Will rescue restore trust? We'll see.

President Bush walks with, from left, Federal Reserve Chairman Ben Bernanke, Securities and Exchange Commission Chairman Christopher Cox, and Treasury Secretary Henry Paulson at the White House prior to Bush's statement on the economy today.


TESS VIGELAND: Speculation says the final product of this bailout will look something like the Resolution Trust Corporation, or RTC, which bailed us out of the savings and loan crisis. No matter the final version, as Jeremy noted, we're all now holding that bad debt.

For more on what that means we turn to a familiar voice. Robert Reich, thanks for being with us.

ROBERT REICH: Hello. I'm delighted, Tess.

VIGELAND: Let's talk, first of all, about who is at risk as we look at the possibility of an RTC-like agency.

REICH: Taxpayers. And we don't know at the risk of how much money. Because the RTC, remember, took over the bad debts of hundreds of savings and loan institutions -- something on the order of $400 billion -- and then resold those assets off so that the American public, taxpayers, were not stuck with that huge bill, something far less. This time around, though, nobody knows what the bottom is. It could be many multiples of that.

VIGELAND: Yeah, I think Sen. Richard Shelby went on TV today and actually threw out the T word -- trillions.

REICH: It's a scary number and nobody should be alarmed. But at the same time nobody should underestimate the potential liability on taxpayers.

VIGELAND: So what exactly does that mean for us?

REICH: Well, it means that if the worst happens and the economy does not recover, or these pieces of paper have very little value because the underlying loans are not going to be repaid, well that means that taxpayers get left holding the bag. Which, in turn, means that the debt -- the federal deficit and the federal debt -- go much, much higher. And, if that happens, then first we can't do a lot of things we would like to do as a nation. And foreigners may get a little bit nervous about the faith and credit of the United States. And they may slow down even more than they are already slowing down their willingness to lend us money. And that results, potentially, in a further drop of the dollar. Which means everything we buy from abroad costs more.

VIGELAND: I thought this idea that came out today was supposed to make us all feel better.

REICH: Well, it certainly made a lot of investors feel better. And maybe it'll work. But, you see, Tess, this is the problem. The crisis on Wall Street right now is less about solvency and about capital than it is about trust. And the real question is, How do you restore trust to a system in which, basically, nobody trusts the numbers that are supplied by big banks on securities?

VIGELAND: Well, let me ask you to answer your own question there. Or try. How do you generate that trust? What is the alternative?

REICH: Well, the answer is regulation. There's just all sorts of areas that beg for more transparency. And until you get that much transparency, people are just not going to trust what Wall Street is telling them.

VIGELAND: Why didn't the government take this sort of radical action earlier?

REICH: Well, the kernel of the idea -- that is, have a separate agency take the bad debt off the books of some of these banks and then resell them just like the old Resolution Trust Fund -- that may make some sense in the short-term. But there's no reason the taxpayers have to be involved. You could do this by a kind of reorganization under bankruptcy, a kind of big Chapter 11 process. You don't have to call it bankruptcy. You could call it a kind of emergency reorganization of financial institutions. Or you could call it liverwurst. It doesn't matter. You just basically eliminate all of the investment value in these banks and all of the focus would be on making creditors as whole as possible.

VIGELAND: Alright folks, you heard it here first. Liverwurst is the answer. . . . Thank you so much, Bob.

REICH: Thank you, Tess.

About the author

Tess Vigeland is the host of Marketplace Money, where she takes a deep dive into why we do what we do with our money.
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The picture starting to emerge is that things are going to pretty ugly regardless of what approach is taken. The main question is going to be: who is left holding the bag? And who should share in the pain?

Mr. Todd is proposing that investors should be bailed out. Why should they transfer their downside losses to taxpayers who would not have shared in the upside?

This is the issue that passage of any act is going to turn on, in my opinion.

Reich asks: "How do you restore trust to a system in which, basically, nobody trusts the numbers that are supplied by big banks on securities?"

My answer would be:
1. Begin by transferring risk away from the investors. This can be accomplished with guarantees or inducements. This is essentially what the bailout is trying to accomplish. However, no-one should fall into the trap of thinking that this is a solution to the trust problem, which is multifaceted;

2. Empower investors to choose their preferred sources of trust in the numbers (if its not the banks then who would they trust more to give them the true numbers). Allow them to validate critical information using a variety of preferred modes and sources of their choosing. Depending on investor preferences, this can include anything from access to more rating agencies (for fast trust) to deconstruction of the securitized debt and monitoring (for high trust) of individual debt holders;

3. Provide investors with more tools and resources to validate critical information (for example, tools that provide sufficient evidence to validate the numbers);

4. Change the rules of the game to ensure that there is an alignment in motivations between debtors, lenders, investors and public policy objectives. For example, if an investment were intended to be low risk, then it would be subject to greater scrutiny and its governance/decision-making would have to be long-term oriented;

5. Implement standard business processes, instruments and mechanisms that ensure compliance with the new rules of the game; and

6. Monitor behaviour relative to the rules of the game, enforcing compliance with appropriate rewards and penalties.

Trust Enablement is universal framework for developing and protecting trust. Regulators need to become aware of it and use it to optimize conditions for trust strategically and comprehensively. If they continue to address trust issues in a piecemeal fashion, as they did with Sarbanes-Oxley legislation, we will continue to experience market volatility; a symptom of mistrust that feeds a vicious downward spiral of trust erosion and socioeconomic demise.

Alex Todd
Founding CEO

Trust Enabling Strategies
Optimizing stakeholder trust for breakthrough business performance


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