11 Oct 2008

Paulson Should Take a Mulligan

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Pepe alerted me to Casey Mulligan’s blog. Some awesome stuff here, especially on the bogus crisis (outside of financial sector). If you’re a bailout junkie, I encourage you to just go to his blog and start scrolling. But for now, let’s focus on a recent post where he explains how incredibly stupid the new plan to purchase bank equity is:

Treasury capitalization would recapitalize the banking industry MUCH LESS than each dollar expended by the Treasury. I was hoping Professor Barro would voice this opinion, because I learned it from him (not in 2008, but back in 1989 when I enrolled in his courses). Quite simply, Treasury capitalization will crowd out private capitalization.

To see this, assume for the moment that future taxes are lump sum (with a known incidence) and the economy is closed — i.e., that all potential bank stockholders are also U.S. taxpayers. Professor Barro has explained that taxpayers will recognize that the Treasury has invested more in bank stocks, and has implicitly done so on their behalf because the taxpayers will reap the gains and pay the losses of those investments. As a result, taxpayers will attempt to reduce their holdings of bank stocks by the same amount that the Treasury increased them.

You might say that taxpayers cannot reduce their investments in bank equity, because those investments are already zero. If you say this, you err both in fact and in logic. In fact, Bank of America announced this week that it would issue $10 billion worth of stock. Even if we ignore that fact and accept the premise that taxpayers have no intention to invest in the equity of existing banks, I cannot believe that investors would not invest in new banks, or would not invest in alternative institutions that could compete with banks. Thus, at best, the Treasury plan reallocates capital FROM new entrants to the banking industry and TOWARD the existing (and struggling) banks. What a plan for strengthing an industry — to take from the young and strong and give to the weak and old! As I have written many times, public policy needs to ENCOURAGE entry, not discourage it.

We cannot assume that taxes are lump sum, or have a known incidence. But recognizing taxation deadweight costs and uncertain incidence only increases taxpayer exposure to bank stock risk, which might cause them to reduce their bank industry investments MORE than the Treasury increases them! What a plan for strengthing the banking industry — to decapitalize it!

I can’t remember if it was Thomas Sowell or Walter Williams (they all write the same to me…) who said something like, “If the Grand Wizard of the KKK aimed to destroy the black community, he could have done no better than the Great Society.”

By the same token, if a Marxist set out to destroy the American financial sector, he could not have outdone Paulson and Bernanke’s actions of the last 14 months. It’s not merely that their actions aren’t helping. On the contrary, they are CAUSING the very instability they claim to be trying to quell. We just had the worst week in the stock market’s history, after the bailout plan was passed, which (you’ll recall) was supposed to avoid unprecedented bleeding in the stock market.

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