financial services bailout

A few quick thoughts:

Yesterday was a good day to get exercised about AIG bonuses.  The most interesting revelation was this one:

While the Senate was constructing the $787 billion stimulus last month, Dodd added an executive-compensation restriction to the bill. The provision, now called “the Dodd Amendment” by the Obama Administration provides an “exception for contractually obligated bonuses agreed on before Feb. 11, 2009” -- which exempts the very AIG bonuses Dodd and others are now seeking to tax.

Dodd’s original amendment did not include that exemption, and the Connecticut Senator denied inserting the provision.

“I can't point a finger at someone who was responsible for putting those dates in,” Dodd told FOX.  “I can tell you this much, when my language left the senate, it did not include it. When it came back, it did.”  

This article from The Washington Post (run in our local paper with a slightly more provocative headline) greeted my wife and me over breakfast this morning.  By way of introduction, my wife is as far to the left of center as I am to the right of center, has never taken an economics course in her life, and is as outraged by the behavior of large financial firms as I am.  When I got to the following passage, I noticed a familiar expression on her face:

President Obama yesterday vowed to "pursue every legal avenue to block these bonuses." But that pledge might have come too late. About $165 million in retention payments started to go out Friday to employees at Financial Products, after numerous discussions with the Treasury Department and the Federal Reserve.

Over the past couple of weeks, this passage from President Obama's Address to the Joint Session of Congress has been making the rounds:

Still, this plan will require significant resources from the federal government – and yes, probably more than we’ve already set aside.  But while the cost of action will be great, I can assure you that the cost of inaction will be far greater, for it could result in an economy that sputters along for not months or years, but perhaps a decade.  That would be worse for our deficit, worse for business, worse for you, and worse for the next generation.  And I refuse to let that happen.

I think the sentence highlighted in bold is very misleading, and the unquestioned adherence it is getting in policy discussions is very disturbing.

It was neither a surprise nor a disappointment that the stock market fell yesterday as it reacted to Treasury Secretary Geithner's latest bailout announcement.  Stock prices reflect the value of expected future profits -- cash flows after all vendors and creditors have been repaid.  If the government had stepped in with (yet) another (even more absurdly generous) plan to relieve shareholders of their obligations to those creditors at taxpayer expense, then naturally stock prices would rally.  So we an at least be thankful that we didn't see that. 

For a more colorful take on these ideas, here is Steven Pearlstein in The Washington Post:

Not enough clarity, they complained. Still no light at the end of the tunnel, bemoaned others. Like spoiled, petulant children, they demonstrated their dissatisfaction by driving stock prices down another 5 percent.

Rather than linking to it, reprinted below is the president's full statement on executive compensation from Wednesday.  It's well worth a few minutes of your time because it may well be one of the strongest pro-American statements about the U.S. economic system made by any president in decades.

There are three things I find most striking.

First, you can't help but be impressed by this:

"This is America. We don't disparage wealth. We don't begrudge anybody for achieving success. And we certainly believe that success should be rewarded."

That very succinct (23 words) caputures the American economic dream completely.  My guess is that every small business owner who read or heard it was cheering.

Then there's this, which followed immediately from the three sentences above:

"But what gets people upset -- and rightfully so -- are executives being rewarded for failure..."

Finally, there's this, which ended the sentence above:

If the government is going to put taxpayer money into distressed firms, then it has the obligation to regulate every way that money leaves the firms before the taxpayer money is repaid.  That includes dividends, large purchases, executive compensation -- everything.  The government may decide that it is not feasible or constructive to micromanage the firms, but that is a decision it should make deliberately.

For me, the key word is "if."  I think that the appropriate policy response is bankruptcy, not bailout in lieu of bankruptcy.  In bankruptcy or liquidation, the question of whether the executives are being paid too much is moot.  In bankruptcy, equity holders are wiped out and management goes with them unless the new owners -- the former creditors -- specifically wish to retain them.  If they make that choice, then they should be able to pay the executives whatever they deem appropriate.  Likewise if they hire new managers.

I'm generally opposed to helmet laws.  If someone wants to take the risk of riding a motorcycle without a helmet, who am I...or the government...to tell them otherwise?

But to my way of thinking, any motorcycle rider who rides without a helmet shouldn't receive any government assistance if that ride goes wrong for any reason.  The deal should be simple: if you ride without a helmet and get hurt in a crash, no ambulance comes to get you and no emergency room treats you unless you have private insurance to pay for it.  You also get no government assistance of any kind after the injury for medical help, unemployment, welfare, long-term care, or anything else.  You get hurt while riding without a helmet, the only one you hurt is yourself.  My tax dollars don't bail you out.  You want to take that risk, be my guest.

That's more or less the way I feel about executive compensation limits: If a company wants to take risks, it should do so with its own, rather than my, money.  If it's playing with just its own money, it can pay the execs whatever it wants.  God bless them.

My first reaction to the headline of Binyamin Appelbaum and David Cho's article in today's Washington Post, "Bank Rescue Would Entail Triage for Troubled Assets," was, What made this idea get any better in the four months since the Paulson Treasury proposed and then didn't implement it?  The answer is nothing.  This is just a more sophisticated way to give (future) taxpayer money to shareholders and non-insured creditors of banks that made poor investments.  This is just more "Bailout in Lieu of Bankruptcy," and it is just as bad a public policy when a Democratic administration proposes it as when a Republican one does.  Any bank that needs this kind of help needs a visit from the FDIC.  For the best commentary I've read, here is Yves Smith.

My first reaction to the headline of Binyamin Appelbaum's article in today's Washington Post, "Despite Federal Aid, Many Banks Fail to Revive Lending," was, How is this news?  After all, this is what happens when you pump money into distressed institutions.  You get gifts to non-insured creditors, not loans to potentially risky borrowers. 

But Appelbaum's article is worth a read, because he tells a clear story about how the opposite of new loans is playing out in the DC area.  Here are two excerpts: