Tuesday, September 30, 2008

The Bail Out

Any solution should observe three guiding principles.

  • Restore the stability of the financial system quickly and and at the lowest possible cost to the taxpayers.
  • Address the root causes of this crisis, i.e. the price collapse in the residential real estate market.
  • Punish those who are responsible for the losses.
Here are some of the problems with the bail out bill.

1. How will the assets be priced? Efforts in the past to establish a price have not been successful. In fact, markets have frozen up largely due to the difficulty of pricing them.
  • If the Treasury pays to close to par, as Fed Chairman Ben Bernanke alluded to at the Senate hearing, it's going to pay too much.
  • If it pays the current prices, no one will sell due to the impact on their capital.
  • If it pulls a price out of thin air, it will be acting arbitrarily. The proposal needs to create a price setting process.
2. Are we better served by buying assets or institutions? It's obvious that the purchase of mortgage related assets from struggling or failing financial institutions is necessary. But why should the taxpayer, instead of the shareholders and debt holders, bear this burden of debt
for financial institutions that are solvent? I think not.

3. How much is this really going to cost the taxpayer? $700 billion is a lot of money. But what if it isn't enough? Some economist are saying the price could be over $1 trillion.

Before anything is consummated the solution should respect the rule of law by spelling out the proposal in sufficient detail for the Congress and the voters to pass judgment. It should follow proven precedents.