Nationalization? U.S. May Buy Equity Stakes in Banks instead of Bad Debt.

(9 am. – promoted by ek hornbeck)

Interesting news today.  Progressives like Paul Krugman, George Soros, and Jerome a Paris have suggested that the economic rescue/bailout would work better if we bought equity in the banks rather than just bad debts.  They see buying bad debt as inefficient and less likely to succeed.  It looks as if Treasury Secretary Hank Paulson is seriously considering partial nationalization of financial instiutions:  

An administration official, who spoke late Tuesday on condition of anonymity because no decision has been made, said the $700 billion rescue package passed by Congress last week allows the Treasury Department to inject fresh capital into financial institutions and get ownership shares in return.

Treasury Secretary Henry Paulson told reporters that Treasury was moving quickly to implement the $700 billion rescue effort and he specifically mentioned reviewing ways to bolster the capital of banks.

msnbc.com: White House considers bank ownership stakes

More, after the fold.

“We will use all the tools we’ve been given to maximum effectiveness, including strengthening the capitalization of financial institutions of every size,” Paulson said at a Wednesday news conference.

msnbc.com: White House considers bank ownership stakes

Paul Krugman has argued that we should buy equity stakes, as is being done in the United Kingdom:

Readers ask what I think should be done about the financial crisis. The answer is, what Gordon Brown in doing in Britain: a bailout, yes, but one that gives the government an ownership stake in the bailed-out institutions. That plus a serious fiscal stimulus plan that includes emergency aid to state and local government.

snip

Not so incidentally, my reading of the TARP as passed is that thanks to the equity participation provisions, it could be converted into a version of the Brown plan at the Treasury secretary’s discretion; let’s hope that he does so discrete, or something like that, as soon as possible. (Brad DeLong seems to agree; the Brown plan is a close relative of the Elmendorf plan.)

Paul Krugman: To do, not to do

Krugman commented favorably yesterday on the news that we may inject capital rather than buy bad debts:

A tentative cheer: Paulson may have been dragged kicking and screaming into doing the right thing to rescue the financial system

snip

Let’s give thanks to Chris Dodd, who insisted on the provision that makes this possible – and to Gordon Brown, for showing the way.

Paul Krugman: Doing the right thing?

This also seems more consistent with Jerome a Paris’ suggestions of nationalization.  It’s in the right direction, at least:

So far, the US government has been quite imaginative in finding new ways to hand over public money to the financial sector with nothing to show for it. I’ve been saying for a while over on European Tribune, but it’s time to say it loudly here: there is no other endgame for the financial sector than wholesale nationalisation so that (i) lending to the real economy can restart and (ii) the cleanup (of bad assets, and badder bankers) can be started.

Jerome a Paris: Nationalisation is the solution

George Soros also is in favor of putting equity in instead of buying bad debt:

The emergency legislation currently before Congress was ill-conceived – or more accurately, not conceived at all. As Congress tried to improve what Treasury originally requested, an amalgam plan has emerged that consists of Treasury’s original Troubled Asset Relief Programme (Tarp) and a quite different capital infusion programme in which the government invests and stabilises weakened banks and profits from the economy’s eventual improvement. The capital infusion approach will cost tax payers less in future years, and may even make money for them.

snip

Instead of just purchasing troubled assets the bulk of the funds ought to be used to recapitalise the banking system. Funds injected at the equity level are more high-powered than funds used at the balance sheet level by a minimal factor of twelve – effectively giving the government $8,400bn to re-ignite the flow of credit. In practice, the effect would be even greater because the injection of government funds would also attract private capital. The result would be more economic recovery and the chance for taxpayers to profit from the recovery.

George Soros: Recapitalise the banking system, 10/01/08

So partial nationalization seems to be the answer.  Government, again, is the solution, not the problem:

Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many United States banks to try to restore confidence in the financial system, according to government officials.

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks’ balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.

The Treasury plan was still preliminary and it was unclear how the process would work, but it appeared that it would be voluntary for banks.

The proposal resembles one announced on Wednesday in Britain.  Under that plan, the British government would offer banks like the Royal Bank of Scotland, Barclays and HSBC Holdings up to $87 billion to shore up their capital in exchange for preference shares. It also would provide a guarantee of about $430 billion to help banks refinance debt.

NY Times: U.S. May Take Ownership Stake in Banks

This appears to be a good move, if it is made.  So far, I’ve not read anything from Barack Obama today on this, although equity purchases are  consistent with his general principles first announced last month:

Well, I think that there’s some core principles where we’ve made some progress. I’d insisted that we make sure there’s strong oversight; I think we’ve seen some improvements there. I’ve insisted that we don’t use this as a bailout for CEOs and they’re not walking away with big bonuses. I think we’ve made progress there. I insisted that taxpayers should be able to get some upside, so if they’ve put money in, they can get money out. We’ve made progress there. And I insisted that homeowners — that they are benefiting from a plan, as well, so that we can prevent some of the foreclosures and the declining home prices that we’ve seen. I think we made progress there. There seems to be a sense that we can move forward, but there remains some resistance among certain members of Congress, particularly in the House Republican Caucus. And what I suggested to the president and to Secretary Paulson is that they need to find out more specifically from those parties what it is that they want, because there needs to be a sense of urgency here, we need to get this done.

WaPO: Obama Outlines Principles for Bailout , 9/23/08

I think this is the final verdict on a failed economic philosophy: free market fundamentalism.

Barack:

It’s an outrage because we did not get here by accident. This was not a normal part of the business cycle.  This did not happen because of a few bad apples.  

This financial crisis is a direct result of the greed and irresponsibility that has dominated Washington and Wall Street for years. It’s the result of speculators who gamed the system, regulators who looked the other way, and lobbyists who bought their way into our government.  It’s the result of an economic philosophy that says we should give more and more to those with the most and hope that prosperity trickles down to everyone else; a philosophy that views even the most common-sense regulations as unwise and unnecessary. Well, this crisis is nothing less than a final verdict on this failed philosophy – and it’s a philosophy I’m running for President to end.

Barack in Grand Rapids, MI: “The final verdict on a failed philosophy” (10/02/08)

Now that I’m a banker by virtue of paying taxes, I want a top hat!