I'm feeling unhelpful, because I've complained bitterly about the Paulson Plan and been cool towards the Dodd Plan, but my own suggestion was an obvious nonstarter. We mustn't offend the delicate sensibilities of creditors, or God forbid give them a haircut. So, really, what would I suggest?
I wonder, what was wrong with the AIG / GSE model? The government has already published a pretty exhaustive list that includes the systemically important and potentially vulnerable financials along with many other firms — the "no short" list. Suppose Congress passed a law providing for fast-track reorganizations modeled on AIG. Firms on the "no short" list would be required to consult with the Treasury prior to any bankruptcy filing, and listed firms would be presumptively eligible for an AIG-style bailout. During an insolvency, the government would take warrants on 79.9% of firm stock, in exchange for a loan or preferred equity infusion sufficient to cover obligations to creditors during an orderly wind-down or reorganization. Existing management would be replaced, and government auditors would examine firm accounts to ensure that there were no "fraudulent transfers" precipitating the bail-out. Any such transfers discovered between the listing of the firm and the reorganization would be criminalized, and prosecuted vigorously. Listed firms would have a fiduciary obligation to the government as well as shareholders, such that "gambling for redemption" near insolvency would also place firm managers in criminal jeopardy.
Temporary routinization of AIG-style bailouts would put skittish creditors at ease. Although Treasury would retain the right to opt out and permit a traditional bankruptcy, the default course of action would make creditors whole. Equityholders and management of listed firms would have a strong incentive not to take the government up on the bail-out if they have any prudent means of avoiding it, since they would lose nearly everything. Taxpayers would own the firms they rescue, and would enjoy the upside of successful reorganizations or divestitures.
Like all the bailouts, this scheme rewards the moral hazard of creditors, and I hate that. There is the danger that it would not be temporary, and that promised regulation to restrain leverage would never materialize, leaving only a subsidy to future blackmailers. Still, I think it's a lot better than silently and opaquely recapitalizing firms without replacing management or forcing at least shareholders to take a hit.
AIG-style bailouts would stigmatize firms that take advantage of them, as any form of bankruptcy does, but many firms do successfully reorganize from bankruptcy, and the stigma would be well deserved. The process would be transparent.
If Chrysler had collapsed, [Ritholtz] argues, vulture investors might have swooped in and reconstituted the company as a smaller automaker less tied to the failed strategies of Detroit's Big Three and their unions. “If Chrysler goes belly up,” he says, “it also might have forced some deep introspection at Ford and G.M. and might have changed their attitude toward fuel efficiency and manufacturing quality.”
If we do end up with a gentle, behind-closed-door bailout of financials, I'm afraid that in twenty years, we may view lower Manhattan the same way we see Detroit today. What Wall Street needs is what it has delivered to so many other industries, a dose of Schumpterian creative destruction, to make room so that better things may rise up from the ashes.
p.s. I do hope to rise to Dani Rodrik's challenge and be concrete about what "better things" might look like, but, alas, my bitter obsession with the looming bail-out takes priority.
p.p.s. Since the government has stormed the commanding heights anyway, does anybody else think it'd be a good idea for some bureaucrat to declare a ban on dividend payments for all firms on the "no short" list? This would have the effect of helping troubled firms preserve cash, while softening the hit individual firms would take if they announce dividends cuts. Firms on the list would have no choice, and only a small minority of "no short" firms are in crisis, so there should be no stigma.
|Steve Randy Waldman — Thursday September 25, 2008 at 1:29am||permalink|