The Other Paulson Plan

John Paulson of Paulson & Co. endorses Treasury action, but with preferred share and warrant coverage for we taxpayers. Agreed, of course, but I still think we end up with a mix of weapons: taking individual items off balance sheets, plus senior equity where possible/desirable. People who believe in either/or don’t belong in the real world.

And so my ongoing question: What’s the hold-up?

This mechanism — purchases of senior preferred stock with warrants in troubled institutions — addresses the problems with the Treasury plan. The financial market is stabilized, companies get recapitalized, failures are avoided, debt securities are supported, and time is gained for illiquid assets to mature.

The institutions continue to function, their cost of funding will decline as equity capital increases, and innocent third parties like bank depositors, broker/dealer clients and insurance-policy holders are all protected. The only difference is that potential losses are kept with the shareholders where they belong.

The Treasury plan would also entail larger outlays than the Preferred plan. By allowing all banks to sell their worst assets to Treasury at inflated prices, taxpayers would be subsidizing healthy banks which have access to private capital (Goldman Sachs, J.P. Morgan, Wells Fargo, and Bank of America, for example) as well as banks that don’t have a private alternative. But under a Preferred plan, only banks that don’t have a private alternative will be given federal assistance. This would reduce the outlay otherwise required to solve the crisis.

Few people familiar with the issues deny that Treasury action is needed to stabilize the financial markets. However, the question is who should bear the cost?

Under the Treasury plan the taxpayer pays the price. Under a Preferred plan, the shareholders of the firms who created the problems bear the first loss.

[via WSJ]