Posted on 10/25/2008 1:31:56 PM PDT by curiosity
As Paulson's and the world's confidence in the original rescue plan has waned, Luigi Zingales, a finance professor from the University of Chicago, who early on opposed the Paulson plan, presents Plan B. Plan B is an innovative approach for dealing directly with the foreclosure crises which avoids the costs and moral hazard problems of other proposals, together with a prepackaged bankruptcy/recapitalization proposal inspired by Lucian Bebchuk.
(Excerpt) Read more at bepress.com ...
A great article for your ping list.
Can’t access the article without registration.
http://faculty.chicagogsb.edu/luigi.zingales/research/PSpapers/plan_b.pdf
Link found through Google search. I assume this is the same article that was submitted (or a working draft???).
His plan to avert the foreclosure crisis:
"Congress should pass a law that makes a re-contracting option available to all homeowners living in a zip code where house prices dropped by more than 20%... In exchange [for writing down the face value of the mortgage], the mortgage holder will receive some of the equity value of the house at the time it is sold... 50% of the difference between the selling price and the new value for mortgage will be paid back to the mortgage holder."
His plan to restore confidence in financial institutions:
"The core idea is to have Congress pass a law that sets up a new form of prepackaged bankruptcy that would allow banks to restructure their debt and restore lending... Firms who enter into this special bankruptcy would have their old equity holders wiped out and their existing debt (commercial paper and bonds) transformed into equity. This would immediately make banks solid, by providing a large equity buffer. As it now stands, banks have lost so much in junk mortgages that the value their equity is tumbled near zero.
"... under my plan, for the next two years, only banks who underwent this special form of bankruptcy would get access to the discount window. In this way, solid financial institutions that do not need liquidity are not forced to undergo this restructuring, while insolvent ones would rush into it to avoid a government takeover."
His conclusion:
"Thus far, the Treasury seems to have been following the advice of Wall Street, which is happy to see public money thrown at its problems... I feel it is my duty as an economist to provide an alternative: a market-based solution, which does not waste public money and uses the force of government only to speed up the restructuring."
See post six.
I like the ideas presented here since it doesn’t require massive intervention by the gov’t. However, that’s precisely why it probably won’t fly: It keeps the gov’t on the sidelines while the market provides an effective solution and politicians somehow believe they can solve a billion simultaneous equations per second better than the market can.
This is what McCain should have come out with after he suspended his campaign. I strongly believe he would be cruising to victory. The amount of resentment regarding Paulson and his cronies can be tapped into, and we won’t continue to debase our currency or have additional government intervention in our financial sector.
The idea of wiping out the equity holders in banks and turning the bondholders into equity holders is great. It eliminates the moral hazard argument.
I also like the idea of only writing down mortgages in distressed areas and making the current mortgage holders participants in any future equity gains. This seems fair to me.
http://faculty.chicagogsb.edu/luigi.zingales/research/PSpapers/plan_b.pdf
The origial URL I entered for the article can only be accessed with registration. The new URL above points to a earlier working paper version of this article, which can be accessed without registration. Thanks a bunch in advance for your help.
Also, in my initial comment I mistakenly referred to Henry Paulson as Frank Paulson. Would you fix that for me? I would really appreciate it.
Instead, my generation will be on the hook for trillions upon trillions of dollars, just so some Wall Street executives can get their big bonuses. It makes me sick
Very interesting proposal - thanks for posting that.
I’ve read that some of Obama’s economic advisers are fairly conservative members of the economic department at the University of Chicago - conservative enough to piss off a left-wing Democrats anyway:
http://louisproyect.wordpress.com/2008/01/09/obamas-economic-advisers/
that Obama met during his time there, wonder if they have any real access or influence.
don’t be fooled. First of all, Austen Goolsbee was the one who went and “secretly” told the Canadians that Barack was just kidding about recutting NAFTA, so who knows what the deal is with him and how much he might have a say. Likely, he is just some moderate lipstick on the marxist pig. Second, Goolsbee is a “behaviorlist” affiliated with Santa Fe Institute and in the same camp of the Freakonomics guy. In other words, he is not conservative from the traditional UofC school but a outlier who was champion “debate nerd” in college. My experience was these guys were high on rhetoric and kissing butt in a political environment, though not very perceptive.
I don’t know. I read the whole article (it’s only 4 pages) and the key thing that hit me is the author’s plan to exchange debt for equity. The toxic debt assets do not have to be written down or evaluated, but will be swapped for stock at the face value of the debt. This sounds like avoiding the fact that the assets (the collateralized debt obligations)are not worth their current face value.
You misunderstood. He's talking about swapping the debt owed by banks, i.e. their bonds and commercial paper, not the debt banks hold as assets.
If you swap the debt the banks owe into equity, you suddenly give the banks a huge eequity cushion which will allow them to absorb the inevitable writedowns of their assets.
Thanks for the clarification. I realized that the assets banks own are (other people’s) debts, and that these are what needs to be re-valued, but I didn’t get that it was the bank’s own debts (other people’s assets) that would be swapped for equity.
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