| | It is tragic that the government has been the main cause of putting banks in the position they are in. But I don't agree that "this bailout is as bad as the last one." I assume this means that the government buying preferred stock is as bad as buying bad mortgage-related assets, which Paulson first proposed. My main reason for disagreeing is that the preferred stock method is less risky for taxpayers. The banks are stuck with their bad assets; they don't get to dump them on taxpayers. Miron does not address this, or dismisses it with it's "still a bailout in all but name."
Mr. Miron writes:
If banks were fundamentally sound but temporarily in need of cash, they could sell stock on their own to private investors. Few investors now want bank stock, however, because they cannot tell which banks are merely illiquid -- short of cash for new loans because their assets are temporarily sellable only at fire-sale prices -- and which are fundamentally insolvent -- short of cash and holding assets whose fundamental values are less than the bank's liabilities.
This lack of transparency is a crucial impediment to new investment, and therefore to new lending.
Any company, bank or not, finds it difficult to issue stock in this environment. Few stock issues occur when stock prices are low. The lack of transparency is an issue for lending to, or investing in, a bank. It is not an issue for a bank to lend to non-financial firms (although its capital position is). The lack of transparency may be alleviated later when credit default swaps, and maybe some of the complex mortgage-backed securities, can be traded on an exchange such as the Chicago Mercantile Exchange (see here).
Government ownership of banks will not be a temporary expedient. Politicians can swear they will unwind the government's position once "economic conditions improve," but no one can enforce this promise. The last part is false. The banks themselves can enforce it. Like it says here the preferred shares are callable at par after three years, i.e. a bank can redeem them. Also, a bank can redeem them before three years with proceeds from issuing new stock. Lastly, the dividend on the preferred stock will jump from 5% to 9% after five years. The jump will be quite an incentive to redeem for a healthier bank. It's unlikely a bank will keep the preferred shares if it can issue bonds at less than 9%. (Edit: It's more than 9% since dividends on preferred stock are not deductible, but bond interest is.)
The government, however, gets stock that might end up being worthless, since some banks will fail anyway. That's true, but the bigger question is what will be the extent of bank failures, whether the government acts or does nothing. Miron does not even try to argue that bank failures will be fewer, and the bad effects on the economy will be less, if the government does nothing.
(Edited by Merlin Jetton on 10/15, 5:02am)
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