Tuesday, September 30, 2008

Is the Paulson plan worse than doing nothing?

The Paulson plan is worse than doing nothing, yesterday's vote was a good one, but it looks like Congress, like European countries, are going to be asked again and again if they want to join the EU until they make the right decision. I heard new commentators today ascribe yesterday's decline in the Dow to the House rejecting the plan. Unfortunately, I was alive yesterday, and I know that the market opened over 200 points down, dropped another 400 points when the AIG list came out, and the final 200 when the House voted "no". Maybe the station I was tuned to (NPR) was for people who were born yesterday, and so did not know what happened.

Here are better suggestions for what to do:

1. Liquidity (short term deposits that fund long term debts)

Yves is on top of this. Essentially, extend FDIC cover to additional elements in the financial system, a move that Bernanke has already begun, but needs to complete.

2. Solvency (banks don't have enough money)

Hussman offers on approach, which is for the government to take super senior debt. This would both improve the quality of balance sheets, and expand (or maintain their size). Issue this debt at a high interest rate, and you have Bagehot's classic "lend freely, but at punitive rates" approach, which is perfectly fine here.

(Also, if FDIC insurance is extended to part of the shadow financial system, it makes total sense for them to borrow directly from the Government also, as that is essentially what FDIC insured term transformation organizations results.)

Waldman has a similar approach, but basis it on the Government taking an equity position instead (so is more Nationalization-like than Hussman).

Michael Lewis is right -- all the Paulson plan does is protect Goldman Sachs' bonus pool.


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