Thursday, October 9, 2008

A Sound Proposal

There is a growing concensus that the US needs to move quickly to help recapitalize banks (that is, give them money to keep operating while taking shares of stock in return). The question is how best to do this? How will the government know how much to pay, and how will it avoid wasting funds on banks that are beyond salvage (so-called "Zombie banks")?

Economist Greg Mankiw has a sound proposal:

Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date.This plan would solve the three problems. The private sector rather than the government would weed out the zombie firms. The private sector rather than the government would set the price. And the private sector rather than the government would exercise corporate control.

In short, the government should put on the table a standing offer to match private investors dollar for dollar when they offer to invest in a bank. If Warren Buffett offers to buy shares of bank X, the government matches the offer. This way, the market sets the price rather than having the government determining what to buy and how much to pay.

I hope someone who matters is listening. Mankiw is a former Chair of the Council of Economic advisors and can probably still get his calls returned even though he has been back in Cambridge, MA, for several years now.

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