Two Better Bailouts

Now that John McCain has bet his shot at the White House on blocking the Hanke-Panke Plan, we might as well step back and ask if there's a better way. Answer? Yes, there is.

The current Hanke-Panke plan is a lot better than the original one, primarily because the government will get equity in the companies it saves (and will therefore benefit when the banks snooker the government into overpaying for crap assets). But it still falls short. It also won't likely be as effective as two better options.

Martin Wolf at the FT (above) has created an economist forum in which a bunch of luminaries are weighing in on how to do this right. Wolf observes that the Paulson plan is just a band-aid--treating a surface symptom instead of the root cause of the problem: our country's huge debt load.

Wolf also runs through the best solutions proposed by his panel. The goal of these proposals is the right one: recapitalize banks while having existing shareholders and bondholders take the hit. This puts the pain where it belongs--in the hands of investors who made (bad) free-market decisions. And it also puts the banks in a position to lend normally again (which the Hanke-Panke Plan won't, unless the government overpays for the trash).

Three solutions:

Force banks to write down assets to market value, stop paying dividends, and raise new equity. We've basically tried this, and except for the top firms, it hasn't worked: Because no investors are dumb enough to invest.
Force banks to write down assets and then recapitalize them by converting debt to equity. This hits both bondholders and shareholders, and it costs the taxpayer nothing. It will also likely be so unpopular with Wall Street--and, more importantly, investors--that it would be politically untenable.
Force banks to write down assets and have the government take equity stakes via preferred stock. This is the way Buffett invested in Goldman (he was comfortable with the carrying value of its assets). It's the way the Sweden did it. It's also the way any responsible private market investor would invest.

All of these solutions force the banks to deal with their own problems--instead of forcing the government to hire managers to look after the crap-asset funds. They also force those who made the dumb bets to take the hit. Unfortunately, neither yet appears to be under consideration on Capitol Hill.