost hundreds of billions of dollars, according to Paulson.
“This has got to be big enough to make a real difference,” he said.
I believe Secretary Paulson is right that doing nothing would have been far riskier to the American economy…
The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative - a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.
…but the Administration is being less than crystal clear about the fact that the risk does not disappear–it just gets moved around. What federal officials are proposing to do is to have the government take ownership of these “troubled assets” (as Secretary Paulson refers to them, emphasis added):
Many of the illiquid assets clogging our system today do not meet the regulatory requirements to be eligible for purchase by the GSEs or by the Treasury program.
I look forward to working with Congress to pass necessary legislation to remove these troubled assets from our financial system.
But where will the “trouble” in those “troubled assets” go? There’s lots of talk about the expectation that the government would eventually get a positive net return out of this deal. But what exactly is the government taking ownership of here–i.e., how much are these “troubled assets” actually going to be worth when everything settles down? I think they’re sounding less than crystal clear because the answer in their minds is not at all clear. This is not like the government bailout of Chrysler (in 1979), which eventually turned profitable because Chrysler was able to produce a tangible product that Americans wanted to buy at the time(minivans…note, I said wantED to buy). (Note that David Leonhardt of the NYTimes argues that the Chrysler bailout may have nevertheless enabled the slow decline of the Detroit auto industry.) But there is no tangible product in today’s case and it seems to me no clear direction to head in producing a better “product.” (And if the government will on net turn a profit from taking over these financial companies, why didn’t the private sector scoop it up first?)
Seems to me that policymakers have decided to swap risky private-market debt for an increase in (what we hope is) less-risky public-sector debt. That was probably the short-term, risk-averse (prudent) thing to do, but it’s certainly not without signficant risk to the longer-term health of the U.S. economy.
The exigencies of the moment aside, combining privatization-of-profit with socialization-of-losses as a matter of policy on a macro scale … seems like it could prove problematic in the future.
Once we get all the biggest financial firms, industrial companies and unions (the auto makers and UAW are lining up for their $50+ billion right now) thinking, “heads we win, tails the politicians bail us out on the taxpayers’ bill and we keep our jobs”, well … what’s the mechanism for controlling the moral hazard in that situation?
it’s hard to object to the government’s mass bailouts as similar debt-producing methods were put into action to bring the U.S. out of the Depression… our economy has been supported and driven by debt ever since
Are we privatizing profit? I wonder if the shareholders of AIG who see the govt. with its hands around the throat of 80% of its equity see it that way.
In bankruptcy court AIG’s creditors would have had their hands on 100% of the shareholders’ equity, with fees and “transaction costs” that were one heck of a lot higher added on top. That was the choice for AIG.
But that wasn’t what I was talking about. What I was talking about is the apparent proposal for a “RTC type” agency to take the toxic loans from the finance system. The thing is, there’s a huge difference between the actual RTC, which picked up the assets of defunct S&Ls after they went bust, and the proposed “RTC type” entity, that apparently would pay taxpayers’ money to acquire these loans from going businesses to help them go along better.
Not to mention the proposed extra $50 billion for the auto industry. I know, GM, Ford, Chrysler have had only 35 years or so to get competitive — during which time Honda, Toyota and Nissan have all landed on our shores and shown how use American workers to build good cars that people actually want to buy — and we wouldn’t want to exercise unseemly haste in pushing them to build enough good popular cars to pay their own bills … but still …
OK, here’s what I’m talking about [.pdf], pretty much exactly (via Tyler Cowen).
Where is the outrage over the timing of this “RTC type intervention. Bear goes down, Lehman goes down, then before MER is allowed to fall to the same self-inflicted fate, Paulson arranges a marriage for his buddy Thain and his two partners from Goldman, who collectively take out $200mm from the deal in guarantees . Then when Goldman begins to tank, where all Paulson’s weath resides, he steps in with the ‘don’t look here, look there’ mother of all bailouts. Id like to know what Paulson made today as a result of the 15% bounce in Goldman’s share price?! It will also be telling to see how this rescue _rescues Wahcovia, which is also run by one of Paulson’s cronies. Yes, transparency is needed. NOW.