"Sweat the Details"

Alan Blinder says details of the bailout matter a lot:

Got $700 Billion? Sweat the Details, by Alan S. Blinder, Economic View, NY Times: The House of Representatives was against the bailout bill before it was for it. But now it’s the law of the land, and the hard part begins: putting this $700 billion plan into effect... Never has that cliché “the devil is in the details” been more appropriate.

The ... “details” in which “the devil” lurks are many and consequential. I’ll focus on just three.

Which assets? The most basic issue is, what kinds of assets should Treasury buy? ...[T]o simplify a much more complicated reality, the plan includes these broad choices...:

• Whole mortgages and pools of mortgages — the idea being to refinance them into new mortgages that homeowners can afford, thus stemming the tide of foreclosures... This is a strategy that I have long favored.

• Mortgage-backed securities and their variants — the idea being to breathe some life into moribund markets... This is the strategy on which Mr. Paulson is widely expected to concentrate. ...Congress explicitly instructed him to devote some money — it does not say how much — to the first strategy.

• Equity stakes in ailing banks and other financial businesses — the idea being that many of these institutions need to be recapitalized before they can resume regular lending. This strategy seems to have emerged recently...

These three strategies are not mutually exclusive and, in the end, Treasury will probably do some of each. But how the $700 billion is apportioned matters greatly. My own favorite remains the first. ...

At what prices? A second critical question is how much Treasury should pay for what it buys. ... Put simply, Treasury has two basic choices.

The first, which I have long favored, is to buy “at market,” or rather as close to market as possible, given that many markets are now dysfunctional. Doing so is the best way to protect taxpayers against loss or chicanery, to avoid favoritism and conflicts of interest, and to render moot the many questions — often highly political — that arise whenever the government starts bestowing gifts on favored sellers. After all, if the government buys assets only at market prices, there are no gifts to bestow.

But buying at market does have two drawbacks. First, it may be applicable only to assets that can be bought at auction... Second, it does not directly infuse any new capital into banks. However, if purchases of mortgages and mortgage-backed securities catalyze ... markets, banks will reap large indirect benefits.

The other approach is to buy “above market,” which is a backdoor way of recapitalizing banks. ... It is impossible to infuse capital “equally” into every needy financial institution; no one even knows what that means. If the government buys assets at above-market prices, it will have to make numerous decisions about which institutions receive gifts and which do not. ...

Minimizing the conflicts of interest Which brings me to the third big issue: conflicts of interest. Starting from scratch, Treasury must buy, manage and ultimately sell up to $700 billion worth of diverse and complex assets. ... Because Treasury lacks the staff resources to do the job, it must outsource most of the work to private companies.

Perhaps you’ve noticed how well the Bush administration has outsourced other government functions. But ... Mr. Paulson ... will have to hire companies with extensive experience in and knowledge of mortgage-related assets.

Now swallow hard and imagine that all these companies .. are 100 percent ... public-spirited. It is nonetheless true that virtually every one of them has a vested interest in which assets are bought and sold, at what prices, and so on. Conflicts are unavoidable if Treasury hires from “the industry.” But from where else can the expertise come? So we all need to watch the conflict-of-interest policies that Treasury promulgates and follows.

This brings me back to the second question. The more the government strays from the sanctuary of buying at market prices, the deeper and more extensive the potential conflicts of interest become.

I’ve already conceded that these purchases cannot be limited to plain-vanilla, auctionable assets. So perfection is unattainable. But as much as humanly possible, the government should buy at fair market prices, for the devil surely lurks in that little “detail.”