10.14.2008

Careful with that axe, Eugene

The eggheads Paulson and Kashkari are about to announce direct taxpayer investments in Wall Street banks via preferred shares. As always, the devil is in the details:
The government will purchase preferred stock, an equity investment designed to avoid hurting existing shareholders and deterring new ones. Such shares typically don't come with voting rights. They will carry a 5% annual dividend that rises to 9% after five years, according to a person familiar with the matter. By investing in several big firms at once, the government hopes to avoid placing a stigma on any one firm for getting government help.

Warren Buffett got 10% perpetual preferred, plus tremendously valuable warrants, for investing in the cream of the crop, GE and Goldman Sachs. The taxpayers are getting 5% and no warrants (UPDATE: maybe token warrants?) for investing in the stinkier banks. That's a direct transfer of wealth from current and future taxpayers to Wall Street fatcats.

I suggested last week that the Paulson should lock in today's ultra-low interest rates on the liability side of the balance sheet by doing a massive 30-year Treasury auction. What he's doing now is the opposite: locking in ultra-low rates on the asset side of the balance sheet. Yes, the rate purportedly rises to 9% after five years, but that still may not be enough to compensate for one or two bank failures and/or long-run inflation. And can anyone doubt that the 9% rate will be renegotiated when the banks cry poverty and donate to Chris Dodd and Barney Frank's campaigns? Locking in low rates on assets takes inflation off the table and leaves default as the only solution to unsustainable government debt. Now, $250 billion of low-rate assets isn't enough to do it, but I suspect this is only the beginning.

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