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

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Comments

[DuganS1]

Let's not forget here that the top 5% of income earners in this country pay over 60% of the federal income tax in this country, and these are the folks that own the most shares in these companies. Conversely, the bottom 50% of income earners in this country pay only 3% of the total federal income tax and probably own few if any shares in these companies. Also note that if the government pays current market value for these asset, they will be significantly "under-paying" because the low current prices is occuring only because of forced deleveraging.

[TheFriendlyAtheist]

Let's not forget that the top 0.1 %, that's right 0.1%, of the population earns as much as the bottom 50%.
Let's not forget that the top 1% owns more wealth that the bottom 90%.
Let's not forget that the richest 400 people in the country have increased their wealth by $670 billion under Pres. Bush.
Let's not forget that we...are getting screwed.

[ella52]

I have met two Obama supporters in the last two weeks that are in your 5% and pay no income tax whatsoever. Me, I am in your bottom 50%, been working over 40 years continuously, have never collected a dime of unemployment, have always paid my taxes.

[thefringecenter]

There is a reason why the uber-rich pay a greater share of the taxes than the middle class and below. And there is a reason why this differential continues to grow that is never spoken about. Middle class earnings have been flat or declining, thus withholding taxes are also flat or declining. The rich, on the other hand, have seen their incomes rise at triple the rate of the middle class during the same period. The rich can have their percentage of the tax burden decline by paying a living wage to all who are willing and able to work. As a middle class worker, I would love to pay more taxes from a paycheck that grows at the same rate as the ruling rich.

[fredlonsdale]

The bottom 50% own a lot of stock through their pension plans and 401K's. While they pay a small percentage of the total federal income tax (I think it is higher than 3% for the working poor), they pay a higher percentage of their income in taxes when you factor in state and federal and local taxes fees and fines..

Let us get real. The top 5% can avoid any tax they do not like. And most of them do!

[kanaschwiiz]

This is bang-on correct: at least that way (the equity purchases the author advocates) tax-payers would own the good and bad things on the bank's balance sheets, not just lifting off the toxic structured products.

[patmoore]

so why not just let them go bankrupt?

I am not terribly persuaded that if we let these high-flier crash that the world will end.

Sure maybe there will be higher yield spreads required in the future.... but so what?

**no bailout!**

[Thermodynamics]

Finally a workable proposal that gets the golden mountain out of hostage.

So, how do we summarize this in a way that the Republican base can understand?

"Government to bail out banks in exchange for stock in same banks.

No Blank Check!

[DXM]

My feelings exactly! The taxpayers shouldn't be stuck buying crappy debt that won't solve the problem. We should instead buy good debt that will 1) prime the pump (to use a New Deal term) of the credit markets and 2) get a useful return on the taxpayers' investment. This bailout (especially as originally proposed by the Bush Administration) is just a colossal waste of taxpayers' money.

[parkrange]

Dear Mr. Boldget

Ref: Bailout Plan Principles

1. Transparency, disclosure and accountability is built into the rescue plan
(Stakeholders {Primarily-US Taxpayers} should not be treated like mushrooms {fed bull dung and kept in the dark}
2. To free up the credit markets, the US Treasury will only buy enough securities/assets required to free up the system using Competitive Force and Market Place analysis in conjunction with Pareto Analyses (20% of the Activities are 80% of the Value)
(The objective should be to buy only the highest quality securities/assets in the minimum quantity required to free the credit markets. The Rescue should be a “best in breed” supply chain (buying liquidity) operation.
3. Organization whose securities/assets are purchased must provide the US Taxpayer bonds and stock as compensation for rescue.
(The bonds/stock requirement helps ensure that only organizations are impaired will be helped. Organizations are incentivized to “stay private” if their liquidity is sound.)
4. Any organization that does not cooperate and is essential to orderly market functions can be seized.
(The US Treasury is obligated to ensure markets function with transparency; and this principle would ensure that illiquid intransient organization must cooperate.)
5. Foreign Banks can participate in conjunction with the financial participation of their Home Country.
(The US Taxpayer is not obligated to bail out the world; and it is “boneheaded” to attempt a global rescue without an “alliance”. Our self interests are to ensure functioning markets for our economic growth.)


.

[schatsie]

ownership works with Board Reprentation... You cannot trust these CEOs and boreds of directors with any real money as they were the ones who screwed up....