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Consensus Builds To Use European Methods to Save American Banks

social-contract.thumbnail.jpgOr to put it another way, to buy equity in banks instead of buying their trash. (Or, more likely, in addition to.) Paulson has been talking about it as have most economists and various pundits. As David Sirota notes, buying stock doesn’t just makes a bank more solvent it also makes a bank more able to lend. The question, then, will be under what terms Paulson buys the stock. There are two ways he can buy stock, under the bailout legislation. In the first he is required to get stock or bonds if he buys anything from a company. In that case he must take preferred, nonvoting shares which are convertible to de bt or, if they aren’t a public company, bonds.

That’s less than ideal, because if the government has to bail you out, the government should get real ownership, and real ownership is when you can vote, get members on the board, and if you own 51% of the company, control the company. Banks which need a huge bailout obviously shouldn’t still be running themselves, since they clearly blew it when they were in charge.

Which leads us to the second way Paulson can buy shares.

The language in the bill allows the Treasury secretary to basically buy almost anything in the world. It’s a very broad clause, so broad you could drive a truck through it. (For example, at least in principle, Paulson could buy up 350 billion dollars of prime Manhattan real-estate mortgages, then sell it all to himself for a cent.) The bad thing about really broad authority is it can be abused. The good thing is that that same authority can be used to allow the Treasury to buy preferred, voting, 10% guaranteed dividend, convertible shares with warrants attached which allow further shares to be bought at a very nice price if the company’s stock appreciates.

Or, put another way, it allows the Treasury to recapitalize the banks by buying shares which give taxpayers as good a return as Warren Buffett, advisor to Barack Obama, got when he helped recapitalize Goldman Sachs and GE.

Bank recapitalization is necessary. It’s not the only thing that needs to be done, but it’s one of the things that needs to be done. However it can be done smart and honest, or it can be done corrupt or stupid. Let’s hope that knowing the eyes of the world are on him convinces Paulson to do it smart and honest.

(Update: Ishmael points out that just having voting rights isn’t enough:

Common shares with voting rights aren’t the only way the gov’t should be protected – as a minority shareholder, the gov’t will not have much protection under corporate law. In addition to an equity stake, the government should also get subordination agreements that preclude the bank from issuing additional shares without gov’t consent, allow for a certain number of gov’t nominee directors, and prevent the acquisition of additional debt by the banks outside of the normal course of business without gov’t consent. In other words, the same thing that a prudent lender gets from any company in financial distress while the debt is outstanding.) 

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Ian Welsh

Ian Welsh

Ian Welsh was the Managing Editor of FireDogLake and the Agonist. His work has also appeared at Huffington Post, Alternet, and Truthout, as well as the now defunct Blogging of the President (BOPNews). In Canada his work has appeared in and BlogsCanada. He is also a social media strategy consultant and currently lives in Toronto.

His homeblog is at