An Alternative Approach to the Bailout: Enable Fast Recapitalization

Lynne Kiesling

Fast recapitalization, removing the signaling penalty by having the government require banks to stop giving dividends in the short run … those are the kind of policies that economists have been discussing, fleshing out, and encouraging over the past two weeks. Of course, the challenge to those proposals is that the parties who end up paying are precisely those firms and industries that are politically powerful.

The public choice economics lesson in this? Mancur Olson was right about concentrated benefits and diffuse costs:

… large groups will face relatively high costs when attempting to organize for collective action while small groups will face relatively low costs. Furthermore, individuals in large groups will gain relatively less per capita of successful collective action; individuals in small groups will gain relatively more per capita through successful collective action. Hence, in the absence of collective incentives, the incentive for group action diminishes as group size increases, so that large groups are less able to act in their common interest than small ones.

The book concludes that, not only will collective action by large groups be difficult to achieve even when they have interests in common, but situations could also occur where the minority (bound together by concentrated selective incentives) can dominate the majority.

Alex Tabarrok has done us all a great service with his post aggregating and summarizing the proposals from a variety of economists:

The consensus among economists is now clear, the best strategy for dealing with the financial crisis is to recapitalize the banks that need recapitalization. Paul Krugman, John Cochrane, Luigi Zingales, Douglas Diamond, Raghuram Rajan and many others all advocate some form of recapitalization as do Tyler Cowen and myself. Krugman would prefer a recapitalization in the form of nationalization. In my view, there is still plenty of private money to buy banks at the right price and my preferred model is the FDIC leading a speed bankruptcy procedure, as was done brilliantly with Washington Mutual (Cochrane also supports this model.) In the middle are most of the others who have a variety of good ideas to require the banks to raise equity in various ways.

Sadly, I fear it’s too little too late. It’s not too little because of the lack of substance in the recommendations; I have read all of the above and can support the core ideas they have in common. But it’s too little because it’s up against all of the concentrated financial industry and business lobbying that I mentioned in last night’s post.

It’s also worth pointing out that Wells Fargo is buying Wachovia in its entirety, which means that this salutory recapitalization is already happening. Policies that facilitate this kind of activity that is already occurring are much, much better than the proposed bailout.

Also, both Glenn Reynolds at Instapundit and Rich Sweeney at Common Tragedies have noted the absurdity of having alternative energy and carbon tax provisions in a credit market bailout bill.

Oh, and I’m still angry and disgusted.

4 thoughts on “An Alternative Approach to the Bailout: Enable Fast Recapitalization

  1. The financiers are snookering us again. We, the taxpayers, will never see that money once Congress caves in to special interests, (as usual). If we try to get it back by taxing these businesses, then they will take the good parts of their portfolios and flee to other countries. Suckers!

    If we use that money to enhance social security, then all of the retirees that lost their retirement funds in the stock market will at least be guaranteed a reasonably comfortable retirement. (The only ones who will still be unhappy are the ones trying to retire to their mansions.)

    Finally! Congress has found the money to make social security work.

    Let Congress know that if they get fooled by this bailout, then the only thing for voters to do is punish congress the way it was punished for the gulf war.

    Bryant Arms

  2. Surely the best way to deal with this is to let those businesses that overleveraged suffer the consequences, and to allow prices to fall to their proper level.

    This does not cheat the owner of a house for surely if he owed no money on the house then he still has his house.

    This does not cheat the person who borrowed against the house he already owned because surely he still has his house and got to use the money he borrowed.

    This does not cheat the person who borrowed to buy a house at the peak of the market, who can afford the payments. It was his investment decision and he should pay the consequences for any loses.

    This does not cheat the person who borrowed at the peak to buy a house and could not afford the payments, he should have been more responsible. He didn’t have a house before and he doesn’t have one after.

    This does not cheat the person who borrowed at the peak to buy a house and who because of declining wage rates due to the deflation now can no longer afford the payments. This too is an investment decision that he ran the risk of happening all along. There is always the possibility one may lose ones job for a lower paying one.

    This does not cheat the bank that lent the money on the house, or the bank that invested in bundled securities. Banks should be considered the most competent of players and the last ones to get a bailout when they make a bad decision.

    Any bailout will cheat people, it will cheat taxpayers, it will cheat those who properly predicted the housing bubble and invested contrary.

    I predicted this economic mess would unfold this way and I bet that the response would be to inflate the currency. I stand to win if the government does not listen to what I’ve just said. My losses on my home will be on the order of $200,000 to $300,000 if the government allows this bubble to deflate.

    Furthermore, I have invested in precious metals that have tripled in pprice due to the monetary bubble. Again I stand to loose lots of money if the government obeys proper economic law.

    Unfortunately, I think that result to be highly unlikely. In a rational world of free markets I would have really liked to bet otherwise. Unfortunately we cannot live in the world of our choosing. I must think of myself and my family and I am betting with the herd.

  3. Economists and the Bailout Revisited:

    Co-blogger Eric Posner notes that most economists believe that the bailout passed today is not a good idea, but argues that it is still justi…

  4. Economists and the Bailout Revisited:

    Co-blogger Eric Posner notes that most economists believe that the bailout passed today is not a good idea, but argues that it is still justi…

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