The US tax payer is indeed getting a lousy deal for his $125 bn capital injection

Willem Buiter agrees with Uwe Reinhardt's article that suggests that the US tax payer is getting a terrible return on the $125bn worth of capital that was injected on his behalf by US Treasury Secretary Paulson into the nine largest US banks. I agree with both of them. Paulson's bailout gift is blatantly unfair to tax payers and the action creates a moral hazard problem that could destablize the US financial system someday in the future.

The US tax payer is indeed getting a lousy deal for his $125 bn capital injection
Uwe Reinhardt is absolutely correct. The US tax payer is getting a terrible return on the $125bn worth of capital that was injected on his behalf by US Treasury Secretary Paulson into the nine largest US banks. This is surprising to me, because the complete or partial nationalisations of a number of US financial behemoths earlier in the year represented rather better value for money for the tax payer.
The nationalisation of Fannie, Freddie, AIG and pieces of the nine largest US banks (with more to come) was necessary to prevent a complete collapse of the house of cards we used to know as the American financial system.
Unfortunately, Treasury Secretary Hank Paulson’s injection of $125 billion into the nine banks (out of a total capital injection budget provisionally set at $250bn (but bound to rise to probably around twice that amount), carved out of the $700 bn made available (in tranches) by the 2008 Economic Stability Emergency Act, was almost a free gift to these banks. In this it was different from the case of AIG, where the Fed and the Treasury imposed rather tough terms on the shareholders and obtained pretty favourable terms for the US tax payer generally. It was also unlike the case of Fannie and Freddie, where the old shareholders are likely not to recover anything.
In the case of the Fortunate Nine, the injection of capital is through (non-voting) preference shares yielding a ridiculously low interest rate (5 percent as opposed to the 10 percent obtained by Warren Buffett for his capital injectcion into Goldman Sachs). Without voting shares, the government has no voice in the running of these banks. It also has no seats on their boards. By contrast, in the Netherlands, the injection of €10bn worth of subordinated debt into ING bank comes with a price tag that includes two government directors on the board and a government veto over all strategic decisions by the bank.
In addition, in the the case of the Fortunate Nine, there are no attractively valued warrants (options to convert, at some future time, the preference shares into ordinary shares at a set price or at a price determined by some known formula). Quite the opposite, the preference shares purchased by the US state, can be repurchased after three years, at the banks’ discretion, on terms that are highly attractive to the banks. The US tax payer is not only getting a lousy deal compared to private US investors like Buffett, (s)he is also doing much worse than the British tax payer in the UK version of Paulson’s capital injection (£37 bn so far out of provisional budget of £50bn). The UK preference shares have a 12 percent yield and come with government-appointed board members.
Even in the cases of AIG, Fannie and Freddie, unsecured senior creditors did not have to take an up-front haircut. Worse than that, even holders of junior debt and subordinated debt could come out of this exercise whole. There were no up-front haircuts, charges or mandatory debt-to-equity conversions.
That, I would argue, is scandalous, both from a fairness perspective and from the point of view of the moral hazard this creates, by boosting the incentives for future reckless lending to elephantesquely large financial enterprises. Unless not only the existing shareholders of the banks benefiting from these capital injections but also the holders of the banks’ unsecured debt (junior and senior) and all other creditors of the bank (with the possible exception of retail depositors up to some appropriate limit) are made to pay a painful penalty for investing in excessively risky if not outright dodgy ventures, we are laying the foundations of the next systemic crisis, even as we are struggling to escape from the current one.

The Fund must be a global asset manager

Michael Bordo and Harold James argue that the IMF must be a global asset manager.

The Fund must be a global asset manager
The chaotic, costly and ineffective international response to the current financial disorder has prompted French president Nicolas Sarkozy, British prime minister Gordon Brown and German president Horst Köhler, a former head of the International Monetary Fund, to call for a new Bretton Woods conference to design a new global financial system.
This is the first big crisis since the Bretton Woods conference in 1944, when the IMF was created, when the Fund has stood on the sidelines. Yet the origins of the crisis lie in some of the areas where it has a direct mandate – in particular, the large current account imbalances – as well as in the areas where it has recently been extending its mandate to cover financial stability.
The core IMF function should be multilateral surveillance. But at present this often means just talking. This is quite different from past visions. The IMF originally supervised the rules of the system of the par value of currencies under the Bretton Woods order, which disintegrated in 1971. The effectiveness of multilateral surveillance as it developed in the 1960s was linked to the IMF’s presence as a significant financial intermediary. It is this role that needs to be rethought.
In the past, the ability to give powerful advice to the systemically important countries, such as the UK, was enhanced by the dependence of those countries on IMF resources. It was the financial power of the IMF that gave it its bite, and that power was enhanced by its borrowing – at first from the Group of 10 nations that constituted the General Arrangements to Borrow.
In the years after the collapse of Bretton Woods, the IMF reinvented it­self as a vehicle for the management of the surpluses of the time. It borrowed from the new surplus countries, which as a consequence in part managed their new assets through the intermediation of the IMF. It was then able to lend to those countries that suffered shocks as a result of the increase in petroleum prices.
A very large financial actor can have a stabilising role. In the more distant past, market expectations were stabilised during panics by the counter-cyclical behaviour of very large private institutions. The multinational house of Rothschild made the first half of the 19th century stable. In the great panics of 1895-96 and 1907, the US economy was calmed by JPMorgan. At the time of the Great Depression in the 1930s, there was no house of equivalent power.
The IMF could be a powerful stabiliser in global markets if it managed a significant part of the reserve assets of the new surplus countries. It would be in a strong position to take bets against speculators, potentially in regard to speculative attacks on both countries and on financial institutions.
The stabilising action would benefit both the world economy and the interests of the owners of the reserve assets, which have (simply by the fact of the accumulation of the surpluses) a similar interest in world economic and financial stability. At the same time, the management of reserve assets by an internationally controlled asset manager would remove suspicions and doubts about the use of assets for strategic political purposes.
In order to carry out this new task, the IMF would need to regain the trust of its members. The rise in reserves in many Asian countries was a deliberate response to the 1997 Asia crisis, in which there was substantial disillusionment with the IMF. A precondition for acting as a global reserve manager would be governance reform in which the new surplus countries were able to exercise substantive influence through the IMF and feel secure that they were not being politically manipulated.
In particular, if the IMF were to be in a position of an asset manager that could shift assets from one market to another, it would need to be at greater distance from US influence and attempts at control: otherwise, it might be seen as a device for propping up the dollar or particular financial institutions for political economic reasons.
In a revised approach, votes in the IMF would be allocated or “bought” to a large extent through the assets held at the IMF. The proportion of votes determined in this way might be as high as 50 per cent, while the rest would be allocated in the traditional way. There is an analogy to this double determination of voting power in the US constitution, according to which all states have an equal share of Senate votes but very different numbers of seats in the House of Representatives, reflecting population differences.
Making a substantial part of Fund voting a reflection of the reserve positions held in the IMF would allow quick adjustments to new international realities. It would make the IMF more of a market institution, much like the ownership of joint-stock companies can change quickly and noiselessly.
A new version of the Fund could be a substantial contributor to stabilising market expectations. The IMF was conceived in 1944 in a world without major private capital flows, in which states would undertake all international transactions. Extending its mission to include some private sector rescues would be a recognition of the preponderant role markets now play. At the same time, the involvement of a rule-bound international agency would minimise the political poison associated with bank recapitalisations as well as currency interventions.