WSJ: The Public Deserves a Better Deal

The wall Stree Journal ^ | 09/26/2008 | JOHN PAULSON

[uncommonsense]

The Treasury plan to buy illiquid financial assets has been widely criticized as being unfair to taxpayers, who will have to bear losses ahead of shareholders of the institutions that will be bailed out.

There is a better alternative to stabilize the markets: Invest the $700 billion of taxpayer money in senior preferred stock of the troubled financial institutions that pose systemic risks. Let's call this the "Preferred plan." In fact, it is the Fannie Mae and Freddie Mac model -- which the Treasury Department has already endorsed and used in practice. It is also the approach Warren Buffett used for his investment in Goldman Sachs.

There are major problems with the Treasury plan. First, by buying banks' worst assets at above-market prices, taxpayers take an immediate economic loss -- while transferring wealth to shareholders and executives of the very institutions that brought on the financial crisis.

Second, this plan puts too much discretionary power in the hands of Treasury officials. Who determines what financial assets are purchased and at what prices? Who determines which bank gets to benefit from these taxpayer subsidies? Will bank shareholders continue to receive dividends, and executives continue to get paid huge bonuses?

When financial institutions borrow massive amounts of money to invest in assets that are now found to be illiquid and poorly performing, it is not the responsibility of taxpayers to bear the resulting losses. These losses should be borne by the shareholders.

[uncommonsense]

In the forum discussion of this, there was a very interesting analysis of this plan:

Excellent analysis. But one point is missing: another reason this plan would cost less is because each dollar of equity preferred will support ten dollars of toxic assets (at market value)- assuming a 10% equity capital requirement. Under the current Treasury plan, the government would have to use ten dollars to buy ten dollars of toxic assets. The preferred proposal leverages the government funds more effectively, while protecting it against mis-pricing risk. Also, the warrants will be based on an observable market price (the firm's stock price), a clear advantage to trying to set prices for toxic securities of varying degrees of value and risk. In addition, limits on compensation could be built into the preferred provisions providing political cover and incentives to take out the government as soon as possible. This is clearly the approach the Treasury should take and hopefully will have enough flexibility to do so.

[Eric in the Ozarks]

They should call it the "Steve Forbes plan."
Of course, this is so obvious that 2/3rds of our elected representatives would overlook it.

[1curiousmind]

let’s hope that McCain and the house republicans are working out the details of a plan of this sort. I predict he will do well tonight and then follow it up tomorrow with this type of plan that will play well with the vast majority of Americans. heck, even the unions! And the dems will be forced to sign on.

well, at least this is what I’m hoping.

[grumpa]

My letter to the Wall Street Journal editor:

The Treasury should insist that each bank that they buy mortgages from simultaneously raise capital in the private sector. This would allow the Treasury to buy the mortgages at the lowest possible price without endangering the bank’s capital base. It would also allow the Treasury to invest less money.

Charles Meek
www.offgridblogger.wordpress.com

[Parley Baer]

Glad to see a decent plan proposed and not just throwing stones like I have seen too much of lately.

[SMARTY]

I am pretty sure the debate will separate the men from the boys.

Specifically, McCain has a clear picture of what has happened and how to address it. No warm, fuzzy humbug to pander to the ‘feelings’ of voters. It will be cold, hard logic ... always irresistible... and Obama will still be spewing ‘Reverend’ Wright nonsense about how whitey is trying to exploit the situation.

[bjc]

This wsj/paulson plan makes a great deal of sense to me. Shareholders and BODs need to exercise their governance roles fully or pay the consequences. Currently shareholders operate as if their only points of leverage are buying and selling a company’s stock - leaving operational and strategic decisions to management.

More importantly, it serves to indicate who one should listen to in trying to resolve this issue. In my view one should listen more to those who have a compelling and evidenced based explanation of both how this problem emerged and how to ensure that the pain is allocated in rough proportion to the culpability of those parties. Alas, since I fear our Government played a major role in the emergence of this mess with dumb policies we will all have to bear some of the pain in putting it right. Those politicians like Barney Frank who championed these dumb policies should pay a political price.

Unfortunately I fear that those most culpable will pay the least because they are actually deciding who will pay.