The entire piece should be read. His alternative to Paulson’s bailout is debt forgiveness through tweaked bankruptcy law. Specifically, “an amendment would make available to companies a prepackaged bankruptcy in which debt forgiveness could be done overnight. To induce financial institutions to undergo this restructuring, the Fed could condition its provision of liquidity to the completion of the procedure. I doubt that any financial institution would choose to opt out.”
Interesting.
Earlier in the piece, Zingales correctly summed up the problems with the Paulson agenda:
First is the cost to taxpayers. We don't know what the price tag is, but it could easily run into the 13-digit range. Second is the risk that the government could essentially end up owning the financial sector. Third is the huge subsidy this will provide to the debt holders. You see, since the value of equity provides a form of guarantee that the debt will be repaid, the more equity that's poured in, the more valuable the debt will become. And so, debt trading at 50 cents on the dollar could easily jump to 80 or 90 cents on the dollar. That increase in value is a net transfer of wealth - straight from taxpayers' pockets into the bankbooks of the debt holders. Paulson is suggesting a variation on this theme: buying up the bad assets of the troubled institutions. This is an indirect way to provide an equity infusion - but it, too, has a fundamental flaw. Namely, it works only if the government overpays for the toxic assets. The cost to the taxpayers will be even larger than in the previous case, without the benefit of any of the upside in case the market recovers.
Why not bankruptcy over bailout? Zingales asserts that Wall Street prefers a taxpayer bailout to being “forced to pay for its own mistakes.” And he's right.
Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council
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