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What's your opinion on the $700bn bill?

Posted By: David Rockwell
Date: Thursday, 2 October 2008, at 3:49 p.m.

In Response To: What's your opinion on the $700bn bill? (Havard Raddum)

If something must be done (I'm not convinced of this), it would be far better to temporarily lower the capital requirements than to blindly buy securities at inflated (above market) prices. This would allow the troubled institutions to stay in business while they try to ride out the storm. It is highly likely that the economic value of the impaired securities is well over the market price. So, recovery is not implausible. What is needed is time for the market to sort out the facts. And, the option of rescue for failures would still be available later. The initial government outlay for this would be zero. The ultimate government outlay for subsequent failures would almost certainly be far less than under this proposal.

The federal government has taken the opposite approach. Wachovia was told to sell themselves at fire sale prices or be seized by the regulators even though they still met all capital requirements (possibly by a relatively slim margin). There will probably be legitimate shareholder lawsuits against the federal government for this action at a later date.

Note that the reason all of this is happening now is that third quarter financial statements will be released soon. Companies were facing the facts since these statements would soon make their problems public. There will probably be a decline or halt in these announcements (for a couple of months at least) as this hurdle is cleared. However, this flurry of activity creates the impression that these events will continue unabated in the absence of intervention.

Note also that the Sarbanes - Oxley bill passed in response to the Enron scandal contains a penalty of jail time for CEOs and CFOs who mislead the public in their financial statements. This is a powerful incentive for Companies to report their financial condition honestly. Also, public accounting firms feel their neck is on the block if they blow this. So, there may be fewer undiscovered problems than might otherwise be the case. We'll see as the third quarter statements are released.

The bailout is a terrible mistake.

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