The Wallstreet Bailouts

I haven’t had any time to post over the last week or two due to way too many things happening it once but I think the following short post is very interesting and timely. There’ll be more regular posting soon.

The following is from Greg Mankiw’s short summary of articles by Paul Krugman (here) and Doug Elmendorf (here):

[The] government should be putting capital into banks and other financial institutions, in exchange for a share of bank equity, rather than using taxpayer dollars to buy bank assets that no one else wants at prices no one else will pay.

Directly from Elmendorf’s article:

A second problem with buying troubled debt is that it provides the most help to the financial institutions that made what are, in retrospect, the worst investment decisions. Banks that stayed clear of this debt or sold such debt at cut-rate prices earlier this year in an effort to move beyond the crisis would receive no direct gain from such a program, while banks that made the biggest commitments to low-quality mortgages and have delayed dealing with their balance-sheet problems would be the biggest beneficiaries.

Third, this approach saddles taxpayers with significant downside risk but limited potential upside gain. One crucial feature of the Treasury and Federal Reserve rescues of Fannie Mae, Freddie Mac, and AIG is that taxpayers received substantial equity shares in these companies and could receive solid returns if financial markets rebound.

And from Krugman:

[T]he financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

That’s what happened in the savings and loan crisis: the feds took over ownership of the bad banks, not just their bad assets. It’s also what happened with Fannie and Freddie. (And by the way, that rescue has done what it was supposed to. Mortgage interest rates have come down sharply since the federal takeover.)

Very worth reading

P.s: My advice when reading short posts like this on any blog is that if you find the post interesting, go and read the source material. This is one of my favorite ways of discovering interesting reading and getting a deeper understanding of world issues.

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