Four Reasons to Punt on Paulson’s Bailout Plan

This weekend Congress will try to thrash out an agreement on a Wall Street bailout. Treasury Secretary Hank Paulson wants to spend $700 billion to buy distressed bonds and other assets that are backed by soured U.S. home mortgages. Okay, let’s pause and take a deep breath and look at four big reasons why NOT to.

1. There is no way to know the right price for this stuff, leaving it likely the government will overpay. The seller of a bad mortgage-backed bond may claim its “fair value” is 60 cents on the dollar. Right now, amid jitters over tightening credit and a still-deflating housing bubble, the best offer on the open market may be 20 cents. So do we trust government accountants – toiling under time pressure, analyzing thousands of different (and complex) securities, probably using vague guidelines – to arrive at the proper price?

2. The U.S. taxpayers will pick up the lousiest of the lousy, probably at the worst prices too. There’s estimated to be more than $2 trillion worth of bad mortgage-related assets out there. So, shocking as it may seem, a $700 billion check doesn’t come close to doing the trick. Financial firms will surely cherry pick the wormiest fruit to offload while pretending it’s better than it is. Their knowing more about the individual investments boosts the chances of the government getting hoodwinked on some of these deals.

3. This is a horribly inefficient use of resources in a free market system. The bailout program could become a full employment act for the investment banking industry. For starters, the government would need consultants and specially trained employees to help it process the deluge of applications from financial firms seeking to shed their toxic waste. Then the decisions: what to buy, how much to pay (the research on that alone should keep a platoon of analysts busy around the clock). Then someone has to manage the assets, decide when to sell them, execute the sales.

4. Letting financial firms off the hook sends the wrong signal and sows the seeds for the next crisis. The message: Go ahead and take huge risks, make bad bets, overextend your capital – the taxpayers will be waiting in the wings to pick up the pieces. It encourages the bad actors to keep behaving the same risk-crazy way they have been, and the good ones to follow suit in order not to fall behind.