Thursday, September 25, 2008

Economists weigh in on the Paulson bail-out

The Economists' Voice has several columns questioning the proposed financial bail-out. The writers all acknowledge that something must be done to address the mountain/planet (pick your metaphor) of bad debt in the financial system. However, they express concerns about the government (taxpayers) overpaying for the debt and thereby needlessly transferring money to Wall Street.

Luigi Zingales recommends that the bail-out be structured closer to a bankruptcy proceeding,

As during the Great Depression and in many debt restructurings, it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for-equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture...Forcing a debt-for-equity swap or a debt forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition.
Aaron Edlin writes an open letter to Secretary Paulson:

Today, I read the U.S. Treasury’s humble request for the authority to spend 700 billion taxpayer-owned dollars. This taxpayer’s answer: "No."

Edlin continues,

You could under this legislation pay $700 billion for "paper" having a face value of $800 billion even though the paper’s market value has sunk to $100 billion or even though the paper has no market, so long as you think the purchase promotes stability sufficiently. You could do so with no review and no appeal. I suppose, taking the words of your legislation literally, you could spend the entire $700 billion buying a single mortgage owned by Goldman Sachs if you thought such a cash injection was just the trick...

And here is a disturbing thought: if the initial tab is $700 billion, is it possible you may wind up coming back for much more? Could the administration that brought us the $2 trillion dollar war bring us a $2 trillion dollar bailout?
Sadly, Congress is more focused on window-dressing for the bail-out than on fundamentally restructuring it to make it more effective and less costly. Yes, we need to do something to clean up the financial mess, but the bail-out is not the way to go.