Why Paulson is wrong

VOX EU ^ | Luigi Zingales

[Erskine Childers]

We are dealing not with a liquidity crisis and the Fed would seem to have it, but rather with a solvency crisis. But we have a system for dealing with insolvency that's even sanctioned by our Founders in the Constitution. It's called BANKRUPTCY COURT.

Prof. Zingales ofers this very commonsensical approach to the problem. All we really have here is debtors with claims on stockholders. Congress can grant incentives to get all of these companies into receivership, and then let the judges freeze prices, cancel debt in a huge round robin (most of this debt is owed between these same companies), and then swap out debt for equity when the dust settles. Equity holders will be wiped out, as they should be. Debt holders will take their lumps, too. The companies will emerge from bankruptcy court with clean balance sheets, but they'll be owned by responsible debtors, at least over all.

This is the way to go, folks.

[Parley Baer]

The way I understand it is the basic Paulson plan would have the Federal government buy up the 5% of the mortgages that are bad. That is where the $700 billion number comes from. So then the Feds would be in the mortgage business until the collect the revenue from them.

It is also quite possible that a lot of those mortgages could become good and the Feds could sell them for a profit. It is entirely possible to recover the whole $700 billion over time and maybe even a small profit could be had.

[yldstrk]

They can all ef themselves as far as I am concerned if credit dries up who the hell cares they shouldn’t be borrowing anyway.....doesn’t the Bible say neither a borrower nor a lender be? And if they lent money to people they shouldn’t have isn’t that their own frickin fault? And why the hell should I caare? Let them fail and let credit dry up. Let the thing crumble and do whatever it will do and that will teach them that every frickin body that shows up is not entitled to credit.

[yldstrk]

Parley that is a frickin pipe dream there.

[wideawake]

The idea is largely sound.

However, if these banks actually file for bankruptcy, then there will be runs on the banks and the federal government will have a several trillion dollar FDIC bailout on its hands rather than a 700 billion bank bailout.

The debt needs to be restructured without calling it a bankruptcy.

[yldstrk]

Yoou are all nuts. this thing is a sham

[ken21]

did anyone hear rush this morning mention a u.s. congressman

that wants to eliminate corporate taxes for 2 years

in order to make the economy boom and to pay for this?

[Eagles6]

save

[ThePythonicCow]

It's neither a liquidity nor a solvency crisis.

That is, the immediate and most pressing problem is not whether some companies are short of cash (liquidity crisis), or have more debts than assets (solvency crisis.)

The immediate crisis is a mutual lack of financial trust between the various large financial players. That trust is the very life blood of the world's greatest economy, of the world's dominant currency, the dollar, the world's biggest economic market and the world's biggest, safest, most liquid investment market ... the United States.

Anyone controlling large amounts of assets is starting to hoard that money, rather than engaging in routine business transactions, for fear the other guy won't be good for it.

Without that trust, we're all a lot poorer.

Questions of what to do with individual companies are secondary.

[abigailsmybaby]

And then maybe not...especially with the group of douche bags that are in congress now.

[org.whodat]

The debt needs to be restructured without calling it a bankruptcy.

Ok, lets start by having all the companies top officials pay back 80% of their salaries for the past ten years, then we check their balance sheet.

[ConservativeMind]

How do we know we are buying the mortgages at a substantially-reduced price?

Answer: We don't. We are just given a bunch of terrible loans, already in default, without a huge discount to the amount remaining on them.

[Wallace T.]

During all the panics of the 19th Century and the early 20th Century up through 1920-21, the Federal government basically took a laissez faire attitude toward the crisis, as did state and local governments, with the exception of possibly providing some temporary relief to specific groups, like farmers or unemployed workers. Most of the economic downturns were short lived, lasting at most two years During the Great Depression, both the Hoover and Roosevelt Administrations took an interventionist approach with the creation of the Reconstruction Finance Corporation and numerous other agencies. The result was that the 1929 Crash led to a decade long depression.

In the words of Andrew Mellon, Secretary of the Treasury in 1929: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people." Unfortunately, President Hoover did not take this sound advice. Nor have George W. Bush and the leaders of both parties.

[supercat]

However, if these banks actually file for bankruptcy, then there will be runs on the banks and the federal government will have a several trillion dollar FDIC bailout on its hands rather than a 700 billion bank bailout.

Collapse is coming. I'd rather the government not make it worse by inflating the bubble even further.

[org.whodat]

It is not about the mortgages, it is about the worthless paper bought and sold on wall street and the so called CDS business where no one knows where the money went, but they want the tax payer on the hook for all the fraud, CDS is nothing more than a device to hedge the bet against a loss. It is fraud. They lost let them pay up.

[supercat]

Anyone controlling large amounts of assets is starting to hoard that money, rather than engaging in routine business transactions, for fear the other guy won't be good for it.

The only way to solve that problem long term (for more than maybe five years) is to deflate assets so their claimed values approach their actual worth.

[ThePythonicCow]

Long term, yes, deflate assets, or inflate money.

But what about the immediate problem of the monetary system that nearly froze last week, and remains at risk of such?

[Erskine Childers]

The debt needs to be restructured without calling it a bankruptcy.

Good point. The author (professor at University of Chicago Business School) mentioned this same point today on the radio. After all, boilerplate contract provisions would require acceleration of debts when a bankruptcy proceeding is filed. That could be handled by provisions in the law suspending those provisions for companies that avail themselves of the program. Ultimately, all we're really talking about is changing the capital structure, swapping out debt for equity. We can call it whatever we'd like and handle it perhaps under a special administrative forum.

I would say that the panic aspect stems largely from not knowing. Investors panic when they don't know what will happen. The main thing now is to let the market understand that the government is ready to take effective action. If tat action turns out to be bankruptcy under government incentives, then it will hurt but at least they'll know what's going to happen, and there will likely not be anything approaching a panic.

The beauty of this is that the current equity holders get wiped out, and the folks who punted on the related credit swaps take their lumps. It wouldn't cost the taxpayer much if anything to do.

But it's politically undesireable to revolving-door types like Paulson. He's obviously there to advance the cause of Goldman Sachs, and feather his own post-Bush nest by buying favors with that $700 billion. The bankruptcy option avoids all of that and places the reorganization in the courts or in some similar administrative setting where it belongs.

In short, it's a way to handle this mess without caving to the "moral hazard" temptation that Wall Street and their lackeys in the government want. We need to get this Luigi fellow testifying before Congress NOW.

[Cold Heat]

but rather with a solvency crisis

It is not, but it will be if not addressed, and there is no way to process thousands of large bankruptcies, much less find work for the millions unemployed.

This article was posted yesterday, BTW. I ripped them and I'll rip it again.

[JLS]

Well you can make a case for bankruptcy. Of course some of us recognize that WE, our representative, under the threat of federal investigation pushed lenders to make unsound loans.

I personally think we should buy up the bad paper we forced out there. You may think tough luck for the owners of a business we regulated into losses. Neither way is the free market. We can not go back and have free market home loans over the past 15 years.