Spero Consulting

We dis­agree with you plan and your speech and don’t believe the fail­ure of any sin­gle com­pany is large enough to jeop­ar­dize the US finan­cial sys­tem. ONLY THE FEDERAL GOVERNMENT CAN DO THAT, and it takes rash and care­less acts on a large scale – kind of like your bailout plan!

Given the over­all level of avail­able cap­i­tal in both the world and US econ­omy – as evi­denced by rel­a­tively low inter­est rates, par­tic­u­larly short-​term Trea­suries – if these secu­ri­ties are valu­able, then some­one should be will­ing to pur­chase them (and, pos­si­bly do it quickly if the price is right). (Yeah, we know about con­ta­gions and herd behav­ior and how it could all fall down. We’re not that igno­rant, but we just don’t see it hap­pen­ing, espe­cially the with­drawal of credit to wor­thy bor­row­ers.)¹

If the secu­ri­ties are indeed worth­less, then the bailout plan is exactly that: a bailout or a mas­sive sub­si­diza­tion of lax man­age­ment and exces­sive risk-​taking in which the gov­ern­ment gives $700 bil­lion and gets noth­ing in return. (Being clever – or is that devi­ous – bureau­crats could attempt to hide a slightly smaller sub­sidy (of less than $700B) by hav­ing the firms throw some good assets into the pool with the worth­less ones.) Nei­ther lax man­age­ment nor exces­sive risk-​taking should be explic­itly rewarded today nor implic­itly encour­aged in the future, which is exactly what a true bailout would do.

Thus, if the bailout is sim­ply a wealth trans­fer from tax­pay­ers to these firms, then we encour­age the gov­ern­ment to nation­al­ize the firms that have the great­est share of these secu­ri­ties (say, as a per­cent­age of total assets based upon his­tor­i­cal costs). By “nation­al­ize,” we mean the gov­ern­ment should take 100% own­er­ship of the firms. 

In that manner, extant own­ers will not ben­e­fit from the behav­ior that they induced through their indi­rect approval of their board of direc­tors and senior man­age­ment. In addition, there would be no need for the other cur­rent Con­gres­sional pro­pos­als about exec­u­tive pay, etc. As the sole owner, the gov­ern­ment could man­age the firms as it pleases and pay civil ser­vice wages if it chooses. (We doubt that it would end well, though.)

Reg­u­lar read­ers know that we cer­tainly don’t rec­om­mend such a plan, but given the under­ly­ing assump­tion that the secu­ri­ties are worth­less (and that it is sim­ply a mas­sive wealth trans­fer), then nation­al­iza­tion does seem to be the best way – and the only fair way – to recap­i­tal­ize these firms.

Let’s be clear. Some­one should be held account­able, BUT we do NOT mean crim­i­nally. We fear that when eco­nomic mat­ters becomes politi­cized as in the cur­rent crisis, the feds will look to put some­one in jail, e.g., the ongo­ing FBI fish­ing expe­di­tions, err, inves­ti­ga­tions. No, we mean be held account­able eco­nom­i­cally, which we would pre­fer to see hap­pen privately.

As we wrote ear­lier today (Sep­tem­ber 24) in Could a “Bailout” Pro­long the Finan­cial Cri­sis?, we would pre­fer to see the hold­ers of these secu­ri­ties (among the com­mer­cial banks, at least) report their marks at the end of the third quar­ter, which is less than a week away. We ask Mr. Bush: why insist upon such a rush to approve leg­is­la­tion by the weekend? Why not at least wait until mid-​October to see who’s lost the most on bad mort­gage bets? Our point in the above post is slightly dif­fer­ent. In it we argue that a bailout will increase the uncer­tainty of prices as each firm will likely have an oth­er­wise higher value for its assets given the pro­posed gov­ern­ment purchases.

Also, if you have the time, please take our Mort­gage Bailout Sur­vey.

(We’ll likely revise this post tomor­row as we for­mu­late our thoughts more care­fully and get feed­back from the chair­man. She is sleep­ing, and we dare not wake her.)