THE PLANK SEPTEMBER 27, 2008
David Cay Johnston, who won a Pulitzer
Prize for his innovative coverage of our tax system, retired this year
as a investigative reporter for The New York Times. He is the author of Free Lunch: How The Wealthiest Americans Enrich Themselves at Government Expenses (and Stick You with the Bill).
Maybe there is a cheaper way out of the credit mess than the plan put forth by Treasury Secretary Henry Paulson, the former chairman and CEO of Goldman Sachs. Any solution that costs less or has a better chance of success deserves serious review before Congress takes an action that will affect taxpayers for years to come.
The most stunning aspect of the Bush Administration's plan to borrow $700 billion to buy illiquid assets like bundles of subprime mortgages was the initial demand that neither Congress nor the courts could review how the money was used. That arrogance caught the attention of everyone who looked at the actual proposal, angering not just Congress, but Middle America.
The second most stunning was the lack of alternatives, the my-way-or-the-highway approach that has characterized the two terms of a president who won office promising he was a uniter and not a divider. The lack of options was also surprising since a basic tenet of management theory is exploring al options and this is, after all, the first time we have a president with an MBA, though not the first time we have a Treasury secretary who was head of an investment bank.
Taxpayers should be troubled that on Capitol Hill and at the White House the talk was about modifying the Paulson plan, not a different approach. They should be just as troubled that most news reporters and TV anchors initially assumed that there must be a crisis and only asked questions around the edges of the plan instead of taking it apart.
Now several options to the Paulson plan have begun to circulate.
One is based on how the Swedish government dealt with its own banking panic 16 years ago, a plan that put taxpayer money at risk, but that also gave taxpayers a chance to get their money back when the banks recovered. That plan, relative to the size of the Swedish economy, cost less than half as much as the $700 billion. And that $700 billion could just be a down payment on a bigger bailout if the Bush Administration plan goes awry.
One of the most intriguing proposals comes from Larry Kotlikoff, a Boston University economics professor who has conducted revealing studies of savings and retirement issues, and Perry Mehrling, an economics professor at Columbia University's Barnard College.
Kotlikoff is the author of an intriguing new book that challenges widely distributed advice on retirement savings called Spend 'Til the End: The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire. (Disclosure: we have the same literary agent, Alice Martell.)
Kotlikoff and Mehrling suggest that Uncle Sam get into the bond guarantee business--for a price (actually, prices). They say this would lubricate the system so credit continues to flow.
Here is why you should be interested: If they are right, it could sharply cut the costs to taxpayers and might even make money.
The professors note that "despite what we hear that 'no one knows' the value of toxic bonds, there is in fact a market for them, currently barely functioning at distressed prices."
Bondholders do not want to sell their weakest bonds for a fraction of their value for regulatory reasons (unmentioned by the professors) and because if Congress approves the Paulson plan the price of the bonds is likely to rise since Uncle Sam will have become a buyer of last resort. Indeed, the worst bonds, those that would sell for a small fraction of their face value, may sell for prices close to their face value if the Paulson plan becomes law.
So how to get bond sales moving?
"The Treasury would offer default insurance for the roughly five different classes or 'tranches' of bonds sold in the market, ranging from the safest AAA bonds, to the worst BBB bonds," the professors propose.
"Insurance premiums would be set based on the market value of the bonds just before the crisis hit, and would range from low" for top rated bonds to very high for the worst bonds. And they would let buyers pay in cash or in preferred stock, the kind of investment Warren Buffet just made in Goldman Sachs.
The professors suggest that instead of issuing preferred stock to the government some banks would pay cash for bond insurance, while others could be loaned money by the Treasury to pay their premiums.
If Uncle Sam loaning money to banks so banks can pay Uncle Sam an insurance premium seems convoluted, be advised that Kotlikoff, who brain is more akin to bubble-headed alien geniuses than mere mortals, loves complexity.
He is also half of a different economics team that figured out that our 401(k) system, which arose quite by accident, may cost many people more in taxes than if they had just paid their taxes up front ands then invested for their old age.
What matters here is that Kotlikoff and Mehrling have put forth an alternative, and one based on market principles. Before borrowing $700 billion, and thus shackling our government for years to come dealing with this debt monster, their idea ought to get a thorough review by Congress and by experts in finance.
Why hasn't Congress put a call for more alternatives and held hearings on options?
--David Cay Johnston