An extended version of this article was published on The Nation.com September 22.
Henry Paulson and Ben Bernanke’s bailout plan is not only the most expensive; it is also the most likely to fail. But there is more than one way to restore trust and restart markets. First, take a leaf from the New Deal. That is, just send bank examiners into all the institutions–investment houses and insurance companies, as well as banks–to assess them. Insolvent ones are closed; everyone knows then that those that survive are solvent. Economic life restarts. The total cost to taxpayers is minimal.
Guess why Wall Street hates this one and why Bernanke and Paulson do not even consider it. In all likelihood much of the Street is insolvent, which is why short-sellers were going wild until the SEC restricted them.
A second way is for the government to inject capital directly into those financial institutions with a reasonable prospect of surviving in the long run. This was the essence of Senator Chuck Schumer’s proposal, which surfaced just ahead of Paulson’s announcement. The New Deal did this, too. It used the Reconstruction Finance Corporation, which put severe terms on banks receiving aid. Wall Street, of course, would love the money but not the terms. Somebody to inspect and certify the solvency of financial houses is also prerequisite for this option, which is anathema to the Street.
Finally, there is Bernanke and Paulson’s choice. Just have the government buy the junk, giving Wall Street real money–our money–in exchange for it. Notice three points about this one. First, the lucky firms continue merrily in business; the Paulson plan, thus far, pays only lip service to reforms. Second, there is the truly alarming likelihood that $700 billion will not be enough. Estimates of the amount of junk out there vary, but the key point is that most financial experts have consistently underestimated the problem, and there is no reason to believe their forecasting has improved. Third, the draft plan is silent on the prices at which assets are to be bought and, presumably later, resold, raising the possibility of sweetheart deals.
It is vital that Congress insist on reasonable terms for the public. For example, the government could take equity in the firms it bails out, which can be sold later at a profit. We prefer this method to warrants, which are rights to buy shares at a low price that ensures a gain if and when they are finally exercised; in past bailouts, firms like Chrysler pressured the government not to exercise such warrants.
To recapture some of the broader market gains flowing from the injection of public money, one could place a modest new tax on interest and dividends. “Carried interest,” the ludicrous special tax break for private equity that not only Republicans but Schumer and other Democratic leaders continue to defend, should go as part of any deal on a bailout.
And finally, obviously, it is necessary to re-regulate. The details might require time to work out, but handing out money before nailing down reforms is too dangerous. Congress should legislate, with a promise to fix details later. If Wall Street doesn’t like it, it doesn’t have to accept the money.