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Friday, September 26, 2008

The Bailout Plan and The Debate

by Calculated Risk on 9/26/2008 06:31:00 PM

I'll post a thread on the debate tonight (starts at 9PM ET).

Here is a live feed. (hat tip AF)

Hopefully there will be some questions on the Bailout Plan. I'd like to see both Senators McCain and Obama explain the economic problem, why they see a need for the government to be involved (or not), what the purpose of the plan should be, and specifics on the plan they would propose or support.

I really don't care about lengthy discussions on how we got here and hopefully that will be avoided tonight.

Important for the comments: I encourage everyone to stay focused on economic issues only. I'll delete comments (or the entire thread) if it gets out of hand. I think this is an important issue and one of these two men will be elected President in just over one month.

My perspective: I believe there is a significant credit crisis right now. The credit markets are in severe distress and we can see evidence of this in the various credit spreads.

A number of financial institutions made bad decisions, and they now need to deleverage. For the most part these institutions can't raise private capital, and as a result they have all but stopped lending. Given a little time, this lack of lending to credit worthy borrowers will significantly impact the real economy.

In response to these problems, the government announced last week that they would present a plan to bailout the banks. Last Friday I predicted the Paulson Plan would have some of the features of the Depression era Reconstruction Finance Corporation (RFC) and make preferred stock investments in banks (with the taxpayers owning the preferred). This would help the banks recapitalize, and punish the existing shareholders by diluting their shares.

My view is that it is in the public interest to make sure the banks continue to lend to credit worthy customers. But it is not in the public interest to protect the management and shareholders of these institutions.

Over time this preferred stock would be sold on the public market. The RFC was one of most successful programs of the Depression, and has been praised by many economists including Milton Friedman.

Unfortunately that wasn't the Paulson Plan. I was very surprised. The Paulson Plan was to recapitalize the banks by paying a premium for toxic assets compared to market prices, leaving the taxpayers on the hook for any losses and rewarding the management and shareholders of the banks that made bad decisions. That is a bad idea and was immediately opposed by many economists like Paul Krugman and Nouriel Roubini who both support some sort of equity investment for taxpayers.

I would prefer that the current plan be junked, and a new RFC type plan proposed. I do feel there is a serious problem and there are reasons for some government involvement. However, at the least, I'd like to see equity investments for taxpayers.

I know that others believe any and all plans should be stopped, and there should be no government involvement. I understand that view, but I respectfully disagree.

Let's see what the candidates have to say.

Note: This week I've received hundreds of alternative proposals - many of them with very good ideas. Unfortunately I haven't had time to read them all, and I apologize for not responding to all the emails I've received. I do appreciate the input and ideas.