A Novel Bail-Out Approach: Buy it All!

In the past I have expressed the fundamental problems with the bailout, namely:

What are we buying?
From whom?
At what price?

Until these are answered Neel Kashkari, Treasury's choice to run the bailout, is sitting on a real big pile of cash while our banking system and economy continue to falter. Kashkari's previous experience was serving six years as a Goldman technology M&A banker, most recently as a Vice President. Six whole years - none of it working with banks or lending. Clearly this makes Neel eminently qualified to handle the bailout.

While Paulson, Bernanke and Kashkari have been sitting around, they have floated the notion of using a dutch auction to acquire assets. This mechanism would allow banks to identify and price assets to be auctioned. The lowest priced assets would be acquired by the Treasury until it had used up its allocation of bailout funds.

This is a nonsensical approach.

Banks would be forced to prioritize what they want to get off their books, at what price, and in what amounts. This sounds good, right? Not really. If banks price their assets too high, they will remain stuck with them as the funds go to other less aggressive banks. If they price them too low they will take a disproportionate hit to capital reserves, and will crowd out other banks who price prudently but need to get assets off their books and the funds from Treasury.

The only way this type of asset sale works is if banks collude. Unfortunately collusion would be illegal.

Another option Treasury has explored is having a third party manage the purchases. Blackrock founder Larry Fink and PIMCO founder Bill Gross have thrown their firms' hats in the ring to handle that assignment, and Gross has gone so far as to suggest that PIMCO would do it for free. Gross and Fink would certainly understand the business better than Kashkari, but might have a slight conflict of interest here, being significant holders of many of these same asset classes.

So, what to do?

Tom Campbell has an idea.

I had the good fortune to meet Mr. Campbell last week and to speak with him at length. Mr. Campbell is so accomplished that he pisses the rest of us off: Harvard law grad and University of Chicago PhD in Economics under Milton Friedman; Stanford Law Professor; Professor of Economics and former Dean of the Haas School of Business at Berkeley; former state Senator; and former four (4) term US Congressman from California. Some other cool gigs too. No pocket protector, no bow tie. Oh, and he is a nice guy. Enough already.

Mr. Campbell (Dr. Campbell? Professor Campbell? Sheesh!) advocates a unique solution to the problem. In Campbell's world, the government decides what assets are most problematic for financial institutions, and buys them all at 53.7% of face value. There is no negotiating, no auction, no determining market value, no deciding whether to accept the price. The government buys them all. From everybody.

This avoids the crowding out of a Dutch auction. It also alleviates the problem of a fixed price purchase, where the only sellers are those who think their assets are worth less than the purchase price. In that system, almost by definition, as a buyer our government would overpay.

In Mr. Campbell's plan, price is not really the point, and the 53.7% price is somewhat arbitrary. It has to be low enough to not unduly reward banks, but high enough to give them some liquidity. And it needs to be fair to everyone - or at least equally unfair to everyone. Finally, the purchases cannot help just a select few firms, they need to be universal.

Mr. Campbell's premise is that for the institutions to get back to work - and their work is financing the investment required to drive our economy forward - the toxic assets (or at least the ones with huge bid-ask spreads) need to come off their books. And it needs to happen now. This is mission critical, and in his view whether the tax payer receives a return on that investment is not at issue.

Certainly many banks would oppose such a plan, arguing that it comprised a "taking" of assets and therefore was unconstitutional. Ah, but Mr. Campbell didn't go to Harvard law for nothing: his research suggests that provided banks are "compensated fairly," a taking is well within the government's rights. Fair needn't be "full value," just fair. Equal treatment, for example, could connote fairness.

Mr. Campbell is not a banker, so he is not intimately familiar with the assets that banks hold, the amounts, or their current market values. But he realizes that the Treasury's process is going too slowly and has inherent flaws. His plan would get us going again quickly. Treasury's Mr. Kashkari could then focus his efforts on exactly what the most problematic assets were, and buy them, rather than on negotiating their purchase with folks far more experienced than he.

Campbell's plan is unique - especially for a long serving Republican politician. It is elegant in its simplicity and scope. And it is fair.

So, Mr. Paulson, what are you waiting for? Lets get Neel working on it!