Who pays for the Paulson-Bernanke Plan? It’s complicated

I just posted this long comment on Paul Krugman’s blog.  It’ll appear in a few days.  They are always lagging behind.

*  *  *

What is the effective incidence or ultimate distributional effects of the Paulson-Bernanke rescue plan?

The argument that the median household benefits from rescuing the financial institutions is not absurd.  If we don’t rescue them, they’ll drag down the whole economy.  Although a growing economy doesn’t necessarily benefit the average household (we’ve seen in the last few years, the gains from productivity going almost exclusively to the top), economic contractions have a way of being even worse for regular people.

That would be the growth/efficiency argument in favor of rescuing the financials.  But how about the (related but distinct) equity argument?  Who wins, who loses?  The devil must be in the details.

As I understand it, a public entity is being proposed to buy out the bad assets in the financials’ balance sheets.[*]   At what price?  How are they going to price them?  There’s no market for them.  The public entity (the USAFobraproa, as I call it, because it’s like Mexico’s Fobaproa after the 1994-5 Tequila crisis) will be the market maker for those assets.

For all practical purpose, the effective, current market price of those assets is next to zero.  That’s why those financials are in deep.  If the public entity paid for them their current market price, the banks would get no rescue.  So, that can only mean that taxpayers are going to pay a price above their current market price.  How much above?  Well, apparently, $700 billion for them all.  The stockholders of banks gain, we lose.

Not unlikely, but not necessarily either.  Because there’s this self-fulling prophecy thing.  If, indeed, the financials collapse and they drag down the entire economy, then indeed those assets (say, mortgages) are garbage, because the economy will not help people service them.  On the other hand, if the financials are rescued (regulated and monitored in their future dealings), then the economy may improve and help people service their obligations, thus making those assets more valuable than currently deemed, which may even turn out a profit to taxpayers.

Can somebody please measure all this stuff and straighten things out for me?  Thanks.

[*] Paulson said yesterday that, aside from those toxic assets, “our” (speak for yourself, man) financial firms are otherwise “financially sound.”  How do we assess the financial soundness of a firm but by looking at the predominant assets in their balance sheets?  That’s like saying that, aside from a person being lazy, duplicitous, and cowardly, his character is otherwise sound.  But I digress.

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