Economists React to Treasury’s Recapitalization Plans

[RedEarth]

Treasury Secretary Henry M. Paulson Jr. is reportedly considering injecting capital into troubled banks in exchange for an equity stake in those institutions. This is similar to Britain’s move on Wednesday to partly nationalize its distressed banks. Some economists reacted with glee to the news:

Nouriel Roubini, who had criticized Congress’s bailout package for not allowing such a recapitalization, gives a good run-down of how Treasury’s strategy arrived at where it is now. He argues that lawmakers did “the right thing” without realizing it:

A totally flawed and ineffective legislation that did not explicitly allow to do the right thing – recapitalize banks with public capital injections – and was rather aimed to do the wrong thing (wasting $700 bn of taxpayers’ money to buy only toxic assets at an inflated price) was rescued at the last moment right before the House vote via an interpretation of the wording of the legislation in the record of the House that allowed such recapitalization. It is a sorry reflection of the state of the U.S. democracy that hundreds of senators and Congressfolks did vote for the biggest bailout ever in U.S. history ($700 bn) without even knowing exactly what they were voting for.

Paul Krugman likewise gives a “tentative cheer” for the move, and offers “thanks to Chris Dodd, who insisted on the provision that makes this possible — and to Gordon Brown , for showing the way.”

Barry Ritholtz at The Big Picture echoes this sentiment:

Sure it’s a year late, and a trillion dollars short. Yes, this would have saved most of the firms that went belly up.

Better late than never . . .

Tyler Cowan at Marginal Revolution asks how partially nationalizing distressed banks would work:

…say the U.S. government owns 20 percent of each major bank. Exactly what instructions do they give the management? (”Hey, guys, just get stuff going again!”?) Presumably the 20 percent shareholder wants something different, and more in line with the public interest, than the desires of the remaining 80 percent. Are we to assume that the 20 percent wins out? Can managers be sued for violating their fiduciary responsibilities? Does the 20 percent explicitly tell the managers to do something other than maximize profit? What if the 80 percent votes to override them?

And Greg Mankiw offers a potential solution, arguing that the government should act as a silent partner in these firms:

It could work as follows. Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date.

http://economix.blogs.nytimes.com/2008/10/09/economists-react-to-treasurys-recapitalization-plans/#more-153

[yourout]

1. "government should act as a silent partner in these firms..." extraordinarily bad idea.

NO FUCKING WAY!