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.

Francis Marion (mail):
Congress has only 4 hours and 55 minutes to pass one of the two competing bills before it is Judgment Day for the American economy.
9.25.2008 12:06pm
Direct from the China Banking Regulatory Commission: CBRC Spokesperson's Statement
The CBRC has never, by any means, ordered or told the Chinese commercial banks to stop lending to U.S. financial institutions. We strongly condemn the South China Morning Post for its irresponsible and groundless report, and we reserve the rights to take further actions including pursuing its legal responsibility if necessary.

This directly contradicts last night's Reuters report. And today, Reuters has indirectly retracted their earlier report.

If you paid close attention, it appears that someone was intentionally attempting to spread panic.
9.25.2008 12:51pm
Bitter Voter:
The American taxpayers are getting screwed either way, but, if I understand your post correctly, at least with the Dodd plan we might, might, get a little reach-around...courtesy of the same Democrats in Congress who blocked previous legislative attempts to try to avert this disaster in the first place.

Not too comforting. No wonder we are all over at Orin Kerr's post trying to at least get a good laugh in this morning.
9.25.2008 1:03pm
J. F. Thomas (mail):
courtesy of the same Democrats in Congress who blocked previous legislative attempts to try to avert this disaster in the first place.

I love how this lie, through repetition, has become gospel truth. It is amazing how the evil Democrats were able to block legislation in a Republican controlled congress with a Republican Administration at a time when Bush was getting practically everything he asked for.
9.25.2008 1:08pm
This is a valid observation that very much changes what I think of the Dodd plan.

As a previous supporter of Dodd for President (despite the fact that this country will never elect a fat man in the age of TV), I am disappointed by his inability to restrain his bill. C'est la vie.
9.25.2008 1:09pm
Ohio Scrivener (mail):

Giving so much discretion to those administering the bailout may undercut its effectiveness. Investors like to have certainty when they make decisions. If they don't know the ground rules, investors will want a premium for taking on the additional risk or delay making investments altogether. Telling investors to trust the government when they won't know who is running the government until after the election is not the most comforting sales pitch.

Finally, while the comment that "perhaps judicial involvement moves outcomes toward the center, given the ideological diversity of judges," may be true in the aggregate, it will not be true for individual cases. The "idelogical diversity" of judges seems to add, rather than detract, from the uncertainty faced by investors.
9.25.2008 1:25pm
Regarding the last point: surely Congress cannot leave policy decisions to the the personal political opinions/policy preferences of bankruptcy court judges? Asserting government powers where none exited before and then leaving the implementation to a system which tries to interpret law by precedent and become consistent over time, but is not designed to make national policy decisions, is a bad idea.
9.25.2008 1:29pm
Bitter Voter:

As evidence of Democrat obstruction to Congressional reform of FM/FM, I was relying on this story from Fox News and this from the NYT. From the NYT article:

''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

Representative Melvin L. Watt, Democrat of North Carolina, agreed.

''I don't see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing,'' Mr. Watt said.

What evidnece do you have that the Democrats were, in fact, trying to avert this mess?
9.25.2008 2:02pm
One issue with the Dodd plan is that it was drafted on a background of punitive intentions. If Wall St is to blame for the meltdown, so the theory goes, then Wall St should pay for it. But it seems to me that the principal beneficiaries of the bubble were those who sold houses at enormous profit. As such, I would like to see a punitive bill aimed at those who obtained excessive profits during the 1995-2006 bubble.
9.25.2008 2:51pm
Spitzer: You make a good point, but "punitive" intentions shouldn't come into it. During the bubble, many people took risks. Some won, some lost. Today, those that lost are asking for a "bailout".

If we decide to socialize the risks then, as you say, it makes sense to also socialize the rewards. We even have a word for this process: "windfall tax". What's good for oil companies is good for homeowners, right?
9.25.2008 5:07pm
devin chalmers (mail):
I am not trying at all to be snarky here: can someone point me to a readable, reasoned account of why we the economy is doomed if we don't support some kind of Wall Street bailout? Is it just that the players involved are "too big to fail", in the sense of killing investor confidence in American enterprise? Or is there something deeper?
9.25.2008 6:08pm
One most be careful to discrimate between "punitive" and "discouragement".

Some of Dodd's provisions are punitive or arguably could be (greater regulation, CEO compensation) but some -- like the requirements for equity warrants -- are discouragements.

If you're going to bailout an entire industry, it's best to structure your bailout so that only those facing certain destruction otherwise would avail themselves of your bailout, and only for the absolute bare minimum amount.

The AIG bailout was a straight capital injection via equity purchase, but this whole Paulson plan relies on struggling financial companies selling assets in order to firm up their balance sheets.

As such, if the bill lacks...incentives...for these companies to sell as few as possible, for as close to their 'real' value as possible, then you will find every company under the sun unloading as many of their worst assets for as much as they can gouge the government for -- and the information asymmetry favors the seller.
9.25.2008 10:29pm
I find this view positively astonishing. Paulson proposes a simple wealth transfer from taxpayers to the shareholders of financial companies, while the Dodd approach treats the public fisc more like an investor who demands both a return and influence consistent with the scope of the investment and the investees need for funds -- basic supply and demand.

Why in the world shouldn't the public fisc have the same rights as any other investor interested in forking over a large sum of cash for what is presently a risky endeavor? After all, no-one's going to force companies to do anything. If they don't like the investment terms, they simply don't have to take the money.

I find it astonishing that the basic economic concept of getting a return on ones investment is called "redistribution", while simply forking money over no strings attached is called "technocratic". I suppose people are free to use whatever label they want, perhaps words are only sounds, stimulants to be used to induce a response. Why not call war peace, freedom slavery, and ignorance strength, or simply call a goat's tail a leg?
9.26.2008 3:06am

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