Criticism of the U.S. Bailout Plan, Part 1
September 23, 2008
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“The Devil Is In The Details” – Proverb
Joe Nocera’s September 19th column Hoping a Hail Mary Pass Connects in The New York Times offers some cogent criticisms of the U.S. government’s bailout program.
… the financial system has seized up. But so far, the government’s actions haven’t helped. Letting Lehman go bust may have sounded good at the time, but it has had disastrous consequences.”
It has led to complete chaos in the multitrillion-dollar market for credit-default swaps and was a crucial reason Morgan Stanley was forced to scramble to stay alive this week. It is also why questions were raised about the viability of Goldman Sachs, a firm with a pristine balance sheet and almost none of the bad assets that are bringing down other firms.
The rescue of A.I.G. further undermined confidence because, within the space of several days, the government did a complete about-face. The bailout suggested the Treasury Department was as confused about what to do as the rest of us.
So rather than help solve the crisis, the Treasury Department has actually contributed to the biggest problem in the market right now: an utter lack of confidence.
Nocera thinks that Criticizing Short Sellers is misleading at best.
The idea that short sellers are the cause of the problem “is more myth than fact, and in any case, it’s not the dynamic here.”
Stocks are falling because companies made huge mistakes that have caused them a heap of trouble. Indeed, in July and August, short interest in financial stocks declined by 20 percent. Why did the stocks continue to go down? Because there were too many sellers and not enough buyers: it’s that confidence thing again. Blaming the shorts is classic blame-the-messenger behavior.
While agreeing that we should save the Money Market Funds, he raises the question of moral hazard.
It bails out poorly managed money funds — the ones most likely to break the buck — at the expense of funds that haven’t taken the extra risk that causes a sudden drop in value.
And then there’s this: If you have your money in a bank account, only $100,000 is insured. But if you have it in a money market fund — which usually has a slightly higher yield precisely because it has a small element of risk — you now have unlimited insurance. It’s the world turned upside down.
Finally, when it comes to the actual Buying of Distressed Assets by the government, Nocera asks
How is the government going to assess these securities — and what price will it pay for them? In many cases, these securities aren’t being sold because they are still overvalued on a firms’ books. That is, their mark-to-market price is unrealistically high. Will the government buy it at the too-high price? If it does, the firms won’t have to take additional write-downs — but it will constitute a huge, unjustified bailout of Wall Street. (More moral hazard.)
But what if the government drives a hard bargain, and gets the securities for what they are really worth — 20 cents on the dollar, say, instead of 50 cents? In that case, the firms would have to take yet more enormous write-offs, which would further damage their balance sheets, and they would have to raise billions more in capital. Maybe the removal of these bad assets would allow the firms to raise the capital. But maybe not — meaning one or more could conceivably have to file for bankruptcy, creating yet another spasm of financial turmoil. It’s a huge roll of the dice by the government.
In conclusion, he says, “As much as we all hope the worst is over, it’s probably not.
And as much as we might hope that the government finally has the answer, it probably doesn’t.”
Not pretty, but there it is.