When governments backstop the financial system, close regulation becomes vital. Without it, the natural tendency of animal spirits to occasionally run wild will over time become unconstrained by any sense of risk. Only this fatal combination can produce the recent Olympian heights of absurdity.

I don’t think the current debacle has all that much to do with market failure. Markets will always fail; it’s part of the discovery process. The problem arises when these painful but necessary localised failures aren’t allowed to run their course. They don’t, unfortunately, disappear; instead, given enough time and enough bad decisions — both private and public — such as those you allude to in your comments, and they will eventually build towards a systemic crisis.

Sadly, the messenger is quite likely to be taken out and shot.

http://www.dailykos.com/storyonly/2008/9/21/9322/74248

Their whole business model was utterly reliant on the low borrowing costs that stemmed from the implicit government backing. Without that, and the numerous breaks and exemptions granted to them because of their quasi public status, they wouldn’t have existed. Allowing(indeed, encouraging)private firms to run up huge debts on the public tab was as close to insane as it’s possible for a policy to be.

Still, as per NPOV, they’re far from the only culprits.

The big problem is that for a long period they were tax exempt and exempt from oversight (they do not have to submit public reports) with implied govt backing – no other public companies have such largesse

Ron Paul argued for reform years ago and predicted the current situation as has the Austrian camp

The policy lesson of the housing bubble, as provided by the ABC (Austrian business cycle) theory, is that the Fed is responsible for the housing bubble as well as the normal booms and busts in the economy, and that as long as it retains its authority to set what are in effect price controls on interests rates, such bubbles will periodically appear in the economy. Federal policy toward housing should be guided by the principles neutrality, laissez faire, and do no harm.

I’m really ambivalent about the thing.

I don’t like this sort of intervention but I don’t like the idea that by not trying we could end up in a wholesale global depression. I really don’t know. The early 90′s plan did work out although I think there was a lot of monetary help from the fed with easy monetary policy.

However as far as things go Paulson’s plan isn’t that bad me thinks.

See here. I wrote about it at ALS blog and why I think it’s the best possible bailout plan ( or takeover using your term) going.

http://alsblog.wordpress.com/2008/09/24/paulsons-bailout-plan-with-new-information/

A bailout is a short injection of liquidity, who knows what this is.

I am surprised that you arent concerned at the loss of govt control and the surrendering of taxpayers money.

This is a bailout and so was Bear Stearn. AIG was a takeover. There is a difference.

Notwithstanding all those definitions I dont really know how the Government could use an auction system to take out these securities without causing a race to the bottom in terms of pricing these securities and forcing further tension if that is what theyre trying to avoid (as a result of further mark to market downgrades).

The other problem with not going with Paulsons plan is that funds for recaps is as scarce as hens teeth so the very consequence of the bailout is to force even more tension by not using Paulsons plan. The upshot is that you end up with a large number of bankruptcies at one time through an auction.

Im not supporting the plan or against it by the way. Im just holding my breath and crossing my fingers it will work.

Surely the Howard government deliberately sinking the SIEV-X and the Apollo moon landing hoax should be added to your list? Why, I am sure Margo Kingston could help you out with a few others, too.

JC – where do the holders go for finance to buy the loan back?

FDB, it may not be for all, but there could be lots of these troubled home owners that may afford a new mortgage set at 60% discount to the original mortgage.

I really am trying to wean myself off responding to you, so slipshod is your reading of what I write, but the problem is that this can then mislead others.

Ummm how so?

I really don’t think you understand the strategy of the package and why it was structured the way it was. If Treasury does a reverse auction the effect may be that it could force the mark to market even at a lower price causing some of the participants to the wall, more demand for recaps and further tension on the stock markets. The stampede to the lowest price is what they’re trying to avoid.

do you really think the US treasury and the Fed haven’t modeled for this possibility.

One doesn’t have to be in favor or in support of the package to understand that an auction could cause a race to the bottom in terms of pricing for very illiquid products.

If you attempting to avoid further financial tension with the large participants it’s possibly the best alternative.

lastly stock warrants have been made or have been discussed as being part of the package so the taxpayer may receive upside on the equity side.

I really am trying to wean myself off responding to you, so slipshod is your reading of what I write, but the problem is that this can then mislead others.

My piece actually says that it’s probably a good thing that the state is becoming the market maker of last resort. So I don’t need an economics 101 lecture on the value of this kind of action. I’m in favour of it.

My objection is that it’s structured to benefit Wall St. From what I can see it is a handover of massive amounts of cash onto the balance sheets of banks – a plan to buy their toxic assets at prices above market rates (something that Paulson has obfuscated about in public and admitted in private. Bernanke has now said the same).

Yes, this will help with liquidity. If this was our only option we’d be in the difficult situation you mention. I’d probably be in favour of the bailout as better than the alternative – a recession or worse. But it’s not our only option. There are oodles of ways a bailout can be structured to maximise the upside for those who put the cash in, this seems to minimise it. And maximising the upside for the mugs who have to stump up the cash also minimises moral hazard in the future.

And what of all the pathologies that got us into this? Executive packages that let people walk away from a sinking hulk with millions? Since we’re playing fast and loose with property rights in order to right the ship, shouldn’t we be giving those things some attention? Where are they in the package?

A bailout in principle is a trade off by taking the hit and possibly averting a really serious recession. It’s more than serious when the credit markets have seized up and equities look like dropping 30%. The aftershock can be pretty devastating. This bailout as someone said doesn’t really resemble the one done in the early 90′s as it looks more like the Japanese model (Credit Suisse economists are making that suggestion). I can send it to you if you like.

The likelihood of this getting passed is typical of American politics. It’s directly inverse to the amount of whining and screaming from the Congress. The more the object to it, the more likely they are going to vote for it.

What I don’t understand is why they don’t do what i wrote at ALS blog:

Maybe this is a really dumb idea and perhaps someone can help think through this. Banks are currently valuing slabs of mortgage securities sitting on their books at 22 cents in the dollar in some cases. Why dont the banks simply offer to sell them back to the holders at the same level or a little higher and close out the mortgage? If they are able to achieve a slightly higher price the banks could actually reduce their provisions.

If the banks offered the mortgage back at say 40 cents in the dollar they could write back some of their provisions marked at 22 cents.