Why not equity?
It would be politically unfeasible for the government to do what Zingales suggests. Remember this is not the great depression and for the government to force a company to give up equity (private property) for cash without their consent would be unconstitutional (at least in today's courts) and political suicide for the dems.

The original Paulson plan appears to be dead now. Why are we rehashing old criticisms?

Gordon, it's not without their consent. Participation in the bailout is completely voluntary. If my tax dollars are going to bail a company out, they should be thankful that the cost is handing over equity to the Fed, rather than bankruptcy. Afterwards, the government can sell off that equity to the highest bidder-- equity that would not even exist were it not for the bailout. If the banks think they can do better elsewhere and have more equity left if they don't turn over a portion of their business to their benefactor, then that's fine-- they can find someone willing to give them a better deal.

As I said on another thread, when you go to the Godfather for help, you have to cut him in on a piece of the action.

I'd really like it if some very smart person could run some numbers to compare the buy-bad-debt (Paulson) approach to the equity approach. My sense is the Paulson plan is a much more expensive way to do it, but I could be wrong. But if I'm correct -- and Paulson's approach will be vastly more expensive than simply recapitalizing these institutions directly in return for equity -- then what possible justification could there be for buying $700 billion worth of bad debt?

I'm sure one objection (emanating from the right) will be that we don't want the government owning banks. Fair enough. I happen to agree. But the legislation obviously could contain a provision requiring the government to gradually divest itself of bank shares over a period of time -- after the crisis has passed.

Moreover, the equity approach avoids the (yet more!) moral hazard issues that will accompany Paulson's plan, by requiring financial institutions to -- heaven forbid! -- actually pay a price (a forfeiture/dilution of equity) in order to have their asses saved by taxpayers. Institutions will thus have an incentive to buy (with their equity) only as much financial assistance from the government as is genuinely needed. In other words, they'll have an incentive to minimize the burden born by taxpayers. Paulson's plan on the other hand is a no strings funnel connecting your paycheck to some billionaire's portfolio.

What I want to know is, given the serious voices supporting the equity approach, why isn't there a full-scale rival proposal emerging from the Democratic leadership in Congress? This is all maddeningly frustrating. Also, what are the chances Obama might join people like Krugman in voicing doubts about the Paulson approach?

Uh... where's the forcing? If the banks want the money from the government they choose to exchange cash for equity. They can choose not to have the money and file Ch. 11 instead.

Or they can choose to swap cash for equity with the Abu Dhabi Sovereign Wealth Fund, as some have already.

Or some few banks are strong enough not to need masses of cash and can raise the equity by just selling it on the market.

Why not skip Wall street entirely and just start bailing out homeowners directly? If we can lower the foreclosure rate and keep people in their homes, the toxic assets are no longer toxic, right?

Worst case, the government ends up with a lot of property on its hands. Big deal! It can sell the property for a profit years in the future. And, on a gut level, government ownership of property bothers me much less than government ownership of wall street banks.

Who knows, years from now government can sell off the property to raise revenue, just like we did in the earliest days of the Republic.

Or am I missing something here?

Remember this is not the great depression and for the government to force a company to give up equity (private property) for cash without their consent...

What Meh (5:44pm) said: you got two choices, sell us some of your equity (you can buy it back in the fullness of time if you wish, and you're able), or file bankruptcy. Moreover, if a financial institution were genuinely teetering on the brink of insolvency, I don't see why the government can't give itself via proper legislation the authority to undertake this form of recapitalization. Desperate times call for desperate measures. And again, such a course of action hardly means we're about to become the USSR: the legislation could be written to require Washington to sell its financial stock portfolio eventually.

Why not skip Wall street entirely and just start bailing out homeowners directly? If we can lower the foreclosure rate and keep people in their homes, the toxic assets are no longer toxic, right?

More robust efforts to help homeowners may help. But in many cases it's too late for that, as zillions of homes have already been abandoned, and thus no payment is being made on them. Moreover, the primary action you can take to help distressed homeowners -- writing down their mortgage principal -- will still negatively impact the financial institution holding the paper.

@Frank

I've had the same thought. Instead of giving Hammerin' Hank the money, just start buying peoples' homes for them. How much would that cost I wonder?

Clearly none of you read Luigi Zingales report.
Of course it's perfectly acceptable for Paulson to demand equity as a condition for assistance. What Zingales wants is to force the banks to give up equity for debt forgiveness (i.e. no consent). Luigi goes on to talk about the greater good and how everyone's a winner (yah right). All I am saying is expropriation is incredibly unpopular and I doubt even the democrats would want to go there.

As an aside don't these rich and powerful banks/investors pay most of the taxes? I guess you could think of this bailout as a massive tax rebate.

What Zingales wants is to force the banks to give up equity for debt forgiveness (i.e. no consent).

Wrong. Zingales says that it would make sense to either mandate debt forgiveness or engage in a debt-for-equity swap.

I don't know if mandating debt forgiveness is a good idea, but I cetainly think that the fed should demand a significant upside in exchange for providing a bailout.

@Jasper,

That's the answer I was looking for, thanks.

I guess if we'd moved on this a year ago, when Bush and McCain were resisting efforts to help homeowners on the grounds that "it might reward irresponsible speculators," then we may have been effective.

Still, I'm more comfortable with the USG buying up abandoned homes directly. Aren't there Katrina/Gustav/Ike/Rita victims that could live in them for the time being? Better than rotting FEMA trailers!

What Zingales wants is to force the banks to give up equity for debt forgiveness (i.e. no consent). Luigi goes on to talk about the greater good and how everyone's a winner (yah right).

Gordon Gekko: Why this obsession over this Zingales fellow? As far as I know he's neither the president, the Secreatary of the Treasury, nor a member of Congress. The country's not required to follow his advice. And as a number of others have pointed out, there's no reason participation in an equity-style recapitalization plan would have to be mandatory. The legislation could be written in such a way as to permit beleaguered financial institutions the option of bankruptcy proceedings in the event they didn't want to sell stock to the government. And in any event, I seriously doubt your contention that mandatory equity sales (when necessary) would be "unpopular." It is badly managed financial institutions and Wall Street sharks that are unpopular. The public isn't going to be shedding tears for these folks if the government has to take drastic measures to save the economy, and as a result bank shareholders are asked to shoulder some of the burden along with taxpayers.

The bad assets are largely bad mortgages ...

It's not clear to me how much of the debt the government proposes to buy is secured by residential property -- or by anything else, for that matter. I need to find someone who can tell me what percentage of the "mortgage-related debt" that the Treasury would purchase is (1) defaulted mortgages and collateralized mortgage obligations (CMO's) burdened by defaults, what percentage is (2) credit default swaps (CDS's) purchased by holders of mortgages, and what percentage is (3) CDS's purchased by speculators, i.e. people who do not hold the underlying mortgages and CMO's.

This bail-out is George Bush's closing argument that he is beyond any doubt the worst President in history.

'helping out the home owners' seems like a good idea, but in the end is just as bad as this plan. To help them out you could give assistance to those unable to make the payments, but all that does is reward the banks once again for making bad decisions.

those execs and underlings that ok'd bad mortgages now get their butts saved because all mortgages would then be rock solid. Home owners too would fudge the system as much as possible in order to get a piece of the pie from the government.

We should have just let the banks eat the losses, and let the debtors claim bakruptcy. It would suck for a while, but not as long as this bailout will.

As usual however our only answer to a problem is to throw money at it. No design, no plan, just throw more money. Sometime soon China will foreclose on us, and we wont have that limitless pool of money to suck from anymore. Wonder what the answer will be then.

I just hope the dems obtain support from the substantial congressional GOP minority. This needs to be bipartisan, or the GOP will try to turn this into another liberal spending program, especially if the dems are successful in attaching homeowner relief.

Since this is being rammed down our throats we need some protection. Call your Senators and tell them to stick with the Dodd plan or no bailout.

I've been reading up on the abuses of the RTC. On NPR yesterday T Boone Pickens mentioned that RTC was a huge give-away to connected people. I am generally no fan, but he is right.

Our weak leaders in congress need to grow a spine. All the Rs need to vote for it or it is no deal.

I've gone from thinking "we have to do something NOW" to "if we are going to do something we better do it right."

Two things I don't understand:

1) Why isn't anyone talking about how we're going to pay for the bailout? Why is everyone just assuming that we'll pay for it by borrowing more money? Why can't Dems demand that payment be arranged for upfront by tax increases on the rich? Then if the whole (s***)pile of assets the Treasury Department buys turns out to be worthless, we're still good.

2) Why not do a bottom-up bailout? If all these toxic securities are toxic because they're based on bad mortgages, why don't we fix the mortgages??

Just create a branch of Treasury with the power to review the mortgage of anyone whose payments are over a certain percentage of their incomes. Give them the power to restructure anyone's mortgage to the highest fixed-rate mortgage they could have reasonably afforded at the time they went to settlement.

That way, if the bank sold them on a mortgage that was inappropriate at the time, then the bank (or the current holders of securities based on different pieces of the bad mortgage) swallows the difference between the actual loan and what was appropriate. But unless the homeowner's circumstances have changed for the worse, the rest of the loan is still good.

Do this on a nationwide scale, and all those toxic securities would still be worth a good deal less than they were valued at in the spring of 2007, but now they'd really have some solid underpinnings to their value.

The result should be to unfreeze the market for these securities. Institutions that turned out to be above water once their assets had a market value would be OK, and those that were under water could be dealt with in a more orderly manner.

So, what's wrong with this plan? What am I missing?

So many issues, so little time . . .

Low-tech: The problem with a "reverse bailout" is the issue of stability. Say you are a bank (or more likely a bond holder) who lent money at say 9% to someone to buy a house. Now the government comes along and says that's too much, you can only get 5%. Well, the next bloke comes along to borrow money, and you are willing given their creditworthiness to lend at 8%, will you lend the money? Hell no, because the government might screw you out of the interest rate you bargained for. While you might say, "who cares" the next guy lending money either won't lend it or won't lend it to anyone but the most creditworthy (i.e. rich). Hence, no one anywhere can borrow any money since everyone will worry the government will change the terms and the economy will collapse.

We could pay for the entire bailout and a whole lot more if the US just defaulted on our government bonds, but if we did that, there would be catastrophic consequences. Same with retroactively rewriting mortgages. It will help those underwater now, but will decimate lending in the future.

Now this isn't to say such terms can't be worked out on an individual basis either voluntarily or through bankruptcy, but to do it society-wide would be catastrophic, and that's without getting into the nitty-gritty of who "deserves" help; people who just bought too much house? people with cash-out HELOC? People who took out NINJA loans? ANyone with an ARM? (I could have saved about $400/month initially with an ARM 4 years ago, am I now a sucker for paying the higher fixed rate if the government would bail me out? Of course now I'm a genius since rates have gone up.) Are we just giving people a free house? I'd love a free house, should I have just taken out a larger mortgage than I could pay and now get to keep it, while the guy down the street bought a cheaper house he could afford, pays his mortgage on time and get no help?

The sad fact is, many people bought homes they couldn't afford and the SHOULD be foreclosed; it's really the best thing for them. They should then rent or buy a cheaper house. Now I agree their were some excesses by mortgage brokers and the like and a government program to refi those into reasonable loans might work, but you still have the problem of the people who cashed-out $300K on their HELOC to buy Hummers and now can't afford their mortgage, but tough cookies.

As for the bailout, there is definitely a "screw the banks" theme out there and it is understandable. But just beware that if you do that, they will be replaced by entities you will like even less, namely hedge funds, private equity and foreign wealth funds. Sometimes a bad solution is the best you can hope for.

Another problem with this proposal is that apparently credit card and auto loan receivables are also going to be purchased with taxpayer money. There is no possible taxpayer upside to those purchases. That portion of the proposal must be stopped.

We have been told that banks need to raise capital. Why haven't they eliminated their dividends? That's the quickest way to raise capital.

Scott - I don't see the problem. Even if the bailout turned into a permanent fact of life, rather than being confined to a one-shot deal to end the current crisis, it would only affect those residential mortgages that were written for more than the borrowers could reasonably afford to pay back.

I doubt that our economy would collapse due to the inability of banks to write residential loans that borrowers couldn't pay back. Our economy did quite well for a very long time when banks only wrote mortgages that were within the ability of the borrowers to repay.

My business partner joked that we should let the IRS have and collect on the mortgages. The IRS would get the mortgagee’s his employer to pay before the employee gets to touch the money. If additional payment is due and the mortgagee is late one month, the IRS would ht him with a $1,000 file. The IRS would make the mortgagee report how much they owe and if they make a mistake $1,000 fine. If the mortgagee is out of work and refuses to pay the IRS will put him in jail.

I'd love a free house, should I have just taken out a larger mortgage than I could pay and now get to keep it, while the guy down the street bought a cheaper house he could afford, pays his mortgage on time and get no help?

Why would you get a free house? If the bank let you take on bigger payments than you could have been expected to make, given your income, then the loan gets a haircut, but only back to the max that you are judged capable of having been able to pay at the time. If you took out a $3000/month mortgage in 2003, but the underwriting standards said someone with your income, assets, and existing obligations at the time was only good for $2500, then it gets cut back to $2500, which you were capable of paying, but hardly makes the house free to you. If you bought a new Hummer in 2006 and can only afford a $2000 house payment nowadays, then you lose the house or the Hummer.

Yes, you messed up too, by buying too much house, but the bank messed up by setting you up in that mortgage, and they're the experts. Supposedly.

More important, they're the ones crying out for rescue. Well, why not rescue them by 'rescuing' you to that extent?

And if we're not going to distinguish between deserving and undeserving investment banks, why should we do the same between individual households? Sure, we'll reduce the mortgages of some people who should have known better, but only to the top end of what they can possibly afford. But all the banks, and all the downstream investors, should have known better.

My business partner joked that we should let the IRS have and collect on the mortgages. The IRS would get the mortgagee’s employer to pay before the employee gets to touch the money. If additional payment is due and the mortgagee is late one month, the IRS would hit him with a $1,000 fine. The IRS would make the mortgagee report how much they owe and if they make a mistake $1,000 fine. If the mortgagee is out of work and refuses to pay the IRS will put him in jail.

Well why not buy the actual property that is the basis of the toxic loans? Effectively, the subprime banks sell the foreclosed homes short to the gov't and take their losses. Now at least the gov't has an asset that can be valued and hopefully sold. I googled the average sales price of $212,000 and there about 500,000 homes facing foreclosure July - Sept. So we could buy all these properties for $106 billion. Hey, I just saved 600 billion!

Now, I am not too keen on making Uncle Sam the world's biggest landlord/mortgage lender but it seems like it would be cheaper.

I am not sure why the implicit assumption is that the prices will skew to an "above-fair" value as opposed to towards a pessimistic valuation. Assuming that the assets being sold are not too heterogeneous, if you have multiple sellers (and it appears you will have many) and you take the lowest price by default, wouldn't possibly result in an underpricing of the asset. Think of two banks, US Bankcorp and WaMu. US Bankcorp pays out a fat dividend and didn't get invest heavily in low grade MBSs and as a result are doing pretty well relative to other financials. Washington Mutual is basically a thrift that is bathing in toxic assets. It has a more compelling need to dump these assets but in order to stay afloat it will also require a higher price to offload the assets. US Bankcorp would probably write these debts off otherwise so for them they can sell the assets at a cut rate price and effectively price the Washington Mutuals out of the reverse auction. I still think the taxpayer will be hosed and equity warrants and CEO compensation regs for benefitting corporations should be attached, but I don't understand the presumption that "above-fair" prices will result. The incentives seem to skew in the other direction.

@ jasper

As far as Obama getting behind the equity approach a.k.a. voicing distaste for the Paulson approach, the only bailout plan most Americans know of. Even if he believed in it (the equity approach) he would never, never, voice negative opinions toward the current and only bailout plan, for if he did so right now when everyone’s freaking out as evident in the 777 point drop, it would be political suicide. Even if he simultaneously suggested alternatives he would be seen as the bailout plan hater. Basically presidential candidates can’t have the balls to fight for everything they truly believe in, and Obama is just as guilty of compromising his values to get elected as most every other politician.