| | |  Editorials | Opinions | September 2008 
The $700 Billion Dollar Bailout
 Paul Crist - PVNN
 |  | Whether the market has over-reacted to the downside remains to be seen... but I have a strong hunch that it has. |  | | | |
In response to Paul Krugman's Op-Ed in the New York Times, Cash for Trash:
Paul Krugman’s 4-step analysis of the meltdown is (no surprise) right on. He’s an economist with amazing intelligence and the unique ability to simplify the explanation so any non-economist can understand it.
As Krugman points out, Henry Paulson wants to attack the problem at step 4, where the government would buy up nearly worthless mortgage-backed securities... and for the plan to work, the government would have to grossly overpay for those assets.
Maybe the current value of those assets has been driven down below their intrinsic value, (meaning the market has over-reacted, as markets do,) and the current value of those assets will later stabilize, allowing the government to then sell the assets back into the market at a profit. Whether the market has over-reacted to the downside remains to be seen... but I have a strong hunch that it has.
But Paulson’s plan certainly rewards the guys who got us into the mess, as Krugman points out.. The government is proposing to pay them above-current-market-value for these distressed assets… otherwise, Paulson’s plan doesn’t work.
But Krugman is overlooking an important factor if he thinks that by addressing the problem at Step 2 we can avoid rewarding the guys who got us into the mess (at Step 2, rather than buy the distressed assets, the government takes an equity position in the distressed financial firms... buying their stock at fire-sale prices.)
At Step 2, the government could buy up, for example, Goldman Sachs stock at fire sale prices... Again, later to sell those shares back into the market at a profit when the (now over-reacting to the downside) market stabilizes.
By buying up shares, the government plays a big hand in stabilizing those share prices by creating more demand for the available shares. (And it is largely from share prices that these firms access to capital is determined... price goes down, they LOSE access to a huge amount of capital. Share price goes up, they GAIN access to huge amounts of capital.) So the government creates demand for those shares, pushing the share prices back up under Krugman's proposal.
These guys are not dumb! They are greedy, and they’ve over-leveraged their firms hoping to make a killing... but they're not dumb. The guys-who-got-us-into-the-mess aren't going to dump shares on the market when the government steps in! They know that the effect of the intervention will drive share prices - their holdings - back up! They just have to sit and wait! Guess who is selling their financial sector stocks? Right... Mom & Pop investor with the 401K. And they are going to sell those shares to the government at the fire sale prices - out of fear and panic - while the fat cats hold out for the inevitable price rebound.
There's no good answer here. The fat cats are gonna come out just fine. And I don't have a better answer.
Paul Crist, originally from Washington, DC, now lives, works, and writes in Puerto Vallarta, Mexico. He holds an MA in International Economics from Johns Hopkins University, School of Advanced International Studies, and is the Editor of the Democrats Abroad Mexico National Newsletter. He can be reached at editor(at)mexicodemocrats.org.
For more information about the Costa Banderas Chapter of Democrats Abroad, click HERE, or contact Paul Crist at 322-222-4793 or editor(at)mexicodemocrats.org. |
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