September 29, 2008
Bailout Bill Turns Crisis into a Disaster
The details of the bailout bill are now on the table and Congress is turning an economic crisis into an economic and political disaster. There are two points: 1) Even the bill works as intended, it will not help much. And 2) The bill will not work at intended: the bill, drafted in haste, can be gamed by insiders and the gaming will cause huge waves political reaction.
First, the crisis has two problems, first, the liquidity in the short term borrowing market (commercial paper and interbank loans) and, second, bank solvency. It is easy to solve the first, but the bailout does not do it directly and impossible to solve the second, which the bill tries to do. The only way to solve the second is either to liquidate banks or, by paying too much for bank assets, capitalize banks with taxpayer money. We are doing the latter rather than the former, which is a huge, huge mistake. This bill will be followed by successive waves of government engineered liquidations or buyouts of banks. Note today that Citigroup bought Wachovia.
Second, the head of the old RTC (dealing with S&Ls) has warned of insider gaming of the system. He was ignored in the rush to pass the legislation. A hasty 110 page bill is full of operational holes that will allow insiders to game the system. For example, if Treasury buys mortgages from SPVs, rather than SPV securities, the executive compensation limits become irrelevant. Banks could sell mortgage or securities to SPVs, who then sell to the government, to avoid the limits. How does one take a "warrant" in an SPV? or an offshore based subsidiary? A match between sharp traders and the thick bureaucrats at Treasury is going to be a very lopsided one. The newspapers will get wind of the problems and the people will feel cheated. The political backlash will be enormous and unpredictable.
September 29, 2008 | Permalink
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