The Biggest Bailout in History: And Why American Taxpayers Should Get Some of the Upside

So JP Morgan is raising its offer for Bear Stearns, hmm? Well, it still may be a good deal for old JP, because the worst that can happen is JP loses $1 billion. If losses turn out to be more than $1 billion, the Fed – that is, you and I and every other American taxpayer – will make it up to JP. Who knows what the assets are really worth? They may be worth 80 cents on the dollar, in which case Bear’s stocks are a huge value even at $10 a share (remember, their market price before the panic was around $70 a share). They may be worth 90 cents on the dollar – even better for JP. Or they may eventually (in the long run, when the crisis is over and housing values start trending upward again) be worth far more --- maybe, just maybe, even approaching $70 a share. JP doesn’t know. Bear doesn’t know. The Fed doesn’t know. Everyone is guessing. Bear shareholders are playing a giant game of “chicken.” They’re threatening to go into bankruptcy – that is, liquidate the firm and essentially sell off their assets in an auction – if they don’t get a better deal from JP than the $2 per share JP originally offered.

But it's not just Bear's shareholders who should be asking for more. You and I as taxpayers ought to be asking for more, too. I mean, we're bearing the big downside losses if everything goes to hell and Bear’s assets are worth less than zilch. But we don’t get any of the upside gain if any of the bets pay off. That’s what I call a lousy deal.

A similar lousy deal is brewing in Congress where Democrats are readying a bill to guarantee the price of securities containing bad mortgage debt, if investors will buy them and restructure the securities so homeowners have a better chance of repaying their mortgages (stabilizing the interest rates and lengthening the terms of repayment, for example). The betting here is that, by doing this, the underlying assets will be worth more than the investor buyers are paying for them. In other words, once these mortgages are restructured, more homeowners will be able to keep paying them, so houses will be generating real money for mortgage lenders once again. But it’s a gamble for a potential investor buyer. And if Congress takes the downside risk out of the gamble, it seems only appropriate that taxpayers should get a portion of the upside gain. (The Dodd-Frank bill would in fact give taxpayers a portion of any homeowner equity gain.)

We as taxpayers are chumps if we bear all the downside losses but get none of the upside gains.

Here’s a better idea: When the Fed bails out a Wall Street bank in danger of collapsing or when government (under the Democrats’ bill) guarantees the price of securities that have an unknown amount of bad debt wrapped up in them, the government should retain a stake. That way, if Bear Stearns stock eventually bounces back, or if JP Morgan shows a big profit on its purchase of Bear, or if buyers of any securities guaranteed by the government make a profit – whatever the upside gain turns out to be -- taxpayers that are footing the bill for potential losses get some of that money. And these upside profits cover us in cases where the gamble turns out bad and we’re left holding the bag.

I’m not suggesting anything so draconian and ideologically objectionable as public ownership. Perish the thought. Let the Brits bail out their big bank and nationalize it, and get any upside gain when and if the bank’s shares become worth something again and the UK sells off the bank. No, I’m making a much more modest suggestion. We should arrange our own bailout deals so that American taxpayers get a portion of the profits on bets that turn out good, in order to compensate us for the bets that turn out bad.

The idea is as American as apple pie: Nothing ventured, nothing gained.