Treasury Secretary Henry Paulson announced today that there is going to be a change in the $700 billion bailout plan. In the bailout bill, it was written that the government planned on buying up the bad assets of banks as to wipe them off the books of banks and add them to the government’s books. There was an option, that Paulson is now saying they will exercise, that instead of buying up the bad debt, they will buy shares in the banks, essentially injecting the banks with lots of cash but not alleviating them of the bad debt. For further explanation on all of this, listen to this great This American Life that explains the financial crisis for those of us who aren’t in the field.
While the market is down 300 points in the first couple of hours because of this news (amongst other bad news), I think overall this is a great decision. Let’s be straight. The taxpayer is still getting screwed by the lack of regulation in certain financial markets which allowed banks the freedom to be much riskier with our money than they should have been. But at least in this proposed approach, the taxpayer is not getting the bad debt.
To paraphrase the This American Life episode I mentioned above (you really should listen to it, it’s great), the previous plan of buying up the bad debt is like having someone come in to your house and clean out all the garbage out of your basement and you have no obligation to this person. They come in, they clean, and they leave, free of charge. With this new approach of buying stock in the bank, it’s like having someone move into your basement and start paying rent. It’s your job to keep that place clean, and that tenant can put pressure on you to do what needs to get done to get the basement cleaned up. That tenant can even kick you out if you don’t clean up (analogous to shareholders voting in a new board which would fire the management team). On top of that, the government will be getting preferred stock, which means that if the bank goes under and the assets are sold, the government will get back their money before the common stockholders get any money back.
So, I think this is a good thing. But only time will tell.