Buy The Companies, Not the Assets

I said this yesterday citing Doug Elmendorf and now Paul Krugman’s saying the same thing. It seems that it’s genuinely necessary for the government to give a large sum of money to financial services firms in exchange for something. But the issue is: In exchange for what? Under the Paulson Plan, in exchange for public money the taxpayers will get distressed assets. In a better plan, in exchange for public money the taxpayers will get equity in the bailed out firms:

Or I should say, the [Paulson] plan does nothing to address the lack of capital unless the Treasury overpays for assets. And if that’s the real plan, Congress has every right to balk.

So what should be done? Well, let’s think about how, until Paulson hit the panic button, the private sector was supposed to work this out: financial firms were supposed to recapitalize, bringing in outside investors to bulk up their capital base. That is, the private sector was supposed to cut off the problem at stage 2.

It now appears that isn’t happening, and public intervention is needed. But in that case, shouldn’t the public intervention also be at stage 2 — that is, shouldn’t it take the form of public injections of capital, in return for a stake in the upside?

Let’s not be railroaded into accepting an enormously expensive plan that doesn’t seem to address the real problem.