Friday, July 31, 2009

A Clear Policy on future bailouts

Senator Ron Paul is keen to get the Fed audited and closed. I don't know how that will pan out but I would seek clarity in one aspect of Fed's functioning. The bailout criteria needs to be defined and communicated.
We need a decision tree to understand how Fed will hereafter decide who gets bailed out. The current "case-to-case basis" and "threat to financial system" arguments are too esoteric. We need clear principles and guides to understand how such decision will be made in the future. There are four critical element of "Guidelines of future bailouts" plan:
  1. We need clear understand of who can seek a bailout. Is it banks? Are insurance companies allowed? Who is allowed? Who is not? Why?
  2. The next part is within this set, who are eligible for bailout, how will you choose? What self-help measures the company has to go through first before coming to Fed for the bailout? What if someone exceeds Fed's / other regulators benchmarks for leverage? Or pays excessive bonus? Will those companies get bailed out too?
  3. How will the bailout amount be decided? Will it come entirely out of Fed gurantees? How about untouched bonus pools? How about unwinding risky position in hard-to-sell paper?
  4. What happens after companies are bailed out? How will they be restructured? How will Fed ensure that those funding the bailout (US citizens) get control over the company?
It is right time to initiate the plan. We have Ben Bernanke at the end of his term. We have some green shoots so markets are reasonably calm to absorb and accomodate the rules of the game. I believe this will reduce uncertainty in the markets. I think it is a moral duty to explain to tax-payers how future bailouts, if any, will be decided. Moreover, I believe tough times lie ahead. It is better to be prepared with a plan - at least for things that we know we might need.