Have we thought enough about all the bailout options?

You Must Act Now!

There is a sense of urgency in enacting the bailout proposal that has caught the pols in between the devil and the deep blue sea. Damned if they dont act as “the economy will meltdown” (a.k.a the wolf is coming; George, IBDEditorials and Warren) and damned if they do (“NO BAILOUT, I am a registered republican,” one constituent wrote. “I will vote and campaign hard against you if we have to subsidize the very people that have sold out MY COUNTRY.”). Meanwhile we have a cadre of academic folks who are citing the “dont succumb to the boy’s cries about the wolf” suggestion; finally there are the wall street types that argue against  the bailout either on principle or implementation (one example listed below).

We are already seeing signs of rushing in Washington DC and we must do everything we can to call for additional reflection. Please call or email your federal representatives today to make sure they hear your voice. In addition to the $9 trillion national debt we are committing an enormous debt to our children who will be facing the repercussions of a national bankruptcy that will impact everything from social welfare to economic competitiveness.

Why Act?

I am not an economist in training and neither do I have an understanding of finance beyond that of an average citizen. But when this crisis broke and the numbers were published, I could not believe it. We are already mired in a colossal deficit, moving politically inexorably (even if slowly) towards socially conservative views about personal responsibility versus government help and now are about to add $700 billion to additional expenditure not going towards education, healthcare, infrastructure, energy independence and a host of other critical needs. So I decided to read as much as possible about the issue in layman’s terms and put together a short explanation of the crisis and the current proposal.

Should we, the taxpayers, provide a bailout?

Free markets are inherently systems that exist within the framework of rules (equitable access to information, capital, judicial system etc) with many agents acting independently. And frequently we have been told that they have access to the best information and consequently make the best decisions thereby providing the most efficiency. Well then along came the wonderful world of wall street innovation that created CDOs and MBSs etc and overseeing tremendous growth, alot of which was based on paper (not real assets like factories, IP etc). And along the way the innovators made some grave mistakes – the  risks inherent in these innovations were either not clear or were ignored by the agents because of the enormous amounts of credit being extended to the US. It seems to me that this is a clear fault of the agents (the innovators and the players both – who happen to be the same anyways) themselves. So why should the government step in to the rescue?

I guess a simple argument that can be made is that since the global economy is now very much like a connected free market, the collapse of its largest component could wreak global havoc, upsetting the larger system. So in the larger interest it makes sense for the government to do something. What has not been addressed or even made clear in the proposal is why the proposed solution does not include international governments given that global stability is at stake. Granted most of the worthless paper stems from American debt but there is still an argument to coordinate whatever solution is proposed globally. Furthermore protection of taxpayer interests and inhibiting profiteering from government help has also not been adequately addressed. There seem to be some rumblings of the administration giving ground on compensation but somehow one just senses that this will play like the call to war in 2003.

If yes then how?

It is difficult to see how the taxpayers can break even, let aside make a profit. The securities are called toxic because fundamentally the market makers are unable to price them because there is no way to assess the risk of the loans being repaid -that depends on cashflow for the average homeowner that is based on jobs (the economy which is allegedly heading for a recession irrespective of the bailout), investments (hmmm… not doing too well since investments so tied up with the economy) and more debt (home equity and other loans or super-leveraging). At some point in the future somebody will have the ability to price these but it is unlikely that they will be worth anything close to their “hold-to-maturity” price (i.e. the price investors would have paid if they assumed the underlying loans would be paid off) UNLESS the real estate market recovers. How soon is that going to be? We went through the exuberance of the explosive digital economy followed by a credit binge especially relating to housing; the only thing that could drive the real estate market back up to the “hold-to-maturity” values would be another economic event like the digital economy – explosive growth in a short period of time; and short of something as disruptive as the internet, that is not going to happen anytime soon. So there is no way the public breaks even, let alone makes money, in any foreseeable time if the government holds assets that are priced based on home values.

So what are our other options?

What about putting that $700 billion in shoring up bad mortgages so that chances of repayment are increased thereby restoring confidence in mortgage-backed securities?  This question is on many tax payer’s mind but the truth is that the leverage runs in trillions and $700 billion wont come close to having the desired impact.

Many other proposals have been floated to mitigate the potential loss to taxpayers from taking ownership interest in the firms that will sell us the bad paper to lending money to such firms to inject the equity required to thaw credit lines to letting the free market move. You would think that a couple of million and some time may permit a rigorous analysis of the options to reveal the potential risks and upsides of all options. And that is what we, as taxpayers, should be pushing for before we make any decisions regarding handing the purse to the executive branch.

The Learning Trail

A historical preview: Diamond and Kashyap on the Recent Financial Upheavals (Freakonomics Blog, NYT)

The proposal from the administration: from NYT

U of Chicago economist Luigi Zingales argument of the principles behind the question of a bailout:
Luigi Zingales: Why Paulson is Wrong

The hard questions about implementing the proposed bailout: aligning incentives to taxpayers’ advantage:
A Hedge Fund Like No Other (WP)

An unabashed repudiation of the proposal and excellent reference:
Why You Should Hate the Treasury Bailout Proposal (NakedCapitalism.com)

A cogent critique of the proposal from a Wall Street maven himself:
The Mad as Hell Series Continues … (Executive Suite Blog, NYT)

Steven Levitt’s totally awesome, most excellent, freakin’ great question:
Bargain Prices? (Freakonomics Blog, NYT)

How do we assign a price to the troubed securities?
Plan’s Mystery: What’s All This Stuff Worth? (NYT)

A different proposal from CMU economist Allan Meltzer – make a loan to the troubled institutions:
Massive Financial Rescue Faces Skepticism in Congress (transcript from PBS NewsHour)

We should be careful in supporting the bailout proposal

I rarely read Paul Krugman’s op-eds in the NYT but after reading today’s since it is on the bailout, I am very concerned about the interest of taxpayers being lost in the anxiety to avoid the “impending meltdown”. If the bailout’s goal is to address investor confidence (to avoid precipitating market losses) by providing the massive bank account of the US govt as a source of funds that could ultimately buy distressed securities then that is simply insufficient for multiple reasons. The objectives must include

• minimizing losses to the govt, and if possible, maximizing any profits to be made
• disallow institutions rescued by the government from profiting directly from the rescue – all potential sources of capital must be exhausted before government money is used to rescue a firm – that includes excessive compensation for managers as well as outrageous bonuses. Afterall the objective of the bailout is to prevent a collapse of the market that drives the economy (credit being the major issue this tim)
• minimizing the impact on the govt’s bank account given that this account is greatly in arrears anyways (thanks to our friendly, compassionate and (socially-only) conservative president). The national debt today stands at $9 trillion and change. We are in dangerous territory and our global solvency is at the hands of nations that we are not exactly on the best of terms with. Ultimately the hand at the US wheel is what ultimately determines the long-term confidence in the US by our fellow nations and we must not forget their financial interests tied into our economy
• At the same time, as Paul K says, we must lose any pridefulness and seek global participation in righting the boat

Barack and co. must carefully scrutinize the proposal and comment on it without getting bogged down in partisanship. Not only will that inspire confidence in our capabilities but such involvement is perceived as necessary given Barack and Joe’s roles as senators. Remaining true to the objectives of saving the nation’s skin as much as possible will take away from our opponents the ability to make false claims about our campaign’s interests.

Welcome to yab

Welcome to Arguendo, yet-another-blog in this broadly and deeply discourse-ful(?) medium that I personally cannot live without. I could even claim to have contributed some ridiculously small percentage to its explosive, post-creation growth as a software engineer, system designer and product marketer at a number of telecom equipment companies. The Internet, of course, is what I am talking about, and strangely enough, it is not until I started expressing my opinions freely (mostly on other blogs) that I truly fell in love with it.

But I am not being entirely fair; the time and the moment have driven this new passion. It is October 2008 and the world is girding to face what is likely to be a punishing period of depressed or even negative economic growth. I hope not. My personal hope is that globalization and technology have created sufficient reduction in cost of economic activity and enough far-spread wealth to render a more resilient, pliable global system that can absorb a few punches. Only time will tell. But the crisis is only one of the problems. After having lived in the US for 16 years, I became a naturalized citizen in August 2008 (I was ecstatic to be able to vote in the 2008 elections – thank you DHS/USCIS!).  And my new country is facing enormous challenges after a few years of gorging on debt to feed insatiable consumerism, and 8 years of governance of mind-boggling incompetence. This is, by far, the most socially momentous period of my life. And so despite having a full day of looking for work and a beautiful 2.5 years old little girl to play with and then still be able to participate fully in the current discourse around me, I have fallen in love with the internet.

True, in the days before she tried to seduce me, but then I only saw her for the utility she offered: email, reading news, buying things etc. But now as she no longer needs to beckon me, and I find myself, finally, understanding what Gens Y and Z are all about, she looks very different. She is warm and inviting, not cold and mechanical. She is sociable and friendly, not inanimate and stoic.

Ugggh – did I really write that about the internet?!!! Oh well, I better stop coz my wife just read this and is giving me a really weird look

For my friends and all others who know me, I hope this allows us to stay connected, and continue our exciting discussions. For all of you who stumbled upon this site, I hope it was worth your while and that perhaps some of you may even join that first group.