Wednesday, September 24, 2008

Questions about Finance Bailout

A battle is raging in Washington over Henry Paulson’s $700bn plan to buy bad debts from banks. Popularised as ‘cash for trash’ The sum is no insignificant amount – it equates to $5,000 per person in America.

One key issue is that the US Treasury will attempt to buy these debts from banks at close to their "hold-to-maturity" value, not the market value.

What this means is that the banks will be able to sell these debts for upto twice the market value. It is hoped that this injection of cash will avoid further liquidity shortages in the market.
In return, the US treasury will have lots of mortgage debts, many of which will be defaulted on, so they will lose money.
The US taxpayer, is rightly asking whether they are getting a good deal. In particular:
  1. Will it work? The bailout doesn't address the fundamental problem of mortgage defaults. It merely tries to deal with the problem by buying bad debt.
  2. As Paul Krugman was arguing here, why is the Government not getting a stake in the company’s it is bailing out?
  3. How will the National Debt be affected by this programme of $700bn? - How much will the government be able to recoup if it spends $700bn on buying assets no one else wants?
  4. Is there not a problem of Moral Hazard? If the government keeps bailing out failing banks and reckless investors, will not the problem keep reappearing? The plan also appears to benefit the banks who took on most risk and were least reluctant to write down their losses. 'Good' banks who didn't take on bad debt, benefit little.
  5. Why are the manager’s of these failing banks still getting multi million dollar payouts? Even Lehman Brothers which went under, still managed to find $2.5bn dollars of ‘bonuses’ It does beg the question of how one can can possibly get a ‘bonus’ for going completely bankrupt.
  6. How much power will Henry Paulson have in spending this enormous sum? He seems to be taken on extraordinary power to 'stabilise financial markets' As it is says in the short but terse 3 page document. 'The Treasury secretary's decisions "May not be reviewed by any court of law or any administrative agency."
  7. Is there really no alternative as many on Wall Street seem to believe?
Of course, it is easier to criticise than it is to suggest a solution to the current financial crisis. But, nevertheless it is an extraordinary plan.

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