Tuesday, October 14, 2008
Paulson's original bailout plan was so ill-conceived, and the markets reacted so poorly, that he had to copy the European model of buying shares in banks in return for injections of capital. As Kenneth S. Rogoff, a professor of economics at Harvard, said, “The Europeans not only provided a blueprint, but forced our hand”.
But the European governments get voting shares in return for bailing out their banks. With voting shares, the governments could force the banks to operate in the best interests of the country, make sure they loan to consumers and small business, and take other action necessary to get their economies back on their feet.
With voting rights, the European governments can also insist that the banks stop buying and selling risky derivatives, which are one of the root causes of the economic crisis.
In contrast, America's bank buy-out gives the government non-voting shares. In other words, the feds can say pretty please, but they have no voting power.
This flies in the face of U.S. history as well. As the Wall Street Journal notes:
"During the Depression, the Reconstruction Finance Corp. bought billions of dollars of preferred stock that came with voting rights. The government then barred banks from paying dividends until they had bought out the government's stakes. This time, the government stakes are nonvoting and the dividend restrictions are less onerous."
Without voting rights, the banks can keep on doing the same things that got them (and our economy) into trouble in the first place.
Update: As an article in Bloomberg entitled "Paulson Lacks Leverage to Compel Banks to Put New Cash to Work" puts it:
"The equity stakes the government is purchasing ... come with no guarantee that the investments will spur lending and unfreeze credit markets. Nor do they give the government board seats or any other leverage to demand that that the firms actually use the money to help the economy.
``The truth of the matter is, they can't put a gun to their head and say you have to lend this money,'' said Charles Horn, a former official at the Office of the Comptroller of the Currency, part of the Treasury Department, and now a partner at the Mayer Brown law firm in Washington.
Treasury officials acknowledge they can't force banks to get the taxpayer money into the hands of their customers. Instead, officials are betting that the government's investment will create conditions where banks have a greater incentive to earn profits from lending than to hoard money to shore up their balance sheets.
Subtle government pressure on banks may not make much difference . . . the U.S. won't take a major share of the banks they invest in. Also, the Treasury has said it won't seek voting rights when it buys stakes."