Monday, September 22, 2008
Blogging from the back of the big health care conference, I see that the Congressional Democrats have responded with a counterproposal to the Paulson plan. The initial press accounts are incoherent, but it is not clear whether that is the fault of the reporters or the underlying proposal. This, for instance, is a real puzzler:
According to the proposal, Treasury may not purchase, or commit to purchase, any troubled assets unless it "receives contingent shares in the financial institution from which such assets are to be purchased equal in value to the purchase price of the assets to be purchased."
Huh? If the Treasury bids, say, $100 million for an equivalent amount of "toxic" mortgage-backed securities, it gets those securities which are presumably worth $100 million. Does it also get an additional $100 million in "contingent shares"? That is how the story reads, so we are hoping that it is Reuters that is idiotic, rather than the Democrats.
In any case, I am all for crushing the equity. The Treasury should do this by bidding a clearing price for toxic assets, rather than book value or some other notional amount. Doing this by effecting a takeover of each and every financial institution for which it would provide liquidity strikes me as counterproductive in the extreme. Why would anybody agree to that deal, and why would we want it as a country or an economy? It seems to me that the Democrats must know this, and are trying to derail the Paulson plan or at least make it politically very costly for the Republicans.
MORE: Tom Maguire has given this proposal, including the precise text inaccurately reported by Reuters, the usual close inspection:
Dodd is calling, in effect, for random equity issuance with no underlying cash in order to dilute some owners if the Treasury chooses to sell assets at a loss, regardless of why or when that loss may have occurred. This does not bring new government equity into the system but may create enough uncertainty to deter private investors from joining in. That is stabilizing? How in the world will any of these firms attract new capital investors (if that is what is needed) with that random cloud over their heads? How will a prospective new investor in a firm evaluate the joint probability that (a) the assets sold by the firm a few years ago have depreciated and (b) the Treasury will actually sell them rather than ride it out?
Krugman will support this because it looks punitive and onerous to Wall Street. But this is daft.
Stabilize the current system, crush the old equity, and attract new equity. Choose any two, but do not attempt all three.
Question from a Finance Noob: Could the government takeover of these troubled companies and their inevitable sale be an attempt to scotch the normal rush of lawyers, frantic to file class action suits?
Actually, this is just saying that the purchase of these assets dilutes the current equity. If the ultimate sale of those assets produces a loss then the equity remains diluted. If the assets sell for the amount the governemnt paid, then the equity is undiluted. If the assets is sold for more, then the taxpayer and the shareholder shares the gain.
The alternative is to force insolvent firms in to bankruptcy then immediately takeover the assets and liabilities and liquidate as market prices improve.
But why should the taxpayer be placed at the back of the queue?