What to do with the banks

There’s a fascinating three-way semi-discussion on how to improve the bank rescue plan over at the National Journal Online. Here’s a snippet from James Galbraith:

… The administration should follow the law. Pass-through receiverships are the legal way to resolve troubled or failed banks. They are also the proven way. They have been used under Democratic and Republican administrations, including for the Savings and Loans under Bush I and for IndyMac under Bush II.

… There is a simple reason why the market is today valuing residential sub-prime mortgage-backed securities as trash. They are trash. There is no way that a diligent outside investor, acting as a fiduciary, can come to any other conclusion. And so there is no way that private investors will come in on deals, unless the government by some device guarantees them against loss.

And in that case, the government will not be engaging in price discovery but in price-fixing. The price will then not be the market price or the “fair value” price at all, but simply the government-set price. Call it the “bail-out price.”

At the bail-out price, the government will almost surely take on major losses, since the underlying loans will still be subject to a very high incidence of default. …

Galbraith comes first, but save his piece for last, since he’s the only one who responds to the other proposals, and the context will be helpful.

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