What Bernanke, the Fed, and the Treasury Should Do

They should listen to “real” people instead of Congress. (Did you ever wonder if one has to be one can short of a six-pack to be a politician?)

See Dean’s Forum Wide-Ranging Discussion of Financial Crisis, Taxpayer-Funded Rescue Bill – full video or clip from the University of Texas McCombs School of Business blog – McCombs Today.

Then scroll down the comments (7th one) and read what Economics Professor Brandl has to say:  

Bernanke, the Fed and the Treasury have to make it clear where the “bailouts” are going to stop.  This will help to put a floor under the financial markets and decrease uncertainty.  They need to be more transparent and clear as to who will be and who won’t be saved.  The piecemeal approach they are following is not working.  Also this “drawing of the line in the sand” should be coordinated with policymakers in other OECD countries as well as Russia and India.  Notice, I deliberately left out China.

Structuring the bailout as buying of assets was a mistake.  Instead the Treasury should have injected capital into the banks and taken an equity stake in return.  This would have punished stockholders in these firms by diluting their ownership stake.  This would also give the Treasury power in setting executive compensation at these firms.  Is this socialism?  No, it is a step in internalizing the fiduciary responsibility these firms have to the broader financial markets and economy.  The current “leaders” of these firms have demonstrated they are incapable of performing this role satisfactory.

The Treasury should be buying the mortgages of people and families who were truly victims and there are many.  But, the Treasury should not be using taxpayer money to bailout real estate speculators or those who should have know better as to what they were getting themselves into with these sub-prime and Alt-A mortgages.  But how does the Treasury make this distinction?  They need to set up some system, with oversight, to do this.  A mortgage-based RTC is what is needed.

Oh, yeah… remember the Resolution Trust Corporation? Why not use a model that worked fairly well?

Since the bailout has been structured as it is, Paulson should have named someone to run it, and the buying of bank assets, who has a great deal of experience and credibility.  Potential names include:

Bill Gross, Chief Investment Office at Pimco, who the Washington Post described as “the nation’s best-known bond-fund manager.”

Paul Volcker, former Chairman of the Board of Governors

Don Powell, former head of the FDIC and famed Texas banker

Glenn Hubbard, Dean of the Columbia Business School, former head of the Council of Economic Advisors

So who did Paulson pick?  A 35 year old former Goldman Sachs underling named Neel Kashkari. Needless to say, this was not a great confidence building move.

Once the current liquidity crisis ends the Fed, Treasury and the new President are going to have to put in place measures to ensure this doesn’t happen again.  Among the things they need to consider should be:

  • Overhaul of the financial regulatory system.  Paulson’s idea on this in the spring was a first (but bad) attempt to do this.
  • Ensure high quality regulators.  This means paying a decent salary to attract well educated and trained “bank examiners.”  The Fed, FDIC and other regulators need to pay salaries of say $125,000 a year to attract the best and the brightest if we expect them to correctly “oversee” sophisticated financial firms.
  • Establish the “rules of the game” for future bailouts.  If any entity is going to be labeled as “too big to fail” who is going to pay “the price” for the bailout?  What will that price be?  My suggestion is to do the following:  make it clear to the board of directors as well as the executives of financial firms, that if the firm they control receives federal government assistance these people will pay personally.  That means, if you run a TBTF firm and that firm requires a government funded bailout, the Federal Government will seize your home, retirement funds, children’s trust funds and demand repayment of your salary for the last 5 years.  This is called internalizing the externality on a personal level.

These are only a few of the things that should be done.  Here is hoping the discussion continues long after the current crisis ends.

The above is also on Professor Brandl’s Macroeconomic Updates page (for now). I think you have to be a UT student or alumni or know a secret “hook ’em” handshake to subscribe to the email list.

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