Mr Paulson’s proposal to purchase distressed mortgage-related securities poses a classic problem of asymmetric information. The securities are hard to value but the sellers know more about them than the buyer: in any auction process the Treasury would end up with the dregs. The proposal is also rife with latent conflict of interest issues. Unless the Treasury overpays for the securities, the scheme would not bring relief. But if the scheme is used to bail out insolvent banks, what will the taxpayers get in return?
Barack Obama has outlined four conditions that ought to be imposed: an upside for the taxpayers as well as a downside; a bipartisan board to oversee the process; help for the homeowners as well as the holders of the mortgages; and some limits on the compensation of those who benefit from taxpayers’ money. These are the right principles. They could be applied more effectively by capitalising the institutions that are burdened by distressed securities directly rather than by relieving them of the distressed securities.
The injection of government funds would be much less problematic if it were applied to the equity rather than the balance sheet. $700bn in preferred stock with warrants may be sufficient to make up the hole created by the bursting of the housing bubble. By contrast, the addition of $700bn on the demand side of an $11,000bn market may not be sufficient to arrest the decline of housing prices.
Something also needs to be done on the supply side. To prevent housing prices from overshooting on the downside, the number of foreclosures has to be kept to a minimum. The terms of mortgages need to be adjusted to the homeowners’ ability to pay.
I will take comments on this submitted by email only to at KSHarmon[at]mindspring[dot]com.
Your [now deleted] ad hominem attack avoids the question at hand: should the Administration be handed a blank check?
Soros is correct on the financial ‘crisis’….we should not hand ANYONE (much less the former head of Goldman Sachs, who reaped the huge financial rewards of the past decades’ Ponzi schemes with the unregulated ‘derivatives’ market) a blank check….especially when he’ll be out the door in a few months, and probably headed right back to his Wall Street cronies!
It was a real disappointment to get to the blog this morning and see the awful comments on this thread, almost all of which went after the author personally instead of interacting with his argument.
Since this was the case, the thread is now comment by email only.
Thanks.