Hank Paulson's Rescue Plan Will Screw You: Here's a Better One

Hank Paulson's plan will soon be rammed through Congress, likely with strings attached for "homeowners" and executive pay. Too bad, because the plan is flawed and taxpayers are likely to get hosed. Especially too bad because a much simpler plan would save the system without socking it to taxpayers.

The main problem with Paulson's plan is this: If the government pays as little for the banks' troubled assets as it should to protect taxpayers (i.e., the market rate), the banks will still be in trouble. Why? Because they'll have to raise humongous amounts of new capital to offset the losses.

Where is this capital going to come from? Paulson doesn't say.

Under the Paulson plan, the way this problem will likely be resolved is that the government will overpay for the assets--to "save the financial system." In the process, the government will also save two constituencies who deserve no protection whatsoever: bank shareholders and bondholders.

If, in the absence of a bailout, the banks were heading toward Lehman's fate, shareholders and bondholders deserve the same treatment as Lehman's (for equity holders, about 13 cents a share). Under Paulson's plan, these folks may survive merely skinned. Taxpayers, meanwhile, will pick up the tab.

So what's a better plan? Equity infusions.

If/when a bank needs capital, the government should provide it--in exchange for a fair equity stake. Knowing there is an investor-of-last-resort should persuade bank clients to stick around. The taxpayers will then own significant chunks of the banks and will therefore benefit from their recovery. Meanwhile, the folks who are directly responsible for all the crap on the banks' balance sheets--the banks--will still be responsible for sorting it all out. And their shareholders--not taxpayers--would take it on the chin.

And how do you get the banks to act fast on a plan like this? Put a cap on the amount of money you'll shell out. Perhaps the same $700 billion.

Specifically, the government should say, "We're now going to invest $700 billion in private banks. First come, first serve. And if you don't get here in time and you then run out of money, tough beans."

(For a similar view, see Paul Krugman's editorial today. The NYT columnist and Princeton professor thinks Paulson's plan is a disaster. Senator Dodd's counter-plan includes provisions for the government to receive equity in exchange for the bailout, which makes more sense. It will still require the government to deal with the toxic assets, though.)

See Also: The Critical Question About Paulson's Rescue Plan

Follow Henry Blodget on Twitter: www.twitter.com/hblodget

Comments

[Chillinout]

They have already agreed to an equity stake in these companies. This bailout is moving so fast that these articles are irrelevant almost as soon as they are published.

So, the American people are going to own most of Wall Street.

[Insearchoftruth]

Management compensation over the last five years must be part of the solution. "Excess" compensation should be returned in exchange for an equity stake on par with that taken be the American public.

[PT6]

The government should take 80% ownership in the troubled banks, put in smart leaders (the current ones have failed), and when the banks are cleaned up then sell them back to Wall Street.

[PT6]

Lets buy these 80% of these banks in trouble like we did AIG, put smart honest people in charge, and then sell them after we clean them up!

The current CEOs obviously do not know how to run these banks and are not trustworthy, so lets take them over.

Why just give them money?

[PT6]

Why save GS and MS and not LEH?

Very suspicious!

This is creating a Monopolistic Banking system

[TheIndependenceParty]

DOJ will look at that come February!

[tedge]

We don't need a bailout plan. We don't need a plan to rescue shareholders and irresponsible corporate executives.

We do need a plan to improve financial system liquidity and to stabilize real estate prices. We do need fundamental reform of market regulation, particularly providing increased financial transparency. We won't get the liquidity if we don't do the reform.

Paulson's plan is the wrong place to start. Its biggest problems are not that it needs more oversight, but that it targets the wrong solution. Buying problem assets from banks, especially from banks that are in trouble, is a very inefficient way to encourage market liquidity. That is a strategy that only continues and compounds the market failures that brought us this mess. To the extent the government intervenes with cash infusions, it should be for new mortgages with responsible players.

Why has Paulson been so wrong, so many times, in such obvious ways? The problem is that he is diverted from effective action by his allegiance to a failed ideology. Paulson's plan was primarily a political ploy to protect the Bush/Cheney deregulated, so-called free market ideology from real reform. It was also a giant pork barrel for supporters as Bush/Cheney head for the door.

You're doing a heck of a job, Pauli.

We can achieve bipartisan support for an alternative action plan without embracing the Bush/Cheney/Paulson solution. We have to. Even if it means that Congress postpones its recess.

[AspenFreePress]

Isn't "Bailout Bush" the guy who hurried us into Iraq? He's no more Republican than I am -- and neither is McCain, frankly -- but if Dems roll over for Bush's bailout can of worms, I'll vote Republican in the future as a protest, even for McCain.
Sterling Greenwood
Aspen Free Press

[research]

yeah, you just smite you nose to spite you face.

[Baltotoast]

I am surprised that someone who used to recommend equities would propose such a naive plan.

When the Fed did the Fannie/Freddie thing they completely lost any credibility they might have had as a partner of the equity holder. Fannie did what they said they were going to do - they raised capital and were within regulatory capital guidelines - and the government made up some drivel about no, what you REALLY need is "economic capital", and proceeded to completely hose the equity holders.

Now, no equity holder in their right mind wants to be anywhere near an entity that the government might "save". Your plan would crater the stock price and make a take-over inevitable...back to the drawing board.

[nerakami]

For the first time in my entire life... Americans need to re-gain and re-claim their VOICE... there is no way we should and will allow the White HOuse to bamboozle the American people.

We say NO... to the bailout as is being proposed by Paulson.... let's review these other guys plans. We don't care how long it takes... it's better to decide on the best plan than to rush into a plan that will drag us down to the depths from which we can never recover...

[elbzee]

I agree with your points, but must admit I disagree with one phrase, I don't believe taxpayers are likely to get hosed. They will UNDOUBTEDLY get hosed. Sorry to bicker!

[zjr909]

It doesn't matter if there's a workable or non-workable plan - because this has nothing whatever to do with economics and everything to do with hierarchy. This is neither more nor less than the ruling class telling the people, once and for all, what the terms of our society are and will continue to be. This bailout is "tribute", pure and simple. Just like all the ancient empires. Expect more and more of the same, with the same patently transparent falsehoods offered as justification. Every time our rulers decide they want another trillion or two, they'll have their PR guys tell us the sky is about to fall but that a trillion ought to keep it in place another couple years. See, it's like this: they're not really ASKING us for a handout; they're TELLING us how much they're going to take this time around. Get used to it. They have.

[AmericanVoice]

Hey I got a great idea, lets all follow the money, and see who made off with all the investors-shareholders, money, and where is it??? Nobodies asking anybody, WHERE HAS ALL THE MONEY GONE"???

[ella52]

It is a great idea!

[fredlonsdale]

Your joking, right? You know where the money went. ;-)

The people who sold their house or the builders who sold their houses at inflated prices got a big chunk.

The Real Estate Brokers and the Mortgage Brokers* got a chunk.

The companies that repackaged the mortgages into securities and then sold the securities got chunk.

The stock brokers and traders who bought and sold the securities in the aftermarket got a chunk.

( Personally I blame the big investment houses, because the were the leaders in taking advantage of the housing bubble.)

A lot of the mortgage brokers were former replacement window, used car and vynal siding salesmen. That should have set off warning bells.

[fredlonsdale]

I forgot, the insurance companies who sold mortgage default insurance on these securities got a chunk. (Remember AIG.)

[changeyournametohussein]

Can someone explain to me why the government wants to give money to these people that purposely misguided investors, played games with lending, and pocketed tons of cash through giant bonuses? Why cannot the government give the money to homeowners to pay back the lendors? This way, the lendors would get their money back without the bonus of interest and without giving them free money for being giant asses. Americans could actually pay off their homes, allowing them more financial freedom... you wanna stimulate the economy, take away $1000s of mortgage payments that struggling families cannot afford.

[AmericanVoice]

NO Blank Check!!! They steal the investors-shareholders money, no accountability, and then they come back with the stolen dollars, and buy companies back at pennies on the dollar, nice work if you can get it. If we are paying and we are the investors, we should also have a voice, and a opportunity to protect our investment. How much more corruption & greed are we going to extend too these people? Aren't we tired of this yet-damn!

[booker52]

I say no bail out!