As I have discussed the bail-out with friends and professors over the last few days, one question keeps emerging:

If we are at the point where we need to infuse this capital into the system to break-up the logjam, Why not participate in the upside?

This is a question that I can’t seem to answer in the negative besides pointing to the pragmatic challenges of having our government run the bailed out institutions. However, at least one nation apparently faced a similar crisis with just this approach. From the NY Times, Stopping A Financial Crisis, The Swedish Way:

Sweden did not just bail out its financial institutions by having the government take over the bad debts. It extracted pounds of flesh from bank shareholders before writing checks. Banks had to write down losses and issue warrants to the government.

That strategy held banks responsible and turned the government into an owner. When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies as well.

“If I go into a bank,” said Bo Lundgren, who was Sweden’s finance minister at the time, “I’d rather get equity so that there is some upside for the taxpayer.”

This seems relatively straightforward, although dealing with the reality of running a number of large financial institutions including Freddie, Fannie, and AIG may not be something we want to leave to our Federal Government. One way around this is to become minority shareholders much in the same way Warren Buffett is now a minority shareholder of Goldman Sachs after his investment in the firm overnight. That way we can participate in the upside without having to take complete control.

In the let’s get angry and irrationally make bad decisions camp: there has been a lot of talk in the last couple of days about capping salaries on Wall Street. From In Bailout Furor, Wall Street Pay Becomes a Target:

The stratospheric pay packages of Wall Street executives have become a lightning rod issue as Congress shapes a $700 billion bailout for financial firms. Proposals circulating on Capitol Hill vary, but they all would impose some limits or approval authority on salaries of executives whose firms seek help.

This is simply ludicrous in my opinion. If we want to run these institutions, then let’s do it as owners not by creating some massive regulatory overhang that will have deterrent effects for decades to come.

We cannot forget the fact that even after this recession America will still have been the greatest economy in the history of the world, and part of that success is driven by the entrepreneurial drive to succeed. Limiting incentives can only have negative effects here and does not do anything except appease embittered politicians and impassioned constituents.

The political process is grinding through these various considerations, and as of yet nothing crazy has emerged. I am still optimistic that our system will come up with the best possible solution for a very bad situation.