Business Law Prof Blog

The Next Bailout? California

California apparently needs an emergency loan of $7 billion.  Those banks who have written credit default swaps on California municipal bonds will now face huge payments.  Should we bail them out too by buying the "toxic" paper?

Floyd Norris Hits the Bull's Eye

Floyd Norris's column in today's New York Times, "Mistakes of the Past Live Again," is right on target.  I can say little but to repeat its themes:  Increasing deposit guarantees reduces the monitoring of banks by depositors;  Changes in mark-to-market rules are driven by a desire to keep assets on balance sheets are artificially high prices, making interbank loans and other loans to banks more risky, not less, because people start doubting the accuracy of bank balance sheets.;  Hasty rules against short-selling were not thought-out; And giving insolvent banks more money often does not make them solvent, it just delays decisive intervention.  A wonderful op-ed.

The Pork in the Bailout Bill

With all the language of doom and Armageddon on the economic front, and the need for fast action to "save the American economy", the Senate took time to put 350 pages of pork in the Economic Emergency Stabilization Act of 2008.  The Senate added all the pork at the last minute and in a rush.  Most Senators could not possibly have even read the act when they passed it.  Some of the pork is humorous -- worrying about dishwasher and refrigerators, bicycle commuters, rum to Puerto Rico and the Virgin Islands, wooden arrows (not laminate!!) for children's bow and arrow sets.  Some of the pork is serious in its own right -- what should the Federal government pay to states in which there is federal, tax exempt land.  No one, no one can sensibly claim that the pork deserved to be in the "emergency" bill on the economy. 

Consider the discussion:  Senator Guffaw states to Sen. Reid, "I am not going to vote for the bailout because taxpayers should not bail out fat cats that took excessive risks and paid themselves excessive salaries."  Reid:  "We are in a crisis--Bernanke says the economy could dissappear tommorow.  I need your vote for the American people.  Show leadership and courage." Senator Guffaw: "That's alot of insider hysteria put out but the fat cats that what to get bailed out.  My phone calls are running 10 to 1 against the bailout."  Senator Reid: "Tell you what.  I will put a provision in the bill helping the wooden arrow factory in your state and put a provision in helping my state get more federal dollars for federal land.  We'll both have something to take home."  Senator Guffaw: "Now you're talking. I'll vote yes."

Is the Senate such an inside game that its members no longer know how bad this looks?  Are do they know and not care?

New Bailout Bill: You Have Got to Be Kidding...It's a Joke Right? Wooden Arrows for Children??

The new bill that the Senate will pass is a 451 page stapled together piece of legislation that has Five Major Parts.  Only one of the parts deal with the credit crisis.  The additional stuff is from bills that have been sitting around for a while and have been stapled on to the main bill.  All this in a hurry.. it is a joke.

Here are the parts: 1) The old House Bill that failed reappears with a few changes.  The big change -- the FDIC is now authorized to insure accounts up to $250,000.  The Secretary of the Treasury can buy whatever he wants across the board to solve the credit crisis.  2) Then comes a "Energy Production Incentive" Act with tax breaks for specialized activities -- a bill that had been sitting on the shelf.  It is not aimed at banks or financial institutions or credit problems.  There are tax credits for dishwashers and marine renewables.  Great.  3) Then comes "Tax Extenders and Alternative Minimum Tax Relief", a hodgepodge tax bill.  The AMT ought to be fixed but the other stuff???  There are tax breaks for motor sport racing, for film and TV producers, for those who received money in the Exxon Valdez Litigation.  There is a break in the rum excise tax to Puerto Rico and the Virgin Islands.  Those who lay railroad track get a brake.  There is a break for "secure rural schools."  My favorite section in the bill appears here -- it is on wooden arrows designed for children. This section is full of specialized boondoggles.  4) Next is a section on "Federal Revenue Referrals" to states and counties that contain federal land.  What the hell is this doing in the bill??  5) The final section is really a completion of the 3d section and split by the 4. Are they trying to hide the 4th section.  It contains more specialized tax provisions, focusing on disaster relief.   There are mine safety provisions as well. This is Congress at its worse.  Facing a crisis and yelling about total financial collapse; Congress uses the bill that "will save us" to stick in three hundred or so pages of specialized junk that has nothing whatsoever to do with the credit crisis.  And it must be passed in a hurry. 

Each of the four additional parts stapled on to the first part are significant and derserves careful attention on their own, not as a free rider attachment to an emergency bailout bill.

This bill is a total embarrassment and if it is the stuff we are going to get to solve anything and do not hold out much hope for it being the fix we need.

What's Next on the Bailout

On a 228 to 205 no vote, the House of Representatives rejected Paulsen's bailout plan. The vote was 133 no to 65 yes among Republicans and 140 yes to 95 no among Democrats.  Among those Democrats voting no were some real surprises -- 5 Committee chairs and several very close friends of Pelosi from other districts in California. 

In any event, what are the options?  Option One:  Present the same bill with minor modifications to get 12 votes needed to pass.  If the modifications attract 12 Democrats, they will provide some limited foreclosure protections for middle class families.  If the modifications attract 12 Republicans, they will levy a fee on all banks to pay for the fund or will use more required purchases of insurance to protect against defaults.  either or both are possible.  This option will come with a new public relations campaign (furious efforts to spin) to convince taxpayers more convincingly that 1) it is not a taxpayer funded bailout (it will be paid back) and 2) it is for the benefit taxpayers and citizens not Wall Street or even Main Street.  A bad bill would be made worse; we would have to live with it.

Option Two:  Go back to the drawing board.  Paulsen needs to be left out of the planning; he has spent his political capital on the failed plan.  Those who favor systematic asset purchases will focus on giving the government power and funds to purchase 1) Homes, lots, and un finished construction ["This is the real 'core' of the problem, no MBSs"], 2) Bank equity across the board  ["Banks need capital to be able to have time to work out their balance sheet problems."], or 3) Commercial Paper ["Main Street needs cash to operate while banks work out their problems.]

Option Three: Liquidate or reorganize Banks as they topple.  The FDIC watches banks, and when they are close to insolvency, seizes them and sells them [Wachovia], liquidates them [Lehman], or reorganizes them -cancels equity and turns debt into equity until the balance sheet is healthy.  The FDIC has the power to pursue the third option but rarely does.    This option also has the Fed injecting funds into the market in traditional ways to maintain liquidity in the credit markets.

Count me in as in favor of Option Three or, in an extreme jam, the commerical paper purchase option of Option Two.

House Bails on Bailout Bill: Paulsen Has to Go

The House refused to pass the bailout bill, only 208 (217 needed) voted to pass the bill.  Pelosi lost any hope of Republican support when, using very poor judgment, she blamed wagged her finger from the podium, blaming Republicans for the crisis on the eve of the vote.  Pelosi also lost the votes of a critical number of Democrats in her own party.  If the Democrats had lined up behind her, her party could have passed the bill without any Republican votes.  The market is down 500 points on the failure of the vote.

Paulsen has to go; he over-reached and failed.  Appoint Thain, get some good advice from you chief economic advisers, go back to the drawing board and try again.   

$700 Billion: Government Could Buy Top 11 Banks!!

One gets lost in the size of the bailout bill numbers.  For $700 billion, treasury could buy 100% of the equity all publicly traded commercial banks but Morgan and Chase.  Or government could buy 100% of the top 11 banks, including Morgan and Chase. Why mess around?  With $700 billion Paulsen could just buy our commercial banks and run them.

Where is Morgenson on the WaMu/TPG Deal?

Morgenson, the muckraking business columnist of the New York Times, blasted the TPG buyout of MaMu a few months ago.  It diluted shareholders, she screamed.  I answered that she had done a hatch job and that MaMu shareholders should thank TPG for throwing money away on the company.  Now that TPG has lost its entire investment on the declaration of the MaWu bankruptcy, where is Morgenson?  She will do a hatch job on something else.  She never understood the initial risks of the TPG buyout deal, and many of other the deals she covers, and it shows.   

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.

Mr. President: Please Fire Paulsen

An open letter to President Bush:

Please fire Hank Paulsen before it is too late.  Here are the reasons: 1) As head of Goldman Sachs he was one of the primary people responsible for our reckless risk taking culture.  He will have no credibility administering $700 billion.  Goldman, for example, was the primary counterparty to AIG, now bailed out. A bailout will benefit the shareholders in his old firm in the billions.  2)  As head of the Treasury, he was late to note, or do anything, about the credit crunch.  3) As head of the Treasury he, once panicked, went immediately to full government control, ignoring the economic views of Republicans in the House and others in the base of his party.  4) As head of the Treasury he submitted an initial proposal that gave him unlimited, unchecked, and reviewable powers.  5)  As hear of the Treasury, he submitted an initial proposal that bailed out an entire asset class -- which is way too broad a remedy. 6) As head of the Treasury, and now called to task correctly on the ambition of his first proposal, he is now granting to Democrats way to many, many concessions that we will come to rue later.  He has lost his backbone as well as his credibility. 7) He got down on his knees in front of Pelosi.  I do not know what this was, sexist, flirtatious, school boy charm, silliness, cravenness, capitulation, in any event it was the last straw for me.  I know one does not change horses in the middle of the stream, but there are exceptions to any general rule;  the horse has drowned. 

Mr. President please replace Mr. Paulsen with Mr. Thain, before you sign any financial bailout deal.