Is the Secretary Paulson and Ben Bernanke Bailout a Good Idea?

There are many saying that Secretary Henry Paulson’s bailout plan is not the best way to deal with the credit crunch crisis. Paulson came from Goldman Sachs. Is he trying to protect his buddies? Are they taking advantage of the fact that the administration of the country will change soon and then the new leaders can blame their predecessors?

The bailout shifts the burden of the losses to the taxpayer. Another problem with that is that we are not even getting fire-sale prices. They say the bailout will not be effective if bottom dollar is paid. So they are trying to speculate on what it will all be worth in the future.

Warren Buffett believes the bailout plan will pass. Berkshire Hathaway (his holding company) took a $5 billion position in Goldman Sachs. “If I didn’t think the government would act,” Buffett said, “I wouldn’t be doing anything this week. I would be undoing things this week. It would be a mistake to buy anything if the government were to walk away from this deal. The Paulson plan is absolutely necessary to avoid going over the precipice.” But don’t run out and buy Goldman Sachs stock, because he did not buy regular shares. He bought perpetual preferred stock with a 10% coupon. These shares are senior to both Goldman’s other preferred stock and its common stock. That means no other shareholders will receive any dividends until Buffett has been paid his 10%, in full, each year.

Eric Fry, The Rude Awakening’s editorial director, says, “Most of the bad guys who created this mess are gone… although not yet in prison, where they belong. And most of the American regulatory agencies are eager to change the rules of the game. These two developments are very helpful. But the process of repairing and reforming the American financial system could be painful. The U.S. Treasury will absolutely, positively increase the money supply to rescue the financial system… which means investors must try to protect themselves against an almost-certain inflation.”

Here is an interesting article: Why Paulson is Wrong by Luigi Zingales, and Robert C. Mc Cormack Professor of Entrepreneurship and Finance University of Chicago -GSB. He says, “As during the Great Depression and in many debt restructurings, it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for-equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture.”

He goes on to say that the experts haven’t mentioned it because, “The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few.”

I do believe that something has to be done, but I agree with many of the dissenters that the $700 billion bailout may not be the right answer.