by Charles Calomiris
The US government is considering broad-based assistance to stem the financial crisis. Hank Paulson, Treasury secretary, and Ben Bernanke, Fed chairman, have proposed the establishment of an entity that would purchase subprime-related assets from troubled financial institutions.
A broad-based approach is needed, but this is not the best way of achieving policymakers’ objectives. Government injections of preferred stock into banks, advocated by Senator Charles Schumer, inspired by the Reconstruction Finance Corporation’s policies in the 1930s, would be a better choice. Pricing subprime instruments for purchase would be very challenging, and fraught with potentially unfair and hard-to-defend judgments. If the price were too low, that could hurt selling institutions; if it were too high, that could harm taxpayers. Who would determine how much should be purchased from whom in order to achieve the desired systemic risk reduction consequences at least cost to taxpayers? How would the purchasing entity dispose of its assets? Read more