This two-pager, entitled Why Paulson is wrong, was emailed to me (and another 800 websites too probably) yesterday by its author Professor Luigi Zingales of the University of Chicago's Graduate School of Business. An excerpt:

If banks and financial institutions find it difficult to recapitalize (i.e., issue new equity) it is because the private sector is uncertain about the value of the assets they have in their portfolio and does not want to overpay[...]The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich—at the taxpayers’ expense. If this subsidy is large enough, it will succeed in stopping the crisis. But, again, at what price? The answer: Billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses.

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 ram down a restructuring plan on creditors, where part of the debt is forgiven in exchange for some equity or some warrants.
It's a good read and, perhaps unsurprisingly for the Chicago School of Friedman et al, concludes:

The decisions that will be made this weekend matter not just to the prospects of the U.S. economy in the year to come; they will shape the type of capitalism we will live in for the next fifty years. 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? For somebody like me who believes strongly in the free market system, the most serious risk of the current situation is that the interest of few financiers will undermine the fundamental workings of the capitalist system. The time has come to save capitalism from the capitalists.

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  1. Anonymous // 9/20/2008 06:04:00 PM

    The link to the paper isn't working...any fix for that?


  2. RJH Adams // 9/20/2008 09:27:00 PM

    The direct link is ok but the paper can also be accessed via the UC Global School of Business page - look to the panel on the right for the paper.

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