.
September 25th, 2008
05:49 PM ET

Back to Basics: The treasury plan won’t work

Robert J. Shapiro
Co-founder & chairman, Sonecon, LLC

Years of reckless mismanagement by the self-styled masters of the financial universe and senior economic policy officials now leave us with no alternatives but major action – but the Administration’s proposals are neither the only alternative nor anywhere close to the best one.

The Treasury says we need its plan to address a liquidity crisis, with banks unable to secure the funds to lend to sound businesses that need to invest or just need to meet their payrolls. There is evidence that overnight lending to banks by other banks or other financial institutions is way down. But there’s no evidence of sound companies unable to get funds to meet operating requirements. Moreover, the Federal Reserve has opened its "discount" window and is prepared to lend funds to any financial institution and at below-market rates. The Bush Administration seems to be trying to steamroll Congress and the public: we have to conclude that there is no liquidity emergency that could conceivably justify the steps they propose.

The Treasury also says Americans have to be prepared to bankroll their plan, because more financial institutions are on the verge of insolvency, which would trigger serious problems for the economy. The insolvency or capital problem is self-evident, since these institutions created it. They borrowed hundreds of billions of dollars to buy mortgage-backed securities and to sell the default-protecting derivatives of those securities, all of which were patently speculative: they bought and sold them precisely because they produced very large streams of monthly income, and since financial markets trade off risk and return, their initial high returns signaled that they were very risky.

Now that the securities have fallen sharply in value, these institutions owe much more on the debt they took on to buy them than the securities themselves are worth. That means capital losses that come out of their equity and leave many of them technically insolvent or close to it. So there is a real capital or equity problem across much of our financial system. The Treasury plan won’t solve it, however, not at least on terms that any sensible legislator, regulator or taxpayer should consider.

The Treasury plan originally contemplated providing that capital by paying financial institutions more than their securities are currently worth – since it’s the current market value of those securities that threatens these institutions with insolvency. So that means ordinary taxpayers would have to overpay for the assets of institutions owned and operated by the richest people in America. That’s the Bush economic doctrine, but it’s not mine – is it yours?

At a minimum, if taxpayers are to overpay rich people for their risky investments, they should get a big equity stake in all the institutions in return. That would make it a version of a debt-equity swap – but if that’s what it is, we alternatively could use regulation to require debt-equity swaps between the institutions and those they actually owe to debt to. That would be cleaner, less intrusive over the long run, and create no taxpayer exposure.

Alternatively, Congress could mandate that these institutions halt dividend payments and raise more capital, since we’re in this fix because they haven’t been subject to capital/equity requirements. Anything can find a buyer at the right price, and as a result of these institutions’ mismanagement, they’ll have to trade more of their equity for the capital - as Goldman Sachs is doing now with Warren Buffet.

That still leaves the most serious business. Congress needs to take serious steps to address the underlying cause of the crisis by stabilizing the underlying assets: provide a new loan facility for homeowners facing foreclosure or new mechanisms to renegotiate the terms of the mortgages of people facing foreclosure. It also leaves one more thing: the stark and unhappy recognition that the Treasury, the Federal Reserve and the White House have produced an unworkable, inequitable and inefficient plan that Congress need not and should not accept.

Editor's Note: From 1997 to 2001, Dr. Shapiro was U.S. Under Secretary of Commerce for Economic Affairs and was principal economic advisor in Arkansas Gov. Bill Clinton’s 1991-1992 presidential campaign and senior economic advisor to Vice President Albert Gore and U.S. Sen. John Kerry in their presidential campaigns. Shapiro holds a Ph.D. from Harvard University, a M.Sc. from the London School of Economics and Political Science, and an A.B. from the University of Chicago.


Filed under: 360° Radar • Economy
soundoff (28 Responses)
  1. Ronald Penney

    I don't think the goverment shoud help those companys out that failed I belive giving them $700B dollars will only help the rich the people in amerca can protext against it they can find other ways slove the problem without putting it on the tax payers

    September 26, 2008 at 3:48 am |
  2. Ronald Penney

    I dont think the goverment should bail out all these companys the people of America can protest again it they can find other ways to help these companys out tax payers didn't create this problem I think giving $700B dollars will only help the very rich

    September 26, 2008 at 3:36 am |
  3. Matthew Vancouver, WA

    Charles Pyle why are you not running for office?

    September 26, 2008 at 1:32 am |
  4. karen

    McCain boils in oil, as his ghostly figure hovers the surreal corridor of Washington, bypassing cheering visitors while ignoring reporters.

    As the republicans say "no" to transparency and "no" to taxpayers as investors, McCain leaves both, Palin (on her own) and the debates altogether, in efforts to listen to others present another deal
    that involves "no regulaton", "no to tax payers as investors", and "no to transparency."

    Result: No deal, spoiled by the republicans. McCain gambles and tell republicans "I'II call the debate off if you all don't vote", yet that offer could only be made to one party.

    LOL.

    September 26, 2008 at 12:06 am |
  5. Deborah Maureen

    I have never communicated this way in the past. I do not trust our leaders to make wise decisions with $700B dollars. I would like to ask if the richest most philenthropic man in America might assist us with this mess. Someone wise, humble and who is more interested in watching pennies than dollars.
    We need to ask if Warren Buffett might consider taking this mess on, thus giving Citizens like me peace of mind that someone with morals and American values is watching out for OUR money.
    I vote we step outside the box and look to successfull business men and women to help. Let Congress and the other financial experts who have been watching this down turn for the Last "17Months" quote by Paulson on Tuesday, continue their life of minimal work and let folks who get things done take over.........

    Deborah
    Clovis, CA

    September 25, 2008 at 11:35 pm |
  6. Mark Little

    It seems like many people don't think the ballout will work. Well, when your bank account in frozen due to no monies, you will then reelize then, that you should have gone for it. It is sad to see the two parties fight over, what could help the tax payers in the future. I do not know abut all of you, but i am getting tired of living from pay check to pay check. Any thing that can get the econemy back on track, I am for it. Protect the tax payer, protect the banks that we all use and to protect my kids's future.

    September 25, 2008 at 11:29 pm |
  7. jim holmes

    You clowns at CNN don't get it, the republicans of the house are doing it for the country, need to read the emails your getting from the people. Claiming their doing it for the party, don't think so...that would be the democrats trying to pass another bill before they even looked at it. When are you going to report on what the people want, have you forgotten about that. Don't trust politicians anymore and definitely don't trust what CNN says anymore. The most trusted media in the business...yeah right...by who's standards!!!!

    Thanks for letting me share my comments

    September 25, 2008 at 11:26 pm |
  8. Annie Kate

    There obviously are other things the government could do besides this 700 billion dollar bailout – is the Congress getting any guidance on other ways to handle this mess? Will the majority of the American people being against this plan make any difference or will they pass this anyway? We have folks in Galveston needing help in their post-hurricane recovery, we have 2 wars this administration got us into to pay for, we have a big deficit already; I don't want a bigger one to pay off or to pass on to my children. They deserve better than that. But the warnings from the Bush administration on what will happen if we don't do this is chilling so I no longer know what to think?

    Annie Kate
    Birmingham AL

    September 25, 2008 at 9:37 pm |
  9. Ken - Port Orchard, WA - USA

    I'm against the proposed bailout. Banks should lend money the old fashion way. That is.... money down, and an interest rate and term pays down the loan. The buyer has a stake because walking away would loose the down. And, the bank has a stake in making good loans because they'll loose money if the buyer defaults.

    If the banks won't lend money anymore, then the Federal Government, via FEMA, should step in and lend the money.

    No Equity? No problem, ownership of property transfers to government and they can rent it back to occupant at market rate.

    Equity, but out of control interest? No problem, the Fed's can refinance the loan at 30 or 40 year term at or near Prime.

    FEMA is setup to handle this, as they've used special financing to insure homeowners that rebuild have the same payments after a disaster as they have before the disaster. Using these tools, they can address this disaster as well.

    September 25, 2008 at 9:30 pm |
  10. Mike in IL

    Am I the only one who finds it astonishing that the Democrats seem to be buying into this hasty and ill considered plan from the Bush Administration more than members of the President's own party? We do not have an astroid bearing down on us with which we must deal immediately or face total destruction. Many financially savvy professionals have strong doubts on the wisdom and efficacy of the current proposal. Congress must take the time to hear and evaluate these opposing voices before making a final decision.

    September 25, 2008 at 8:55 pm |
  11. Cheryl-Chi-Town

    September 25th, 2008 7:21 pm ET

    To Charles Pyle – I don’t think your idea is crazy at all! It makes very good sense to me. I for one would buy a condo and a new car! When Obama wins you should apply for the Sec. of the Treasury job!!!!!!
    _________________________________________________________

    I agree with both of you......and I have a masters in economics......and I would payoff my mortgage.......start up my flower shop.......I would put in my resume for one of the positions to ensure that the funds are distributed appropriately......The people will than be represented by the people and for the people.

    September 25, 2008 at 8:50 pm |
  12. Jan from Wood Dale, IL

    Today, dozens of the country's top economists sent a letter to Pelosi and Reid expressing to Congress their great concerns for the plan proposed by Treasury Secretary Paulson. They see 3 fatal pitfalls in the currently proposed plan:

    1. Its fairness. The plan is a subsidy to investors at taxpayers' expense. Investors who took risks to earn profits must also bear the losses. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

    2. Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwords.

    3. Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

    They are asking Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action that will wisely determine the future of the financial industry and U.S. economy for years to come.

    September 25, 2008 at 8:36 pm |
  13. Gary Russell

    There is a storm on the horizion. If the goverment goes ahead with this bail out for the high rollers on wall street. Doin't be surprised to see a lot of new faces in Washington. They will not get my vote!

    September 25, 2008 at 8:33 pm |
  14. Michele

    Joyce makes a good point. Our country is a perfect example of what my dad used to say, "Big hat, no cattle" As a business major, I'm afraid this is a house of cards.

    September 25, 2008 at 8:01 pm |
  15. Andy Ca.

    OOOOOPS! Hey Charles Pyle – do the math again! It comes out to $425.00 per person. I guess I won't be getting that condo and car after all.

    September 25, 2008 at 7:54 pm |
  16. Joyce

    Doesn't anyone realize that any bailout with "taxpayer dollars" will be borrowed from the Chinese, who already own billions of dollars worth of US Treasury Bills? I for one do not want to give the Chinese any more power than they already have over us for fronting our cost of the Iraq war! This is something no one is talking about - when they say the taxpayers will front the bailout - it is really the Chinese! How stupid does our government think we are? I guess that will be shown when we see the votes for McCain who stood by for 36 years watching us get screwed by our government and the Bush Administration and did nothing to stop it! We cannot survive another 4 years of Bush strategy! Please wake up Americans!

    September 25, 2008 at 7:38 pm |
  17. Andy Ca.

    To Charles Pyle – I don't think your idea is crazy at all! It makes very good sense to me. I for one would buy a condo and a new car! When Obama wins you should apply for the Sec. of the Treasury job!!!!!!

    September 25, 2008 at 7:21 pm |
  18. auldgranny

    Give every American household 1 million dollars, trickle-up economics works.....

    September 25, 2008 at 7:15 pm |
  19. peter weelmaa

    Our government, A group of two face rats, that have wrecked the dollar, that the Americans people count on. They've ruined this vessel of economic safety, that we count on. How can we believe a word that they say, when they've told the people so many lies.

    The saying, fool me once shame on you, fool me twice shame on me. My opinion, is to clean this whole government out, from top to bottom. Sure the possibility of some bad is there but what do we have now. Liars and cheats that have shown us, that they sell out the American people. We need dramatic change, let's compromise and get rid of the power players and keep the senate Democratic. But, these power brokers, have got to go on both sides. Change can only happen when we get our government serving the people, like our fore fathers intended them to do.

    September 25, 2008 at 7:04 pm |
  20. peter weelmaa

    Our government, A group of two face rats, that have wrecked the dollar, that the Americans people count on. They've ruined this vessel of economic safety, that we the people count on. How can we believe a word that they say, when they've told the people so many lies.

    The saying, fool me once shame on you, fool me twice shame on me. My opinion, is to clean this whole government out, from top to bottom. Sure the possibility of some bad is there but what do we have now. Liars and cheats that have shown us, that they sell out the American people. We need dramatic change, let's compromise and get rid of the power players and keep the senate Democratic. But, these power brokers, have got to go on both sides. Change can only happen when we get our government serving the people, like our fore fathers intended them to do.

    September 25, 2008 at 7:02 pm |
  21. Shawn J. Mushtaq

    This $700-billion bailout needs principles to conform to the average American worker. Because people are loosing their jobs, this bailout plan might not hold in our economy. I wish I could explain to the president/presidential nominees of several options they need to grasp from my prospective on returning the workforce back to the American people in an agreement for corporation/company bailout! It is critical that these politicians have to make an agreement to ship back employment opportunities to the average American worker if the CEO’s want to save their corporation(s)/company(s)!

    Sincerely,
    Shawn J. Mushtaq
    B.A. Political Science ‘10
    GCSU- 2008 Senatorial Nominee – 2008 “Make It Happen” campaign

    September 25, 2008 at 6:58 pm |
  22. Mark Dragovich

    I'm a real estate agent and manage foreclosures for banks. This point
    about the taxpayers reaping the benefits of acquiring these defaulted
    assets, are misguided. I have worked in the sub prime banking market for over 15 years, at a
    bank and as a real estate agent, both sides of the fence, and when
    selling these assets there are rarely monetary gains to the seller. Who
    is going to sell these assets? It takes banks years and millions of dollars to
    develop a proper liquidation system. Often times auction firms are
    employed to move large quantities of homes in a short period of time,
    this means discounting the price just to get rid of it, and in 99.9% of
    cases a loss is taken. How do you think we got to this point? With an
    inadequate management system in place these assets will sit vacant
    and will be subject to vandalism and weather, two things that can't be
    controlled. These mortgage backed assets (houses) will be sold at
    below market value in almost all cases below what we, the tax payers
    paid for the asset, and if we, the tax payers, think that this business
    practice will make us money, we are fools.

    September 25, 2008 at 6:37 pm |
  23. Chafia

    Like every body else I’m very Concerned about the economy,
    I do not know what the Congress is trying to do, but in my opinion there is s very simple solution that I like you to pass to the lawmakers if you can:
    If one of as has money problems we go to the bank for loans. We pay back with interest.
    No the banks has money problems, so in this case the Government gives loan to the banks that needs it not to the companies and the bank should give loans to the companies that are really interested in surviving and this will allow the banks to pay back the government with interest lower than the one they charge the companies, small amount at the time.
    This I think will force the banks and the companies for reform and stop paying millions to CEOS

    I also think the Media should play a roll in solving this crisis, now a days with the Internet its easy to communicating with people world wide, so why don’t you let people write you solutions. You will be surprised how may smart people out there that can help with their Ideas
    Thank You
    Chafia

    September 25, 2008 at 6:34 pm |
  24. Charles Pyle

    I'm against the $85 BILLION bailout of AIG. Instead, I'm in favor of giving $85,000,000,000 to America in a "We Deserve It" dividend. To make the math simple, let's assume there are 200,000,000 bona fide US. citizens, aged 18+. Our population is about 301 million counting every man, woman and child. So, 200,000,000 might be a fair stab at adults 18 and up, (excluding those in prison). Now, divide 200 million, 18+ adults into $85 billion – that equals $425,000.00 each! Yes, my plan is to give that $425,000 to every adult as a "We Deserve It" dividend. Of course, it would NOT be tax free. So, let's assume a tax rate of 30%. Everyone would pay $127,500.00 in taxes. That sends $25.5 billion right back to Uncle Sam! It also means that every adult 18+ has $297,500.00 in their pocket. A husband and wife would have $595,000.00! What would you do with $297,500.00 to $595,000.00? * Pay off your mortgage – housing crisis solved. * Repay college loans – what a great boost to new grads. * Put away money for college – it'll really be there. * Save in a bank – create money to loan to entrepreneurs. * Buy a new car – create jobs . * Invest in the market – capital drives growth. * Pay for your parent's medical insurance – health care improves. Enable deadbeat parents to come clean – or else. Remember this is for every adult U.S. citizen, 18 and older (including the folks who lost their jobs at Lehmann Brothers and every other company that is cutting back) and of course, for those serving in our Armed Forces. If we're going to re-distribute wealth let's really do it! Instead of trickling out a puny $1,000.00 "economic incentive". If we're going to do an $85 billion bailout, let's bail out every adult U.S. citizen! As for AIG – liquidate it. * Sell off its parts. * Let American General go back to being American General. * Sell off the real estate. * Let the private sector bargain hunters cut it up and clean it up. We deserve the money and AIG doesn't. Sure it's a crazy idea, but can you imagine the coast-to-coast block party?! How do you spell Economic Boom? W-e D-e-s-e-r-v-e I-t d-i-v-i-d-e-n-d! I trust my fellow adult Americans to know how to use the $85 Billion "We Deserve It" dividend more than do the 'geniuses' at AIG or in Washington, D.C.. And remember, my plan only really costs $59.5 billion because $25.5 billion is returned instantly in taxes to Uncle Sam. Good idea? I think so. Now if you apply the same to the 700 BILLION buy out plan, wow! End of the economic problems in every home owener, buisness big or large, end of proverty, end of health care problems, and the end of most every other problems 90% the American people are facing in todays world.

    September 25, 2008 at 6:33 pm |
  25. Rob

    Is someone communicating these ideas to congress, and not just writing about them on the web? If not, please do so NOW!

    September 25, 2008 at 6:28 pm |
  26. CP Slicker

    Maybe we should try TRICKLE UP economics????
    Trickle down is not working...Spend the money on the PEOPLE...We will spend money on home improvements, loans, buying new products, making payments. This money will trickle up to the big companies. THE PEOPLE WILL BE HAPPY AND OUT OF DEBT.
    We can use some money to improve our roads, bridges, schools, parks, thus, creating jobs. We can not survive with jobs leaving the country at such a fast rate.
    The most important thing is to FIRE each and everyone of the greedy thieving Corporate Officers.

    September 25, 2008 at 6:27 pm |
  27. Michele Zumwalt

    The nine most terrifying words in the English language are, 'I'm from the government and I'm here to help.'
    Ronald Reagan

    September 25, 2008 at 6:25 pm |
  28. Sharon Overley

    Because his arthritis is so bad, my 60 year old husband takes six pain pills a day so he has the pleasure of climbing into attics, up and down ladders and squatting for hours in the heat and cold to barely keep our heads above water. He knows he cannot quit working, therefore, he never complains. I watch him grit his teeth just to sit down in his chair at night, too tired to eat most days, and you ask us to give more? Our representatives and their buddies live in La-La Land!

    The fact they have allowed our country to reach the precipice of financial meltdown is testament to their commitment to the rich and powerful and the do-nothing, self-serving attitude that has become commonplace in our country’s governments. To allow them, the bedfellows in this nightmare, more money to patch-up another greed-generated corporate, Wall Street problem is inconceivable. “Capping their salary…” That’s more of the same! They have just squeezed another money-pit dry and are looking for their next conquest with Congress’s help!

    My suggestion is to make everyone involved in creating this mess, Senators, Representatives and lobbyists included, to liquefy assets, whether it’s offshore accounts, Swiss numbered banks accounts, multiple homes (McCain) around the world, stock options, savings, etc., to pay for this mess. Whatever shortfall they still need, tap into the millions of millionaires and billionaires in the country for the balance. If every one of them just donated $100,000 to the pot, Congress would have more than enough. My friends and I are all tapped out. Our 401k’s, savings, etc. are already gone. We are already in a depression. I’d rather take my chances with the meltdown.

    September 25, 2008 at 6:00 pm |