The Bailout Won’t Work Without Equity

10Oct08

Paul Krugman has written a new column arguing that the government should receive equity, ownership shares in the financial firms in return for the capital we’re going to inject into them. I agree with him, but I think that his column neglects a critical part of the case for ownership.

At this point, absolutely no one expects the leaders of Wall Street to behave responsibly with money that is entrusted to them. For years now, they have demonstrated an almost unbelieveable lack of awareness of the crisis developing in their industry. Or, maybe it’s not a lack of awareness so much as a lack of concern, a lack of ability to change course, or a sense of responsibility. In any case, these are clearly people who suffer from catastrophic incompetence, a catastrophic lack of ethics, or both.

The safe bet is that these people will do the worst possible thing with any further money that is entrusted to them. In the current economic environment of danger and uncertainty, our current Wall Street leaders will each pursue their own, individual, best strategy for profit maximization. That strategy is to pull back, suspend business, shift your wealth to something safe like T-bills, and let other people undertake the risk of lending while you try to ride out the storm. If they all behave in this way, the economy will completely shut down, as it is doing even now. But since pulling back is the safest strategy for each of them, as individuals, we know that is what they will do as a group. We know it because they have already demonstrated that they will march right off the cliff as a group in the pursuit of their individual, short-run profits. So we can be certain that any money that we give these guys will not be used to resume normal business lending, which is what the economy desperately needs right now.

And when I say that “we”, I mean that everyone in the US economy knows that these people are not to be trusted. The money we pump into the financial industry will not reassure the public unless the public knows that it’s not going into the hands of the same corrupt incompetents who got us into this mess. No one has any faith that these fools can lead us out of the current collapse. Lots of people argue that handing money over to these guys is immoral, but what’s worse is the real sense that bailing them out is useless. That belief that the bailout is useless is a critical factor right now, because it leaves the public uncertain as to how and if the crisis can be resolved. And the economic decline has started to accelerate due to people cutting back in reaction to the sheer uncertainty of the situation.

So we have two problems: first, that our financial sector is run by fools, and second, that we all know it. The only solution I can see, the solution to both of our problems, is to assure the public that the fools are no longer unsupervised. The government needs to take get real, voting equity shares in return for the public’s money because the government, temporarily, needs to have a say in the management of these firms. No matter how much you may loathe government and politicians, the fact is that the government has much more of a stake in the success of the economy as a whole than the clueless clowns who currently run Wall Street. The government can be expected, as part owner, to demand that the financial sector use the public’s money to resume normal operations, rather than to squirrel the public’s money away in private ratholes.

A lot of people have argued for government equity stakes so that the public can have a shot at getting its money back after the economic recovery. That is a good and sound argument, but I think that the more important argument is that the bailout just won’t work unless the government has a say in how the money is spent. Otherwise we’re throwing $700 billion at people who have already pissed away more than that, and everyone in the world knows it. No one trusts Wall Street at this point, not even Wall Street, which is why the stock market is collapsing despite the passage of the bailout.

The financial crisis is not going to end until we get some regime change on Wall Street. We can get that change by just waiting for the economy to collapse along with the financial sector, and then the Wall Street clowns will go away along with our jobs, retirements, and homes. That’s the free market way to solve the problem. Or we can demand that the government get a voting, ownership share in return for the capital we have to inject into Wall Street, and thereby get a say in how the bailout money gets spent. I vote for option number two.

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