Monday, September 29, 2008

Problems with the new bailout plan

Paulson originally wanted to stabilize markets by participating in them. This plan destabilizes markets by creating a whole set of separate and complicated markets.

What's the quick answer?

(a) Full authority for Paulson, but he needs to have more on the line. I like the idea of military rank and military justice. See if he is willing to face a firing squad if he is convicted of malfeasance. If he were, it would show that he is willing to put something on the line, and it would show the markets that he is genuinely earnest about doing more than saving Goldman Sachs counterparties. At the very least he should be liable to be fined his entire net worth. Bringing Buffett on board might stabilize the markets, but I doubt very much that he would be interested.

(b) Full disclosure of all banks. The current plan has a situation where a bank that goes to Paulson calls itself into question during the negotiation (before it is clear how much equity Paulson would ask for) and a bank that doesn't go to Paulson might still have bad paper on its books. So simply saying that all banks have to take immediate write-downs, but that equity infusions will be available to cover their insolvency (i.e. more like Sweden). But something that forces all banks to open their books completely.

(c) If it turns out that the credit markets are in a tailspin, allow Paulson to get involved in the short-term debt markets. If McDonald's needs to borrow short-term money, and the banks are too terrified to lend even though McDonald's is genuinely AAA, then the USG should not rely on the banks as intermediaries: it should just step up and buy the short-term commercial paper.

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