Luigi Zingales: Why Paulson Is Wrong

Last week, my colleagues Doug Diamond and Anil Kashyap guest-blogged on the financial crisis.

The response to their piece was amazing. At one point, their blog post was the second-most-emailed article of the day for the entire New York Times, even though it wasn’t even in the printed version of the paper — just on our blog.

I can’t remember ever seeing a blog post make the most-emailed list.

After that kind of reaction, how could I pass up the opportunity to publicize the ideas of Luigi Zingales, another one of my colleagues, whose provocative piece is entitled “Why Paulson Is Wrong.”

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  1. BT says:

    Great piece indeed. It is unfortunate that no one seems to be talking about any alternatives to the $700 billion dollar bailout, except for a catastrophic financial meltdown.

    There are three things I dislike about the current bailout plan.

    1) the precedent it is setting for other companies in the future. Every struggling big industry is going to make a case for why it “can’t fail” and seek government money. The automakers have already been doing it.

    2) the enormous cost to the future generations. This generation of taxpayers will reap the rewards of the promised stabilization of financial markets due to this bailout. Most of this generation will even get tax cuts in the coming administrations. But, the coming generations will have to pay for this bailout, $10+ trillion federal deficit and entitlements like social security, medicare and medicaid.

    3) the way the government is selling it to the people. When Chris Dodd tells the public that everyone was horrified after Paulson described the extent of the current financial crisis, I was having flashbacks of Cheney and Bush talking “mushroom clouds” just before the invasion of Iraq. If you scare people enough, they will oblige to anything, no matter how obscure and fuzzy the facts are. I hope congress does its homework this time and scrutinize the deal.

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  2. BT says:

    By the way, Paulson looks like a wholesome character, but he was a Goldman Sachs CEO and I suspect he has vested interest in helping the financial giants as much or more than the average American people. I hope Bernanke the Academic sets him straight. Most of the people in congress are probably not well versed in the workings of the financial markets to pose a serious challenge to Paulson’s proposals.

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  3. DJH says:

    For Craig (#5) and others who can’t easily view PDF files … there are some online PDF-to-HTML/text converters. (This particular document is all text, no graphics, so in this case either will do.) Search one out online.

    Here is one I found: It requires you first to download the PDF, then upload it for conversion. You will see it paginated just like the original PDF, but with formatting largely gone (only text alignment is preserved).

    There is also Zamzar, at which I’ve used, though not recently. It may function by inputting the PDF URL, bypassing the download-then-upload requirement, but at the moment I can’t tell, I can’t get to Zamzar behind my firewall at the moment.

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  4. jhattva says:

    i’m not 100% the gov will de facto pay too much for the assets, merely by virtue of being the gov. there’s a much bigger concern that 700B won’t be enough, with the focus of the current plan being mortgage related debt, and eve4n bigger concern that, if done too hastily, real transparency into relationships and dependencies among parties and actual payment histories of individual mortgages won’t come about. on this reasoning, i think there’s a big risk of paying too much.

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  5. nik / says:

    If, as Paulson suspects, the assets “RTC2″ will buy are not worthless, but just illiquid right now then the answer is to wait until the “frozen” markets thaws.

    By definition the Treasury will be unable to properly place a value on them. What are they going to do? Buy at par? Last traded value? Acquisition cost? Replacement cost? Equivalent asset value?

    If he’s right, the proper answer is to stop making firms mark these assets to a nonexistent market.

    If he’s right, the proper answer is for a savvy and intrepid(and perhaps newly unemployed?) entrepreneurial investor buy the junk up for a song, hold it for a year or two, and feed it back into the markets at proper prices. Why must it be the government who does this? Probably because they’re the only ones with no profit incentive.

    The real problem is not frozen markets or illiquid assets. Its LEVERAGE as I’ve been explaining in my blog:

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  6. PaulK says:

    There is too much assumption that all this risky debt is worthless. Part of the problem has been that the loan holders are often restrained from changing the terms to keep the people in their houses vs. foreclosing. Since foreclosing returns far fewer cents on the dollar and even less when lots of them at once (depresses all values, especially foreclosed areas), it makes sense to try to negotiate with the debtors (give them more runway, keep payments where they were for longer, allow a below mortgage sale with debt writeoff if above what a foreclosure would return, etc). The question is whether a RTC2 will do that properly (mixed results with the S&L mess). We can lose far less taxpayer dollars (regardless of the risked amount) if we are not so eager to foreclose every mortgage. This would have a value to much of the country as well, since it would stop the freefall of home values that will continue if nothing is done. I am not sure how a cram down of debt relief itself solves this, since you need to still separate the hopeless debt from the ones that can be salvaged.

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  7. Steven Schornack says:

    has anyone asked for Rep. Ron Paul’s opinion?

    He spent much of his campaign warning about the President’s Working Group on Financial Markets and the Federal Reserve who are now riding to the rescue of those markets. What does he think now?

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  8. Chris Whatley says:

    The whole idea of this bailout works for me if it comes with a sizable tax increase on the investor class and keeps taxes for the wage earners stable. Then the burden of cleaning up the explosion lies on those who reaped the benefits of the bubble in the first place.

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