Hank Paulson and Ben Bernanke have many excellent decisions in this crisis, starting with the fact that they’ve made decisions (lesser leaders would have been frozen in the headlights). One decision that still remains mystifying, however, is why Hank and Ben built their bailout plan around a crap-asset-waste-hauling program instead of a tried-and-true bank recapitalization program.
In every decision they made leading up to the Bailout, Hank and Ben went the recapitalization route–either by forcing sales (Bear Stearns, Wachovia, WaMu) or by injecting capital in exchange for a majority stake (Fannie, Freddie, AIG). When it came to the Bailout, however, they suddenly veered from this course, pursuing a plan that both history and the vast majority of economists suggest is weak.
So why did they do this? They have yet to offer a compelling explanation.
The NYT’s history of the 36 hours that triggered the current credit panic said that they settled on a crap-asset-purchase plan right at the beginning:
Almost from the start, they concluded the best systemic solution was to buy hard-to-sell mortgage-backed securities.
Given Bernanke’s expertise in the Great Depression (and banking crises in general), this is mystifying. Throughout history, injecting capital into banks has been more effective than buying up assets, which Bernanke would surely have known. So what gives?
We suspect Paulson and Bernanke settled on the asset-purchase plan because they were trying to pre-empt the crisis, instead of waiting around for banks to fail. To accomplish this, they had to find a way to pay the banks to play, and the solution they came up with was to pay more for the crap assets than they banks thought they were worth.
We still don’t understand why being the investor of last resort didn’t seem to be a better option (“Can’t raise capital? Come to us and we’ll make you a deal”). But that explanation is the best we can come up with.
We also don’t understand why, now that they’ve had a month or so to think about it–and two weeks to read others’ reactions–Paulson and Bernanke don’t modify their plan. But that one probably has a simpler explanation. (“Um, you mean admit we were wrong?”)
Anyone else have any better theories? We’re all ears.
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