Bailout Critic: Plan Could Cost $3 Trillion

Even some who believe in the bailout say it will cost more than $700 billion.

October 13, 2008, 1:11 PM

Oct. 13, 2008 — -- The U.S. government is changing its approach to the financial crisis, and that change seems to be coming straight from the playbook of U.K. Prime Minister Gordon Brown. Last week Brown unveiled an $87 billion plan to inject money into British banks. In return, the British government will receive shares in those banks.

Critics like Barry Ritholtz said it's about time the U.S. got onboard, even though he warns it could cost up to $3 trillion. spoke with Ritholtz, the author of "Bailout Nation: How Easy Money Corrupted Wall Street and Shook the World Economy" and the CEO of the institutional research firm Fusion IQ, to hear more about his thoughts on the federal government's rescue efforts.

Q: Has the United States fallen behind the United Kingdom in its effort to solve the financial crisis?

A: The U.S. really seems to be flailing about. There's a very famous Winston Churchill quote that says the United States will do the right thing after it exhausts all other possibilities, and it's really true. We've sort of meandered from one half-assed idea to another to another and it's just far too much kicking around. ... It's not a problem of confidence, it's not a problem of falling house prices.

The most fundamental underlying problem is that banks are undercapitalized. This is at a corporate, governance, structural level. I don't mean the balance sheets, I don't mean how much money they have in their trading accounts, I mean on a fundamental basis of shareholders' equity versus liability. They don't have enough cash. They don't have enough capital. The way you get enough capital in these situations is what Warren Buffett did with GE and Goldman Sachs, and it's what the Swedes did during their crisis in the '90s and it is what Gordon Brown has proposed last week.

I don't care if you're a Republican or a Democrat. You have to be disappointed in the lack of leadership from the White House. I mean, the president's been pretty much AWOL. He's been letting his Treasury secretary and the Federal Reserve run this. This is a systemic crisis that calls for leadership from the highest levels in government. … I just get the sense that these guys are trying to run out the clock. They're sitting this out. They're back-benching and saying, 'Hank, Ben you guys run it, we're not going to be involved.' It's just so bizarre to me. These are the sort of crises that you want to see the president step up.

A: I think the original TARP plan of Treasury Secretary Henry Paulson was pretty silly -- buying the assets off the balance sheets of banks doesn't solve the problem. In fact, it creates, a whole lot more problems. There's a moral hazard problem there. ... You're basically saying, "So you guys recklessly speculated and leveraged up. Now you have all this crappy paper on your books. We'll take it off your hands." That's a terrible way to approach it.

The Gordon plan, and we can call it the Brown-Buffett plan, makes a lot of sense. You get capital where it's needed. You do it at a price that's set by the market. You do it on terms that are beneficial to the taxpayer because why would private equity put money into something if it was not going to survive or do so on bad terms? In this environment, cash is king. You know the private equity guys like Buffett are driving a hard bargain. Why not let the taxpayers ride along with them?

Q: Why did buying bank stakes initially meet with resistance from the U.S. Treasury department?

A: I have to think it's idealogical. I think we've gotten to the point where it's pretty clear that the vast majority of the senior people in this administration, they're against government doing anything, and I just think it's bad ideology saying, "Well, we don't want the government to be investing here." You know, here's the problem with free markets: there is a natural tendency on the part of human beings to think shorter term versus longer term and if you take the free market ideology, the free market absolutism ideology to its extreme, you could basically create a case for why there should never be referees on the football field.

A: They don't. But they're a printing press -- they can do whatever the hell they want. Remember Ben Bernanke's helicopter speech? [He said] we have technology and it's called a printing press … and if we have to, we can drop money from the sky. ...There is no free lunch, you can run the printing press all day long, and you run into a dollar devaluation issue and a potential down the road inflation issue. But you know, you're choosing between less worse options.

With certain things, sometimes the choice is between two bad options and in this case, the bad options are do we let the whole system go to hell in a handbasket or do we cause a little dollar deflation and a little systemic inflation in order to genuinely avoid systemic risk?

Every past bailout we've seen, for the most of this past year, they've all cost more than originally thought. AIG is something like $135 billion already. That was supposed to be $85 billion. This [$700 billion package] is a start. My best guess is by the time we're done, it'll be between $2 trillion and $3 trillion.

Read more about Barry Ritzholtz's thoughts on how the government should resolve the financial crisis here.

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