Hank Paulson's Flawed Bail-Out

I was asked yesterday why, given the state of the US economy and looming prospect of credit markets becoming as liquid as the Arizona desert, the US Congress was not passing Treasury Secretary Hank Paulson's troubled asset relief program (TARP). Let me provide you with a taste of the answers to that question:

The Economist:

It could safeguard irresponsible bankers’ jobs, while doing little to stop troubled mortgage debtors from being thrown out of their homes. It seeks to invest massive power in a treasury secretary with a lifelong loyalty to Wall Street. The banks with the worst assets (ie, those which have made the worst decisions) could receive the most help. Most disturbing, the taxpayer will be funding an enormous, ill-defined programme, without any stipulation as yet that the banks who orchestrated the mess will pay a penalty.

Martin Wolf:

The fundamental problem with the Paulson scheme, as proposed, is then that it is neither a necessary nor an efficient solution. It is not necessary, because the Federal Reserve is able to manage illiquidity through its many lender-of-last resort operations. It is not efficient, because it can only deal with insolvency by buying bad assets at far above their true value, thereby guaranteeing big losses for taxpayers and providing an open-ended bail-out to the most irresponsible investors.

Luigi Zingales:

If banks and financial institutions find it difficult to recapitalize (i.e., issue new equity) it is because the private sector is uncertain about the value of the assets they have in their portfolio and does not want to overpay. Would the government be better in valuing those assets? No. In a negotiation between a government official and banker with a bonus at risk, who will have more clout in determining the price? The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich—at the taxpayers’ expense. If this subsidy is large enough, it will succeed in stopping the crisis. But again, at what price? The answer: Billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses.

24/7 Wall St:

What has become clear is that Treasury plans to purchase bad assets from banks at prices very near their original value. The risk to taxpayers under this program would be tremendous. If housing prices continue to fall, so will the value of the paper the government has purchased. Under this set of circumstances the public could be at risk for underwriting the great majority of the Treasury's purchases and never having a chance to recoup their investment.

Let me add my own two cents. Here's how Section 8 of the original proposal reads:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Excuse me? This gives an enormous amount of discretionary power to the US Treasury and its boss. Given the sums of taxpayer's money involved, oversight is absolutely necessary. Paulson responds.

On a related note, does anyone else think Henry Paulson sounds like a professional wrestler?