Votermedia Finance Blog

October 31, 2008

Summary and link back to governance

Filed under: Uncategorized — Mark Latham @ 2:23 pm

University of Chicago Finance Professor Luigi Zingales explained clearly the political obstacles that are blocking efficient resolution of the financial crisis:

“Since we do not have time for a Chapter 11 and we do not want to bail out all the creditors, the lesser evil is to do what judges do in contentious and overextended bankruptcy processes: to cram down a restructuring plan on creditors, where part of the debt is forgiven in exchange for some equity or some warrants.

But if it is so simple, why no expert has mentioned it?

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. Since the many (we, the taxpayers) are dispersed, we cannot put up a good fight in Capitol Hill; while the financial industry is well represented at all the levels.

Do we want to live in a system where profits are private, but losses are socialized? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalized and prudent behavior rewarded?”

My design for a cram down and recapitalization is somewhat different, but in the same spirit. I would add a push for tax reform, a new mechanism for automatic equity issues to prevent bankruptcy, and better incentives in executive compensation.

To achieve all these remedies and reforms, we need to counteract the private-public collusion that undermines taxpayer and shareowner interests. That will require fundamental governance reform in democracies and corporations. So I’ll get back to working on that.

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