Paulson v. Dodd: distributional considerations.

What is the difference between the two bills? Broadly, we can identify two dimensions: technocratic and distributional. On the technocratic side, Dodd supporters argue that the financial crisis will be resolved more cheaply if (for example) the government demands equity warrants or must submit to judicial review. Maybe, maybe not. The main difference, it seems to me, is distributional.

This difference is reflected both in political rhetoric (with the Democrats arguing that their bill favors the taxpayer) and the substance of the bills. If you think that the average over-indebted homeowner and the average taxpayer are less wealthy than those who operate and hold shares in big financial institutions, then the Dodd bill favors lower-income people relative to the Paulson bill, at least if its provisions work as intended. The homeowner relief provisions will transfer wealth from holders of bonds to homeowners who are likely to default (though not necessarily future buyers or sellers of homes). The constraints on executive compensation should transfer (a tiny amount of) wealth from rich people to taxpayers. The equity warrants are said to benefit taxpayers by giving them a share of the upside if there is one (I’m skeptical: remember that taxpayers will also have to pay more for the warrants). We can depict these distributional differences on the standard political scientist’s diagram of one-dimensional policy space, as follows:


Where L is left, R is right, D is the Dodd plan, and P is the Paulson plan. However, as I have noted before, there is a twist, namely, the amount of discretion that each plan grants to the executive branch in the person of the Treasury Secretary. We can use brackets to show how discretion works, with “[ ]” for the Paulson plan, and “{ }” for the Dodd plan. One possibility is this:


The way I have written it, each plan gives the Treasury Secretary a great deal of discretion over distributional outcomes. Both plans give Treasury enormous discretion to set the price; and the pricing decision will determine whether wealthier people do better or poorer. But the Dodd plan, by offering protection for homeowners and taxpayers, shifts the range of outcomes to the left.

But there is another possibility:


The Dodd plan’s leftward bias is almost entirely discretionary (or will be, apparently). Treasury has the option to limit executive compensation, demand equity warrants, and protect homeowners, but it is not really constrained to do so. So the Dodd plan extends the range of discretion, making more leftward outcomes possible but not necessary, in which case everything depends on who runs Treasury and hence, after Paulson, who wins the election.

It may be that the oversight mechanisms in the Dodd bill would confine Treasury’s discretion more than I have suggested. Bankruptcy judges are given a lot of discretion, and if they, by inclination or office, tend to help poorer people, then the rightward squiggly bracket should be moved to the left. The same point can be made about judicial review. Perhaps judicial involvement moves outcomes toward the center, given the ideological diversity of judges.

P.S.: people on the left and right might oppose any kind of bailout because they believe that no crisis exists or that the government can only make it worse. I put this view to the side in this post.