Balkinization  

Monday, September 22, 2008

Different remedies, same constitutional problem

JB

Today Paul Krugman points out, as several others have recently, that instead of purchasing bad debt and selling it off, the government might be better advised to purchase shares in failing financial institutions. This would promote liquidity by helping to recapitalize these institutions, and it would give the government (and the taxpayers) a stake in their recovery. Secretary Paulson's current plan, by contrast, would seem to require purchasing bad debt at a premium price, which would make Wall Street institutions better off without demanding very much from them in terms of reform. It would also place all the risk on taxpayers.

Whether we solve the crisis by purchasing debt or purchasing equity, however, the constitutional problem raised in my earlier post remains the same. (This is a point about proper constitutional design, and not about whether any court would find the plan unconstitutional.).

We must not try to solve our current difficulties by giving the Secretary of the Treasury, (aka the Executive Branch), carte blanche to purchase whatever he likes whenever he likes, to deputize private parties to act as agents of the government, and to buy and sell shares and proceeds on whatever terms he thinks best, without any form of regulation or oversight, whether legislative or judicial. The dangers of malfeasance, corruption, self-dealing and conflicts of interest are present even if we are talking about purchasing equity rather than debt. They just arise in slightly different ways.

Any solution to the fiscal crisis that allows the President to take over large portions of our financial markets has to have regulatory and oversight mechanisms, not only for the banks and financial institutions, but also for the President himself. The powers that Presidents gain in emergencies they do not easily surrender, and almost never do so voluntarily. Moreover, Presidents often think that by helping their friends they are helping the country. This is true whether the President is a Democrat or a Republican, liberal or conservative. The next President will almost certainly assume any new powers we give to this one.

What we are talking about in this crisis is not simply providing additional liquidity to financial markets. What we are talking about is fundamentally altering the executive's role in managing a key sector of the economy. We place these powers not in the hands of an independent agency like the federal reserve board relatively isolated from day to day political pressures, but in the hands of political appointees who serve at the pleasure of the President and who will inevitably be influenced by political considerations both high and low. We are contemplating something quite big and potentially quite lasting here. If we do this, we had better do it right at the outset.

Comments:

If Paulson's proposal is enacted, is it anticipated that "free markets" would implement it? If so, wouldn't this be a bailout of "free markets," i.e., the government stepping in to wipe clean the slate that "free markets" dirtied so that "free markets" can again control?
 

I've said on other threads that the punditocracy does not yet apparently comprehend that this is not just a US domestic crisis. Other regulators are involved and so are banks which are not regulated in the USA.

Already a row is blowing up between the UK administrators of Lehman Brothers and the US over the repatriation of US$4billion of Lehman EU operations money sent overnight to NY but not returned with the UK Administration seeking the return of the money in the US insolvency.

Up to now, there has been a prnciple of "home state regulation". Within Europe a bank is regulated in its 'home state' - i.e. French banks in France, UK banks in England and US banks have been admitted to the European market on the basis that their primary regulation was in the USA by US regulators.

I think that when the dust settles, it will be found that the Goldman Sachs and Morgan Stanley moves to submit themselves to US banking as opposed to SEC regulation were also a condition imposed by the European regulators as the price for their continued operations in European markets.

I do not think EU regulators are terribly interested in seeing the US government take equity stakes in EU banks - I think they are interested in the US taking out of the market the toxic paper which through regulatory negligence they allowed to be marketed throughout the world system.

And I think that if push were to come to shove that is going to be the price of continued US access to the EU credit markets where US institutions are net borrowers.

Since the US is in dire need of a continued inflow of credit funds from overseas, I do not see how the solution for which Mr Krugman and others are advocating is in any way workable. Not unless the US banking system can suddenly generate sufficent new deposits from US savers to finance all the lending needed to keep the US economy going during the present recession.

Ask the US super-rich if they are going to be happy with the rate of return offered on US basic savings accounts - the McCain family might have an answer to that question.
 

This administration knows exactly what it is doing. It does not have the taxpaying proletariat's interests in mind.
 

Professor Balkin:

Today Paul Krugman points out, as several others have recently, that instead of purchasing bad debt and selling it off, the government might be better advised to purchase shares in failing financial institutions. This would promote liquidity by helping to recapitalize these institutions, and it would give the government (and the taxpayers) a stake in their recovery. Secretary Paulson's current plan, by contrast, would seem to require purchasing bad debt at a premium price, which would make Wall Street institutions better off without demanding very much from them in terms of reform. It would also place all the risk on taxpayers.

1) To start, we will be purchasing these assets at a severe discount (65 cents on the dollar has been reported on NPR), not a premium.

2) If we buy a stake in the banks, we assume part of the 35% loss on the assets. However, if we purchase the assets at a discount, the bank and its shareholders properly eat the 35% loss on the assets and we could actually make a profit on this real estate if the government is patient enough to wait a year or two for the market to rebound. In the worst case, we have avoided assuming much of the loss. This is why lenders do not buy a stake in the borrowing company, but rather demand collateral from the assets.

3) Nationalizing an industry NEVER improves performance. Our banks made mistakes for which they should pay, but they are not even close to the utter money sinks that are Fannie and Freddie.

4) At most, the government should impose the minimum amount of regulations necessary to outlaw any fraudulent instruments and to set a reasonable basement for the credit worthiness of borrowers.
 

I repeat: the Bush administration is one of the lamest ducks in our history, and they are also a gang of murderous criminals who lie about everything. There is no reason to trust, believe, or cooperate with them, nor do anything drastic before the 111th Congress convenes.
 

Charles:

Do you know the definition of a "lame duck?" For a lame duck, it is strange how Mr. Bush is still running the show in DC. This crisis management while the Dems in Congress stood by and admitted than they didn't know what to do is just the latest example.

You folks have no idea what a tremendous job Treasury and the Fed have done here. When a very similar property bubble burst occurred in Japan, it crippled their economy for over a decade because they had no idea how to deal with the problem. It appears that the US economy may come through this largely unscathed as was the case after the S&L crisis.
 

I do not think EU regulators are terribly interested in seeing the US government take equity stakes in EU banks - I think they are interested in the US taking out of the market the toxic paper which through regulatory negligence they allowed to be marketed throughout the world system.

In fairness, isn't some of the regulatory negligence attributable to European (and other) regulators world wide? Admittedly, this problem began in the US and we are principally responsible, but the very fact that the paper was traded world-wide suggests a failure of regulation on a global scale.
 

its not clear that this paper is even worth 65% of its face value. the problem is no one knows if the paper is worth anything at all - or if it ever will be. The paper means nothing in terms of value unless there are buyers for it. That is a huge assumption.

The reason why an equity purchase is more advisable is it aligns the interests of the banks and the taxpayers. the banks can eat the losses, and hopefully become more prudent in their investments.

The woes of Fannie Mae and Freddy Mac were not created because of government involvement, but because of private actors abusing the implied guarantees from the fed. nothing in the mis-management of those companies had anything to do with government direction. those were players who went beyond the mandate that had, and ventured into markets they shouldn't have.

Constitutionally, the point is very important, and is fundamentally about maintaining, (or imho, recreating) each department's prerogatives to protect their proper realm. But is this really a problem that can be fixed through design? Congress could, at any time, challenge the administration. While we could argue that some commentators will assume executive power is properly applied, no matter the situation, there is nothing inherently stopping Congress from asserting itself as the first among equals that it is. instead, it seems to be the quality (or lack thereof) of its membership that causes the problem. What design components will correct the spineless, feckless, craven and callow dems? what design will prevent the republicans from marching in lock-step behind their leader, and instead seek legislation for the public good?

In summary, what proposals do you have for constitutional design solutions to bad representatives, controlled by faction?
 

What I find intriguing about the federal government buying bad mortgage debt, is the question of what happens to the payments still being made on the debt purchased. Do those payments go into federal coffers? Does the federal government foreclose on borrowers who stop making payments? Do the foreclosed properties become federal property? Will the fed pay property taxes? Will municipalities be able to levy fines against the fed if the fed fails to maintain its properties per local code?

I have to wonder about the situation that can arise with the fed moving to become a major holder, if not the major holder of residential property.

On the upside, if the fed wants to be able to change the terms of those bad mortgages, it would seem ostensibly they wouldn't have to coerce private lenders into doing so.
 

bitswapper: I have to wonder about the situation that can arise with the fed moving to become a major holder, if not the major holder of residential property.

It's not clear to me how much of the debt the government proposes to buy is secured by residential property -- or by anything else, for that matter. I need to find someone who can tell me what percentage of the "mortgage-related debt" that the Treasury would purchase is (1) defaulted mortgages and collateralized mortgage obligations (CMO's) burdened by defaults, what percentage is (2) credit default swaps (CDS's) purchased by holders of mortgages, and what percentage is (3) CDS's purchased by speculators, i.e. people who do not hold the underlying mortgages and CMO's.
 

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