Bailout Conditions: Ending Welfare as We Know it

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Dean Baker
TPMCafé (Talking Points Memo), September 27, 2008

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Like many other economists I have been writing about the conditions under which the taxpayers should be willing to hand over vast sums to the Wall Street wrecking crew. This is inevitably involves a game of chicken to some extent. But a properly designed bailout turns it into a simple question of revealed preference.

We give Wall Street terms that require giving up so much equity that the banks really don't want to take the deal. They will take the deal because they have to take the deal, the alternative is bankruptcy.

There is a very simple way to determine whether the deal is the right deal.

If the deal is the right deal, the stock market should rally; the threat of a financial meltdown will be pushed back, if not eliminated. However, if it's the right deal the financial stocks will not rally, they might even plummet.

The right deal will not give the shareholders anything. It will require the banks to surrender so much equity in exchange for their bailout that the share price could fall when the bailout is announced. After all, the shareholders of AIG were not happy when the Fed stepped in and keep the giant insurer operating. If we get the right deal, the stockholders of the surviving financial companies should be almost as unhappy.

So, there you have it. The right deal means stock market up, financial stocks down. Or to put another way, no deal until we see the "For Sale" signs in the Hamptons.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues.