Loosely Connected Thoughts on the Bailout
posted by Dave Hoffman
Intuitively, I’m with Gordon. This is a two-way trust problem: investors can’t trust the bank’s numbers; and voters can’t trust Paulson’s motives or competence. Ordinarily, two-way trust problems require some kind of strong incentive/reward system to solve. But Paulson is on his way out. Under what incentive-based theory is he motivated to optimal performance?
On Dodd’s proposal. Unlike Zaring, I don’t think that the reports claiming that this would result in an equity stake are “posh.” Doesn’t 2(c) limit the purchasing authority in just this way? (The authority to purchase limited unless we receive a contingent share “equal in value to the purchase price”, contingent shares automatically vesting if the asset isn’t sold at a profit). What am I missing?
Bainbridge writes “the idea of government ownership of the means of production still gives me the proverbial willies.” Me too! That said, 90% of those willies are based on imagining Phil Gramm in control of the financial service industry (and having the rest of the economy in a pincer). If I thought that McCain, or any of his consultants, had given any serious thought to a comprehensive, dynamic, regulatory process in response to systemic risk before last Monday, I’d be less concerned. (I do think that Obama’s team is more competent at managing this kind of complexity, in part because Obama’s instincts are less driven by a need to find bad guys than McCain, though Obama’s executive compensation foolishness turns me off).
Teaching corporations this semester has been a blast. Two points came up in class yesterday worth sharing.
One student said, basically, why should we pass a huge bailout today, when simply talking about passing something might string the markets along long enough for some of the tightness in the credit market to ease? I blew this comment off, but thinking about it overnight, it was quite astute. Like Nate, I’m probably perfectly happy to let institutions eat their own bad risk decisions, and to fail. (I say this, recognizing that I work in an industry that can’t easily pass along costs to its consumers, and therefore I’m just the kind of person who will end up driving a cab in the worst-case scenario). But, the doomsday scenario – freezing of the commercial paper market – is not something that anyone can be sanguine about. Since that market is basically frozen because of uncertainty, perhaps more days or even weeks of delay and discussion, without the world ending, would allow rebuild the trust necessary to let the Banks die without taking the rest of the system with them. Probably not, but worth thinking about.
Someone else (and it could have been me) said “assuming that this isn’t a story of intentional wrongdoing, or disloyalty, why is the law so bad at preventing financial negligence.” The answer to that question, of course, doesn’t lie in Washington, or New York, but in Wilmington. Is it fair to blame the terrible decisions about the mortgage market taken in the last few years on the business judgment rule (and, implicitly, on the Chancery Court)?
September 23, 2008 at 11:56 am
Posted in: Corporate Law
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Responses (1)
Gordon Smith - September 24, 2008 at 3:03 am
Dave,
Thanks for the endorsement. I have been wondering about that last paragraph, too. My support for the BJR has always been based on comparison to a world in which courts enforce negligence claims (vigorously?). Given that courts are prone to error, especially in cases that invite hindsight bias like these cases would be, it seems like the costs of enforcement would likely be very high (both direct costs of mistaken judgments and indirect costs of risk-averse directors). The costs of enforcement include negligence, but we suspect that those costs are mitigated by market forces. To the extent that the government bails out negligent actors, that force is reduced and negligence increases. That’s the moral hazard argument in a nutshell. This is all oversimplified, to be sure, but even doing the analysis outside of a blog comment, I still prefer the BJR to vigorous policing of negligence.
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