Friday, October 10, 2008

Paul Krugman, Hank Paulson, and me

Why, it seems like only yesterday (but was, in fact, Monday) that I was wondering out loud about the chances the US Treasury would exercise an option written into the final version of the bailout law to demand stock in exchange for the money funneled to the banks. This so-called “stock injection” plan sounded to me like the preferable way to spend our $700 billion (give or take), seeing as it gives the government some real equity in exchange for our real cash, it is has both longstanding (FDIC) and recent (AIG) precedent, and could provide for some of that accountability demanded by most of us on streets named other than Wall.

Well, on Wednesday, New York Times columnist/Princeton economist Paul Krugman, and, as you will read, UK PM Gordon Brown, gave my laymen’s interpretation a little street cred:

Readers ask what I think should be done about the financial crisis. The answer is, what Gordon Brown in doing in Britain: a bailout, yes, but one that gives the government an ownership stake in the bailed-out institutions. That plus a serious fiscal stimulus plan that includes emergency aid to state and local government.

The Brown plan, by the way, is 50 billion pounds; scaled by GDP, that would be the equivalent of a $500 billion plan here. The headline number would be smaller than the Paulson plan, but the probable effectiveness much, much greater. Not so incidentally, my reading of the TARP as passed is that thanks to the equity participation provisions, it could be converted into a version of the Brown plan at the Treasury secretary’s discretion; let’s hope that he does so discrete, or something like that, as soon as possible.

Which leads us to Thursday morning’s revelation.

Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system, according to government officials.

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks’ balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.

. . . .

The American recapitalization plan, officials say, has emerged as one of the most favored new options being discussed in Washington and on Wall Street. The appeal is that it would directly address the worries that banks have about lending to one another and to other customers.

This new interest in direct investment in banks comes after yet another tumultuous day in which the Federal Reserve and five other central banks marshaled their combined firepower to cut interest rates but failed to stanch the global financial panic.

Now, I don’t know if Paulson had something like this in the back of his mind all the time (it wasn’t exactly spelled out in the original “three-page plan”), or if someone like Senator Chris Dodd or Senator Chuck Schumer clued him in to what was added to his authority; I don’t know if Hank checks out Planet Money, Paul Krugman, any of a number of other fine economist bloggers, or me (OK—pretty sure he doesn’t check out me). . . or if the Secretary of the Treasury just has no other flipping idea what to do. . . but Paulson let the idea of equity for injection slip out in a press conference late Wednesday. . .

Now, I will pull back the curtain just a touch, and confess that all of the above was written about 24-hours ago—so what has happened since?

Well, the short answer is: Nothing.

OK, let me be a little less short. The Dow dropping another 678 points is not nothing—the industrials average is now off 40% from its record high exactly one year ago. The Nikkei is in full-on panic mode—it suffered its worst one-day loss in 21 years on Wednesday, and is plunging more as I write this. European markets are also opening with big, big losses. The feds guaranteed AIG another 38 billion samolians because they have almost burned through their initial $80 billion.

And John McCain has revised his merely crappy half-assed mortgage proposal (scrubbing from his website the line about buying mortgages at their current, lower values) so that it is now a completely terrible half-assed proposal. . . wait, that is pretty much nothing.

But the other things—the continued downward rush of economic indicators (including things like the LIBOR and the TED Spread—neither of which I dare try to explain because I barely understand it all myself)—those are something. . . something that makes one want to do, uh, something.

Unless you are Secretary of the Treasury, Henry Paulson. . . because, as best I can tell, he has done (and here’s why I use this word) nothing.

What is now weeks after Hammerin’ Hank and Sideshow Bob Bernanke laid it all (supposedly) on the line and warned Congressional leaders that if they didn’t act immediately (immediately!), we would have no economy to rescue, and weeks after those Congressional leaders and Still President Bush and much of the establishment media all lit their own hair on fire to reify the bubble boys’ hysterical frame, and, now, a week after said Congress and president gave Paulson all he could have wanted, and, frankly more, what has the SecTreas done?

Weeeeeelllllllllllllllllll. . . he has appointed a (another) Goldman Sachs alum to start designing some sort of system to purchase the shitpile of bad. . . you know I was going to say “assets,” but that just doesn’t seem like the right word anymore, especially when you are not only dealing with subprime mortgages but intangible gambler’s chits like credit default swaps. Anyway, there is now a guy working on a plan—maybe some sort of reverse auction, maybe just a way to shrink wrap bricks of 10,000 $100,000 bills—that should be ready in, eh. . . four or five weeks.

As mentioned by me, and even floated by Paulson, Hank now has the authority to give banks a direct cash infusion in exchange for equity—so why is he sitting on his hands?

I have read that Paulson might have caught deflationary disease. This is the idea that things are rapidly losing value—so, why buy some chunk of equity today, when the same amount of money could get you a bigger chunk tomorrow? Sounds like a sound investment strategy, right? Well, if you were a traditional investor, maybe. . . but the federal government wasn’t empowered by the bailout bill to act as an investor—at least that’s what I thought—supposedly, this “TARP” was supposed to be thrown quickly over this drowning pool. . . . OK, enough with the metaphors—Paulson is supposed to use this money and his new authority to backstop the financial system, to loosen up credit markets, to buoy investor confidence (there is some debate about whether that third point is a good idea).

Instead, it seems like the Treasury Secretary, after yelling “Fire!” (new metaphor, sorry) in a crowded theater, is now watching everyone stampede out (trampling many on the way), and waiting until the fire gets big enough to justify his earlier histrionics.

Of course, some will argue that it was behavior very much like this that helped transform the Crash of 1929 into the Depression of 1933.

And, of course, none of this—none—does the first thing to help the here-and-now, day-to-day economic problems of working or formerly working Americans.

So, what now, mes amis? (Wow, I’m like the French John McCain!)

It seems most economists agree that Paulson needs to use his stock injection authority, and pronto. He needs to give the banks a good chunk of change with the understanding that they will, in turn, start lending again. The US government will get bank stock in exchange—but I want to make sure that we taxpayers get preferred stock, and, I’ll go further and demand voting shares. Without voting shares, it will be impossible for the government to ensure that banks act in the interests of the American people and the global economy. Everybody claims they want accountability—exchanging cash for voting shares is the way to get that accountability. (Of course, this assumes that we have a government that acts in the interests of its people—big assumption, I know.)

Then—and this is equally important—Congress needs to come back and pass some real economic stimulus. No, I am not talking about some winky tax rebate—too small and too slow. I, as mentioned before, support a FICA holiday on the first $10,400 earned by every working American (because this will start putting money in the pockets of those that need it most starting the same week that such a law was enacted), coupled with New Deal-style programs to support and educate the poor, repair our nation’s aging infrastructure, and begin planning and building the electronic infrastructure needed for this information century.

Or, at least, find a way to put real money quickly in the pockets of those hit hardest by this recession (yes, we can now use that word without qualifiers)—then come back in late January with a new Democratic president and bigger majorities in Congress, and pass a full, new New Deal, adding affordable healthcare for all, tax equity, and investment in post-hydrocarbon technologies and green jobs to the programs mentioned above.

OK, more backstage news: I wrote up to this point, and before posting, I decided to open up (electronically speaking) Friday’s New York Times, and read what Paul Krugman had to say. Well, surprise, surprise:

[K]ey policy players have largely wasted the past four weeks. Now they’ve reached a moment of truth: They’d better do something soon — in fact, they’d better announce a coordinated rescue plan this weekend — or the world economy may well experience its worst slump since the Great Depression.

. . . .

[W]hen Mr. Paulson announced his plan for a huge bailout, there was a temporary surge of optimism. But it soon became clear that the plan suffered from a fatal lack of intellectual clarity. Mr. Paulson proposed buying $700 billion worth of “troubled assets” — toxic mortgage-related securities — from banks, but he was never able to explain why this would resolve the crisis.

What he should have proposed instead, many economists agree, was direct injection of capital into financial firms: The U.S. government would provide financial institutions with the capital they need to do business, thereby halting the downward spiral, in return for partial ownership. When Congress modified the Paulson plan, it introduced provisions that made such a capital injection possible, but not mandatory. And until two days ago, Mr. Paulson remained resolutely opposed to doing the right thing.

But on Wednesday the British government, showing the kind of clear thinking that has been all too scarce on this side of the pond, announced a plan to provide banks with £50 billion in new capital. . . together with extensive guarantees for financial transactions between banks. And U.S. Treasury officials now say that they plan to do something similar, using the authority they didn’t want but Congress gave them anyway.

The question now is whether these moves are too little, too late. I don’t think so, but it will be very alarming if this weekend rolls by without a credible announcement of a new financial rescue plan, involving not just the United States but all the major players.

And Krugman finishes with this cheery bit of encouragement:

[T]he time to act is now. You may think that things can’t get any worse — but they can, and if nothing is done in the next few days, they will.

So, with that, I think I better wrap this up and post it—the economic situation is evolving rapidly, and, who knows, Hank might need some ideas!

* * *

I would be terribly remiss if I did not recommend that everyone interested in these sorts of things read this amazingly comprehensive post by Stirling Newberry. Yes, it is long, but it provides a level of insight and clarity too scarce during this time of economic turmoil. Stirling gives us a great deal of history and makes proposals far more radical than mine. I was going to quote a little, but I can’t possibly do it justice, so please click on over and give it a look.

(cross-posted on Daily Kos)

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Blogger vigdor said...

There's quite a bit of content out there to look at regarding the stock injection. Of course the NPR shows are tremendous - they should be required listening for every American. They are so well done. There’s another site out there that’s really informative - The site is really informative and well done. It’s not This American Life - but it’s really, really good & informative.

2:18 PM  

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