Paulson plan vs. Dodd plan: my email to Eric Posner
I thought the original Paulson plan was terrible with regard to rule of law, and in that sense I thought the equity stake idea of Dodd was better. A modified Paulson plan might be as good, it is hard to say.
[Eric now blogs that the Dodd plan gives the Treasury more power than current versions of the Paulson plan. His post is very important.]
In reality I expect that either the Paulson or the Dodd plan would have to move quickly to incorporate some aspects of the other. We’ll likely get some version of both loan-buying and equity shares, in any case.
The key factor is what kind of institutions are set up for making the next round of decisions. That’s not getting much attention but of course there is no reason to think this is the final step or the final change in conditions.
Think of a barrel of apples, some good, some less good. To oversimplify, the Paulson plan has the government buy some of the bad apples. The Dodd plan has the government buy a 20 percent share in the barrel. In both cases government buys something.
My intuitive rule of thumb is to want the government to be doing its buying in the better organized, more liquid market. They are less likely to screw that up. That tends to favor the Dodd plan in my view.
I like one other feature of the Dodd plan. Our government loves cash revenue. Furthermore the U.S. economy is set up so the "public choice" advantage of the government owning banks for the long haul is not so obvious. We don’t have "insider-based" capital markets, for instance, so owning a bank wouldn’t give a politician so much chance to dole out loan favors. I believe our government would be in a hurry to reprivatize those banks in return for the cash. The Paulson plan, as I understand it, does not have an equally clear end game.
I may put this email of mine, or an edited version of it, on MR, check there for reader comments…
Tyler
Night thoughts: How or whether do equity holdings give the government "upside" in eventual bank recovery? Holding equity yields nothing if the banks never recover. If the banks will recover, you would think a loan from the Fed would suffice. But we’ve already tried that. So what exactly are the assumptions here? Somehow it is the Fed/Treasury actions which *cause* the banks to recover. How does that happen? They overpay for the loans at mysterious prices? That just puts the Dodd plan back into all the problems of the Paulson plan. If the government ends up overpaying for loans in the Dodd plan, and then someday gets 20 percent of that overpayment back through its equity share, is not a huge positive advertisement. (Isn’t simply "knowing when to stop the subsidies" the best way to protect the taxpayers?) And in the meantime, what kind of credit guarantees is the government offering these banks and their creditors?
Don’t forget Mark Thoma’s good analysis: "So, by having the government take a share of any upside, the result may
be less willingness of the private sector to participate in
recapitalization."
It is easy to say that the Paulson plan is worse. (Oddly I think the Paulson plan makes most sense in Paul Krugman’s multiple equilibria model for asset values.) But you shouldn’t think that the Dodd plan is very good. Most of the Dodd plan boosterism I’ve seen doesn’t look very closely at how it actually going to work. There’s lots of talk about justice and the taxpayers getting upside and then a reference to the RFC from the New Deal.
Finally, in my view the Paulson plan makes (partial) sense if a) the major banks are in much worse shape than anyone is letting on, and b) you believe in multiple equilibria confidence models for these underlying asset markets. I’m not saying those assumptions are true, but it would be nice to start by confronting the exact assumptions under which each plan might prove better than the other.