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NY Times Weighs In on TARP

Interesting article from the New York Times opinion pages:

September 24, 2008

An Inadequate Case for the Bailout

Under skeptical questioning in the Senate Banking Committee on Tuesday, Treasury Secretary Henry Paulson and the Federal Reserve chairman, Ben Bernanke, gave no ground in defense of their $700 billion proposal to bail out the financial system.

They also gave little reason to believe that their proposal would protect taxpayers from huge losses. Instead, they said that any eventual loss would be less than the losses that Americans would endure if lending froze up, as it did briefly last week in the panicked aftermath of the failure of Lehman Brothers and the near-death of the American International Group.

The candor is appreciated, but it is not a good enough answer for Congress or the American people. Rather than rushing to approve the $700 billion bailout, lawmakers need to examine alternatives. They should look for one that ideally would let taxpayers share in the gains from any postbailout revival, along with the bankers and private investors who will make money if the bailout succeeds. Several ideas have been advanced that Congress should examine.

Prominent among them is a plan to make a direct investment of taxpayer dollars into financial firms, rather than buying up their bad assets. With that money, the firms could absorb the losses that they are bound to take as their investments go sour and avert failure and panic. Once the firms begin to recover, taxpayers would earn a return. Such equity investments are risky, however, and careful analysis is needed to show if they would be riskier than what the administration has proposed.

Another proposal, advanced by Senator Christopher Dodd, would buy up bad assets, as proposed by the administration, but would give the government the option to acquire stock in the firms receiving help. The danger is that private investors, fearful of seeing their ownership stakes diluted if the government becomes a shareholder, might be reluctant to invest money. That would deprive the firms of investments they need to recover.

There is time to clarify that sort of uncertainty. The financial system is vulnerable to more severe problems, but the credit squeeze has eased a bit since the administration’s bailout was proposed. That’s partly because of the expectation of a bailout, so Congress should be clear that it is working on a plan with appropriate speed.

Credit markets have also been helped by emergency measures that have shored up the system, including a $50 billion government guarantee of money market mutual funds. The bailout of Fannie Mae and Freddie Mac has helped to keep mortgage rates on the low side.

One thing is certain. If taxpayers do not share in the potential profits from a bailout, someone else will. On Tuesday, the Federal Reserve announced that it was relaxing rules that require investors who take large stakes in banks to submit to longstanding regulations on transparency and managerial control. Private equity firms have pushed for the changes because they would like to become big investors in beaten-down banks but do not want to be regulated.

Relaxing the rules invites more of the same type of opacity and risk-taking into banking that caused many of today’s financial problems. Politically, the Fed’s timing could not have been worse. Taxpayers are being asked to buy up banks’ junky assets, with little expectation of return. At the same time, private equity firms are being invited to make what are likely to be highly profitable investments in the same banks.

That’s not a plan that lawmakers and voters can support. Congress has more work to do.