Wednesday, October 8, 2008

How to save the the weakening financial/banking system

Harvard Professor Greg Mankiw proposes the idea of recapitalizing the financial system :

The question for the moment is, How can we get capital back into the financial system? Ideally, it would be great if more Warren Buffetts would step up to the plate and recapitalize financial firms with private money. Unfortunately, that might not happen fast enough to prevent a major economic downturn.



And the solution :

The government can stand ready to be a silent partner to future Warren Buffetts. Here's how it works -  Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date.



I like the idea very much because it helps all 3 parties : the beleangured banks hungry for capital, private firms (like that of Warren Buffettt) seeking good investments, and safe use of taxpayers money.

Furthermore solves three problems :

The private sector rather than the government would weed out the zombie firms. The private sector rather than the government would set the price. And the private sector rather than the government would exercise corporate control.



Towards the end, Professor Mankiw also stresses Alan Greenspan's point that immigration be increased which will lead to higher demand for housing. In turn, houses will get filled up, raising the lowly house prices. Consequently subprime obligations would rise, reducing the bailout needed and providing higher skilled workers to the US .

But I don't like this last idea much because America will simply rely on other countries for their skilled workers, and shift the burden of the housing mess on these new immigrants.

What are your thoughts on the same. Keep the comments rolling in........

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4 comments:

  1. [The government can stand ready to be a silent partner to future Warren Buffetts. Here’s how it works - Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date.]

    I'm no expert in finance or economics, but just as a matter of course, is that a realistic proposal? Isn't it almost a given that once government is given new authorities it is very reluctant to give them up. Think "temporary" tolls, for instance.

    Now that the Fed has an 80% stake in the largest insurance company in the world, do you see them handing back control to private interests in the near future?

    Case in point.. the Fed is in the mortgage business, as we all know, these days. And here's the mindset of the party who currently controls the Congress...

    [During the floor debate on Friday, Reps. Frank and Waters assured Democratic colleagues that they had personally lobbied Treasury Secretary Hank Paulson on these measures and would press him to consent to "do the kind of loan modifications we've been urging."

    Waters exulted: "We're in charge! . . . We own them now."

    If the banks and others that collect payments on these distressed mortgages don't write down enough loan principal to keep Rep. Frank happy, he threatens hearings and new legislation next year.]

    I was reluctantly in favor, by the way, of the bailout bill because I didn't want the credit markets to seize up and give the rest of the financial system a heart attack.

    In any case, I'm interested in hearing about good plans that can work, especially given the new framework and changing dynamics at hand.

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  2. [...] How to save the the weakening financial/banking system [...]

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  3. Seems like a feasible solutions but we are again like in academics looking at a ideal world and not looking at the political motives, private sector will not have a level playing field.


    Chirag, I will have to disagree with you here as america has always relied on other countries for their skilled workers, and shifted the burden of the housing mess on these new immigrants.

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  4. Thanks for reading the post and for all the comments.
    @thepoliticalpage : All we can do is hope that the new administration works efficiently and plugs all the leaks and loopholes that were earlier there in the mortgage business.
    @chirax : thats exactly what I'm trying to say : There's nothing original in that idea because US has always been doing that.
    On the other hand, they've created such an environment and other facilities in US that attracts the best skilled people from the world over to stay and work in U.S.

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