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Paulson plan vs. Dodd plan: my email to Eric Posner
I thought the original Paulson plan was terrible with regard to rule of law, and in that sense I thought the equity stake idea of Dodd was better. A modified Paulson plan might be as good, it is hard to say.
[Eric now blogs that the Dodd plan gives the Treasury more power than current versions of the Paulson plan. His post is very important.]
In reality I expect that either the Paulson or the Dodd plan would have to move quickly to incorporate some aspects of the other. We'll likely get some version of both loan-buying and equity shares, in any case.
The key factor is what kind of institutions are set up for making the next round of decisions. That's not getting much attention but of course there is no reason to think this is the final step or the final change in conditions.
Think of a barrel of apples, some good, some less good. To oversimplify, the Paulson plan has the government buy some of the bad apples. The Dodd plan has the government buy a 20 percent share in the barrel. In both cases government buys something.
My intuitive rule of thumb is to want the government to be doing its buying in the better organized, more liquid market. They are less likely to screw that up. That tends to favor the Dodd plan in my view.
I like one other feature of the Dodd plan. Our government loves cash revenue. Furthermore the U.S. economy is set up so the "public choice" advantage of the government owning banks for the long haul is not so obvious. We don't have "insider-based" capital markets, for instance, so owning a bank wouldn't give a politician so much chance to dole out loan favors. I believe our government would be in a hurry to reprivatize those banks in return for the cash. The Paulson plan, as I understand it, does not have an equally clear end game.
I may put this email of mine, or an edited version of it, on MR, check there for reader comments...
Tyler
Night thoughts: How or whether do equity holdings give the government "upside" in eventual bank recovery? Holding equity yields nothing if the banks never recover. If the banks will recover, you would think a loan from the Fed would suffice. But we've already tried that. So what exactly are the assumptions here? Somehow it is the Fed/Treasury actions which *cause* the banks to recover. How does that happen? They overpay for the loans at mysterious prices? That just puts the Dodd plan back into all the problems of the Paulson plan. If the government ends up overpaying for loans in the Dodd plan, and then someday gets 20 percent of that overpayment back through its equity share, is not a huge positive advertisement. (Isn't simply "knowing when to stop the subsidies" the best way to protect the taxpayers?) And in the meantime, what kind of credit guarantees is the government offering these banks and their creditors?
Don't forget Mark Thoma's good analysis: "So, by having the government take a share of any upside, the result may be less willingness of the private sector to participate in recapitalization."
It is easy to say that the Paulson plan is worse. (Oddly I think the Paulson plan makes most sense in Paul Krugman's multiple equilibria model for asset values.) But you shouldn't think that the Dodd plan is very good. Most of the Dodd plan boosterism I've seen doesn't look very closely at how it actually going to work. There's lots of talk about justice and the taxpayers getting upside and then a reference to the RFC from the New Deal.
Finally, in my view the Paulson plan makes (partial) sense if a) the major banks are in much worse shape than anyone is letting on, and b) you believe in multiple equilibria confidence models for these underlying asset markets. I'm not saying those assumptions are true, but it would be nice to start by confronting the exact assumptions under which each plan might prove better than the other.
Posted by Tyler Cowen on September 24, 2008 at 07:16 AM in Economics | Permalink
Comments
I hate the Paulson plan because it's all carrot and no stick. I can't state how strongly I oppose using taxpayer money to shelter private sector investors from the consequences of their profit-seeking choices.
I hate the Dodd plan because it hands over even more control of the economy to the government. I can't state how strongly I oppose giving the government greater power as a participant in markets.
Here's my proposal (call it the "Speak softly and carry a big stick" plan):
The Treasury acts as a market maker for impaired assets, but any overpayment that goes to companies must be clawed back in the form of future tax obligations.
How it would work:
Let's assume you've got an MBS or CDO security with $1 face value, held by a number of different institutions. The market isn't trading, and the bid is 20 cents with an ask of 40 cents.
If the Treasury is going to get the market trading, it's got to narrow the spread, and if it's going to put taxpayer money on the line, it's got to take steps to protect their investment.
It can run a dutch auction, where it says it will buy $x of secuirities, and the insititutions compete for who will ask the lowest price (say 35 cents). So far, this is all carrot.
Here's where the stick comes in. As a condition of selling, the insititution must post a non-retractable bid, along with their asking price. The bid helps add liquidity to the market. To provide incentive for the company to place a higher bid (and narrow the spread), as a condition of buying the security the Treasury gets a priority claim (in the form of a deferred tax obligation) on the company for the difference between the bid and ask, times the face value purchased.
So if a company sold $1 million in face value to the treasury at a price of 35 cents ($350,000), and raised their market bid to 25 cents ($250,000), they would incur a $100,000 tax obligation to be paid out of future profits before any dividends can be paid to shareholders.
This would allow the markets to get moving again, banks can move impaired assets off their balance sheets, re-capitalize, and restore their credit-worthiness (since the tax claim is paid after interest costs), plus shareholders have to fully pay back taxpayers before they can realize any benefits of the bailout.
Posted by: Russ R. at Sep 24, 2008 8:18:02 AM
From a cynical perspective, isn't every plan that originates in Congress more likely to be politically motivated and to allow rent-seeking, whether by politicians or companies? Process-wise, I think I'd prefer a version of the Paulson plan amended by Congress (for accountability and clear scope, not an additional handout to other parties) than a plan from Congress. It seems to take more advantage of checks and balances.
In terms of the goals of the plan, I thought it was to remove the worst of the uncertainty around asset prices so that capital-holders would come off the sidelines and the rest of the system could function more or less normally. It's unclear to me why the government needs to buy some of the good apples. That approach seems like it greatly dilutes the impact. As to how to Paulson plan would be executed, I'd hope that they would focus on buying from institutions that are otherwise healthy while letting truly sick ones continue to go out of business. I don't think a moderate amount of additional bank failures would be a bad thing. Not sure how to implement that. Would an otherwise healthy bank be more willing to sell its toxic securities at a low price than a more poorly-managed one? I tend to think so because the healthier bank is more interested in focusing once again on the strong part of its business. Just conjecture.
Posted by: Greg at Sep 24, 2008 8:20:10 AM
One week and counting: the world is still spinning just fine.
I like Alex's bridge analogy. Let's stop propping up collapsed bridges and instead support the ones that haven't failed.
Posted by: meter at Sep 24, 2008 9:17:55 AM
Martin Wolf in the Finacial Times is already using the past tense about the Paulson plan.
Wolf is also running Luigi Zingales critique of Paulson.
There seem to be four "plans" now in play:
Paulson based on buying the garbage.
Dodd based on making them give an equity stake in return for clearing the garbage,
Metzler making them take loans to clear the garbage, on conditions that hurt them.
Buffet with a polite and measured combination of Metzler and Dodd (as offered to and accepted by Goldman Sachs for clearing the mess the garbage has left there).
Subject to seeing the detail, I reckon a Buffet-type plan is the US Federal authorities' (including Congress) best bet on all counts.
Posted by: David Heigham at Sep 24, 2008 9:18:20 AM
I recommend Congress recall that it, in fact, is the law-making body of the land, and it could come up with an economic 'rescue plan' not only whether or not the Secretary of the Treasury liked it -- it has the authority to create entities like the Treasury in and of itself.
Maybe Congress ought to recall that they are, in fact, the ones with the power, here, and not an ad-hoc committee called together by the Secretary of the Treasury.
Posted by: El Cid at Sep 24, 2008 9:23:25 AM
They overpay for the loans at mysterious prices? That just puts the Dodd plan back into all the problems of the Paulson plan. If the government ends up overpaying for loans in the Dodd plan, and then someday gets 20 percent of that overpayment back through its equity share,
Maybe I misunderstand, but I thought that under the Dodd plan the govt got back 125% of the overpayment through its equity share.
Posted by: Bernard Yomtov at Sep 24, 2008 9:25:50 AM
A year ago King Juan Carlos told Hugo Chavez "Porqué no te callas". Sorry Tyler but that's what I thought when reading your post.
You write "Think of a barrel of apples, some good, some less good. To oversimplify, the Paulson plan has the government buy some of the bad apples. The Dodd plan has the government buy a 20 percent share in the barrel. In both cases government buys something."
To have any serious discussion of the Paulson plan you have to know the terms and conditions of the purchase of assets. So far I have not seen any details and it is clear that you don't know them either (I have not been able to find any detail about the Dodd plan so I cannot say anything about it).
Posted by: E. Barandiaran at Sep 24, 2008 9:31:55 AM
I would like more simplicity in all this.
What are the problems with Kling's proposal to drop capital requirements and to give the banks time to offload the MBS's (to Buffett et al.)?
Posted by: Andrea at Sep 24, 2008 10:56:25 AM
Anything that allows companies in need of bailouts to survive is not good. It contributes to moral hazard and encourages EVEN less reliance on individual responsibilty in the future.
Why is Goldman Sachs and JP morgan critical to the survival of our country? If some companies are so important could we have a list published of the sacred companies in this country? So that all the country can know who they should asprie to work for? or is this jus ta secret that only the right kind of people are priveleged to know about?
Posted by: Gabe at Sep 24, 2008 11:00:01 AM
The government has upside in any profitable private sector undertaking because profits are taxed. Secondly, the bulk of the income tax burden is on high-earners and again, those are more likely to be people who work on Wall St than at Walmart.
Any equity "upside" is just an additional tax in a disguised form. It also doesn't address the principle problem with the Paulson plan (and with bailouts in general), which is: If you could figure out the prices of these things so easily in the presence of an uncertain housing outlook, no-one would have got themselves into trouble in the first place. It's hard to figure out the prices of things, that's why we have markets in the first place.
Posted by: Sean Hunter at Sep 24, 2008 11:11:35 AM
Paulson = douchebag
Wall Street = douchebags
They basically flushed the economy down the toilet and now they want us to crawl through the sewers to help them out.
Posted by: Roy at Sep 24, 2008 12:42:01 PM
Before you praise the "Buffett Plan", take a closer look at what it is. He's taking a stake in GS, ON THE BASIS THAT THE PAULSON PLAN GOES THROUGH. ie it's only worth his while to buy into GS if the other taxpayers pick up all the toxic crap that GS can throw at them.
I'll bet it's even in the fine print that the deal is off if the bailout doesn't happen.
Posted by: foo at Sep 24, 2008 3:36:56 PM
Can someone tell why Dodd is involved in fixing this when he is part of the problem? He received a special mortgage rate from Countrywide, and he took money from Fannie Mae. I see a major conflict of interest.
Posted by: Ed at Sep 25, 2008 9:14:34 AM
If we dont like the outcome...which will come before the elections...we should do this.
I call it the IN-OUT/OUT-IN campaign...grass roots, internet based. It means vote out those in, and vote in those out...don't you think the "newbies" would be ready to kiss any and all...babies?
And then...simple...boycott all products and services (if we can afford any then) for those list in the Bail-Bush umbrella.
The internet can be a powerful "virus of logic" that could be spread intelligently over crises.
Posted by: Rachael at Sep 25, 2008 1:09:21 PM
So my understanding was that the equity stake business was partially to induce foreign governments to bail out their banks rather than letting the treasury do so. The idea being that these governments would be skittish about the US government having a substantial equity stake in certain big banks and thus be induced to bail these banks out themselves instead of having us do it.
No real idea if this is true but this is what I heard on some news program.
Posted by: TruePath at Sep 25, 2008 8:54:20 PM
Solution-Since the Congress is trying sell the taxpayers that they will make a profit on the they are paying to bailout the banks and why doesn't amount the investers put their millions in and reap the profits. They walked away with millions with I'm sure added up to the $700 billion.
It is all a scam-the market does not go down almost 800 points in one day and then up the next almost 500 points-we are being manipulated....while gold and silver is stable.
Posted by: Linda Johnson at Oct 1, 2008 10:52:33 AM
