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IT'S THE PRICING, STUPID.
Here, in its simplest form, is what the administration seems to think (this comes from conversations I had with administration officials over the weekend). It may be the case that these are mispriced assets rather than worthless assets. If that's true, then treating them as mispriced assets rather than worthless assets will save everyone involved a lot of money and carry a lot less downside risk. It is, at any rate, worth trying. The trouble is that the government doesn't know how to price anything. So if you want prices, you need private investors. And if you want private investors, you need to overcome the skittishness that's taken hold of the markets. And if you want to overcome the skittishness that's taken hold of private investors, you need a deal that they virtually cannot refuse. This is that deal. In its terms, it's all private upside and public downside. But even if the public downside here is more galling than is something like nationalization, it's not actually bigger. Quite the opposite.
"Many of the critics," one official sighed to me, "are underestimating the difficulty of their counterfactuals." Ben Bernanke does not appear to think the administration has the legal authority to forcibly take investment banks into receivership. What happens if a legal challenge disrupts the process?
Virtually no one thinks that Congress is willing to quickly offer either the legislation authorizing such an action nor the massive upfront money that receivership would require. Will Ben nelson and George Voinovich vote to take control of the banks? And what happens to the market while Congress is debating? And to Congress if the market dives?
No one knows if the Treasury Department has the technical capacity or simple competence to swiftly assume control of much of the United States banking sector. If Treasury seems unable to simply build out a banking plan and claw back bonuses, what makes anyone think they can run the banking sector?
No one knows how bad the downside is if you botch receivership, or if receivership doesn't work. It is easier to abstractly argue the virtues of successful nationalization than contemplate the consequences of unsuccessful nationalization. As such, it should be the absolute last resort. And this plan preserves it as such. There is a non-trivial chance, after all, that the banks will not sell to the private investors because the private investors will not buy the assets at a price that makes the banks solvent. If the private market determines the assets are worth 30 cents on the dollar but the banks will collapse if they're not bought for 45 cents on the dollar, then the auctions will reveal insolvent banks that cannot be rendered whole through market measures. In that scenario, nationalization will become a consensus strategy, and as such, lose much of its downside.
So the Geithner plan is really two bets in one. The first is that this is not the worst case scenario and does not require the fixes developed for the worst case scenario. The second is that if this turns out to be the worst case scenario, then we still have those fixes available to us, and the need is clarified among the actors -- like Congress and the market -- whose reaction in the absence of consensus could scotch the whole thing.
There are two main problems with this, I think. The problem of pricing and the problem of politics. But I'll get to those in subsequent posts.
COMMENTS (27)
If the average is 30c, composed of some at 10c and some at 50c, won't the investors buy at 45c, sell after clarity is reached, collect 5c for the 50c assets and leave the government holding the baby for the 35c shortfall on the others?
Posted by: Vagueofgodalming | March 23, 2009 8:34 AM
Vagueofgodalming: Yes. This has been another edition of simple answers to simple questions.
Posted by: Steve LaBonne | March 23, 2009 8:39 AM
You raise the point that the government might not have legal authority to take over some of the banks in question, at least not an authority that is clear enough to avoid lengthy legal battles. And you also suggest that, should this plan fail, it eliminates any remaining doubts that nationalization is the right option, since it then will be the only option left.
Well, what if some plucky Congressperson drafted legislation now making clear that any financial institution whatsoever (on US soil) may legally be taken into receivership as deemed necessary by the President and Treasury Secretary. If the law is on the books, that'd be a fine incentive for the bankers to avoid recalcitrance and do their damndest to make the current plan work. That is, for the banks to accept the lowest price possible that doesn't leave them insolvent. And, as you say, if that price is too low even for subsidized private "rescue" investors, then the game is up. At least, I sure as hell hope it would finally be up by then. Agh, who am I kidding. These guys seem nearly omnipotent at making the game go on into infinite overtime.
Posted by: Jonathan | March 23, 2009 8:55 AM
So lets see: The market isn't pricing these assets correctly! But its just too difficult for us to price these assets ourselves,so we must rely on the market we completely pump up to price them correctly!
The idea that after they spend another $1 trillion that they have a future recourse if this doesn't work is laughable.
Posted by: Rob | March 23, 2009 8:57 AM
Yeah, this post confirms what I was thinking too - especially now that the dollar figure has been reduced to "at least $500B". This is clearly an experiment more than anything else... And, it will cost a lot less than actually doing a full solution we don't know will work. (You have to be an economist to think that just looking at Japan and Sweden constitutes sufficient data to make a decision!)
The notion that Krugman and the commentator above has that Obama will somehow be "unable" to do anything else after this one shot is absurd. If there's a crisis & the situation is clearly dire, Obama and his Administration will be able to do whatever they need (even if it means trampling over democracy - there's still a tendency to think that Democrats & Obama specifically are "soft" and there are things they won't do... but I wouldn't be so sure). In the age of blogs and twitters and 24/7 cable news, people have lost the patience and understanding to take the long view - they end up panicking over the need to do things immediately and see results right away. They also tend to maniacally focus on single issues - if we only fixed the banks, everything would be ok! There are no panaceas.
Posted by: bahrad | March 23, 2009 9:16 AM
It's all about what incentives the managers have.
The managers (the WH in this instance) doesn't give a shit about how the stockholders (the American public) fare at the end of the day.
That's why we're getting this particular 'plan', and why everyone not either working for or trying to curry with the WH thinks it's an awful deal.
-----
Of course Ezra will lie through his bared fangs about this all.
When it comes down to a conflict between the truth and his career, Ezra always comes down on furthering his career.
Getting access is easy if that's the only principle you have.
Posted by: Petey | March 23, 2009 9:24 AM
I want some of what you're smoking.
Posted by: Steve LaBonne | March 23, 2009 9:27 AM
1. There are no investment banks.
2. Authority already exists to take action required to prevent collapse.
3. No authorizations from congress are required. The FDIC already has recourse to Treasury.
4. The government will replace the BODs and senior management, the people who do the work will remain
5. If this plan doesn't work, we will have wasted a ton of money and Obama will appear to be incompetent. A high price to pay to say you tried everything.
In short- the rationale is BS!
Posted by: ron | March 23, 2009 9:34 AM
Krugman acts like the Swedish model is a magic bullet. Sweden's economy didn't immediately turn around as it has been portrayed by some in the media.
Here is a summary of what happened in the 1990s:
Falling GDP and lower employment resulted in a sharp deterioration in public sector finances. In 1994, the central government budget deficit exceeded 15% of GDP. Due to the combination of low growth during two decades and the severe economic crisis, Sweden fell from third place in the prosperity league (measured as GDP per capita adjusted for purchasing power) in 1970 to ninth place in 1990. During its crisis, Sweden slid further to 16th place but later bounced back a bit in the rankings and stood at 13th place by 2004.
Don't get me wrong the Swedish model is better than the Japanese model. I just think that Krugman, Atrios et al are overselling the Swedish model.
Posted by: Micheline | March 23, 2009 9:48 AM
Yes, thank you so much for bringing up the Sweden example. The economy did not really get recovering until 1998 - at the same time as the global economy started booming anyway.
I'm not smoking anything... The reality is that if they nationalize and there are no immediate boosts to the economy as a result in 9-12 months - he's still fallen flat on his face. Krugman might be happy, but no one else would be. I think that the left wing echosphere has gotten itself worked up in a lather because they are as desperate for a silver bullet as anyone right now - and there is no such bullet. There are only ways to make the inevitable Great Deleveraging less painful. Also, everyone on the left loves Sweden, so if Sweden does something, it must be awesome and socially just (forget that Sweden's problems were caused and "saved" by neocon-lites who only preserved what social programs they did - with deep cuts - because it was a political necessity).
Posted by: bahrad | March 23, 2009 9:55 AM
petey
sorry for this disgression....
thank you for your contributions, sharing your personal feelings about the author of this blog, in case any of us forgot how you feel since yesterday.
do you tell your neighbors that you dont like, that they lie through their bared fangs, or do you just unleash that here?
i am taking a nine and ten year old to school this morning, and i am going to show them your comment, so they can learn about ad hominem attacks...they will see the venom, and understand.
Posted by: jacqueline | March 23, 2009 9:55 AM
I don't want to seem ad hominem, either - who knows what wrath it might bring - but I think, as has happened a lot lately, Ezra dutifully reports "administration officials" thinking in a way that sort of buys into their overall worldview; and the problem here isn't the plan so much as the way they try to push its necessity: this... or disaster.
I'm not agreeing to those terms; I think the "private investment" proposal is weak because it agrees to things I don't: ultimately, we have to accept that some, probably most, if not all of the mortgage bonds have little or no value. They won't "come back", they're not "misunderstood." Yes, it will be painful. Yes, we will force some banks - big ones - into bankruptcy. We can do this now... or we can do this later... but we will do it.
The reason Paulson's initial plan - which I still believe was the most direct approach, and therefore preferable to what's happened since - failed was that it was too honest and not enough at once: buy up those "toxic assets" (er, "legacy loans"), but pretend they're worth something more than they are, or ever will be. We've been struggling with something very basic ever since, which isn't so much about "pricing" them, or paying for them as it is facing up to our failure - and until we can do that, we're nowhere. The Administration, still, refuses to bite that bullet. And much of DC, including Ezra, is letting them slide by, making excuses and not challenging what is, really, the status quo. Which is really just putting off the reckoning, and he inevitable. I'm just not sure we can wait much longer.
Posted by: weboy | March 23, 2009 10:20 AM
petey is self absorbed he makes jacqueline sad jacquelines thoughts are lyrical wisdom sharing space with the angry rants of the uncouth debases them
jacqueline will use his hate as a teaching moment since she is above the rabble she is a wise and majestic queen and everyone loves her
Posted by: g*d save the dauphine | March 23, 2009 10:30 AM
i am taking a nine and ten year old to school this morning, and i am going to show them your comment, so they can learn about ad hominem attacks...they will see the venom, and understand.
Would this be before or after you show them the bible of venom you created especially for Hillary Clinton?
Oh, Pot? That's the kettle returning your voice mail.
Posted by: Anonymous | March 23, 2009 11:03 AM
no, anonymous....
this would be after we had our many teachable moments about hillary and bill clinton....
about accountability of elected officials..about people in public office, lying about experiences in their lives, and standing by presidents who lie......
about how they ushered in the era of lying into the camera to the american people.
the personal records of people who are running for the presidency are fair game.
and yes, hillary clinton's remembrances of running for cover was a wonderful teachable moment on telling the truth about things that happen to you.
the clintons provided many teachable moments for children on telling lies when you are serving in public life.
they are greatly responsible for the loss of trust, the lies and entitlement that have put us where we are today. that will be in our history books.
they opened the door.
Posted by: jacqueline | March 23, 2009 11:43 AM
no, jacqueline; it was idiots like you that opened the door by falling for that nonsense the msm was selling then...the blame is squarely on your shoulders for everything that follows, including where we are today...accept responsibility for once.
Posted by: Anonymous | March 23, 2009 12:26 PM
accept responsibility for once
A particularly hilarious comment from someone posting as "anonymous"
Posted by: Cay | March 23, 2009 12:35 PM
history has proven me right.
bill and hillary clinton
ushered in
the era of blatant lies
absolute entitlement
and moral bankruptcy.
their legacy continues.
it is now a verifiable part
of our history.
only the spiritually weak,
would defend their actions.
the thread
leads right back to them.
i rest my case.
Posted by: jacqueline | March 23, 2009 12:43 PM
history has proven me crazy
bill and hillary clinton haunt my dreams
i have ushered in the era of blatant nonsense
absolute self-absorbtion
and moral equivalency
my legacy will continue
through my precious children
i am fucked up
Posted by: jaqueline | March 23, 2009 12:54 PM
"i am fucked up."
~~~posted by jaqueline
i am very glad to see that you spell your name differently from me.
i would not want anyone to mistake your post for one of my own.
Posted by: jacqueline | March 23, 2009 12:59 PM
so very lonely and confused
Posted by: jaqeuline | March 23, 2009 1:05 PM
The people you talked to and yourself are either did not read the legisaltion, read it and stuck your head in the ground like a coward. The Treasury secretary has the authority to liquidate any financial institution that takes TARP money Sec 103 item 2:
SEC. 103. CONSIDERATIONS.
In exercising the authorities granted in this Act, the Secretary shall take into consideration—
(1) protecting the interests of taxpayers by maximizing overall returns and minimizing the impact on the national debt;
(2) providing stability and preventing disruption to financial markets in order to limit the impact on the economy and protect American jobs, savings, and retirement security
As to nationalizaation, by which I assume you mean the FDIC liquidization, it is done all the time. without TARP Citigroup would be in receiveership w/ the FDIC. the taxpayers would own the junk after selling off parts like Travellers and Smith Barney. The FDIC could move all mortgages and securitized assets to FNM. We would own the rest but it would be no problem to hire a firm to manage them for a fee
As to legislation would only to reenact Glass Stegal to avoid the current problem w/ banks not being banks but multinational. for executive compensation the orginal TARP covered that as well. We have simply had incompetent administration of the law:
SEC. 111. EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE.
(a) APPLICABILITY.—Any financial institution that sells troubled assets to the Secretary under this Act shall be subject to the executive compensation requirements of subsections (b) and (c) and the provisions under the Internal Revenue Code of 1986, as provided under the amendment by section 302, as applicable.
(b) DIRECT PURCHASES.—
(1) IN GENERAL.—Where the Secretary determines that the purposes of this Act are best met through direct purchases of troubled assets from an individual financial institution where no bidding process or market prices are available, and the Secretary receives a meaningful equity or debt position in the financial institution as a result of the transaction, the Secretary shall require that the financial institution meet appropriate standards for executive compensation and corporate governance. The standards required under this subsection shall be effective for the duration of the period that the Secretary holds an equity or debt position in the financial institution.
(2) CRITERIA.—The standards required under this subsection shall include—
(A) limits on compensation that exclude incentives for executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution;
(B) a provision for the recovery by the financial institution of any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; and
(C) a prohibition on the financial institution making any golden parachute payment to its senior executive officer during the period that the Secretary holds an equity or debt position in the financial institution.
(3) DEFINITION.—For purposes of this section, the term “senior executive officer” means an individual who is one of the top 5 executives of a public company, whose compensated is required to be disclosed pursuant to the Securities Exchange Act of 1934, and any regulations issued thereunder, and non-public company counterparts.
(c) AUCTION PURCHASES.—Where the Secretary determines that the purposes of this Act are best met through auction purchases of troubled assets, and only where such purchases per financial institution, in the aggregate exceed $300,000,000 (including direct purchases), the Secretary shall prohibit, for such financial institution, any new employment contract with a senior executive officer that provides a golden parachute in the event of an involuntary termination, bankruptcy filing, insolvency, or receivership. The Secretary shall issue guidance to carry out this paragraph not later than 2 months after the date of enactment of this Act, and such guidance shall be effective upon issuance.
(d) SUNSET.—The provisions of subsection (c) shall apply only to arrangements entered into during the period during which the authorities under section 101(a) are in effect, as determined under section 120.
The only thing left is CDS's which I believe should be outright annuled. A 10% default on the nominal amount outstanding is equal to the GDP f our country. If this isn't a national security threat nothing is.
Posted by: Robert M | March 23, 2009 1:22 PM
"The reality is that if they nationalize and there are no immediate boosts to the economy as a result in 9-12 months - he's still fallen flat on his face. Krugman might be happy, but no one else would be."
Huh? The entire Republican party's game plan is to drag their feet, hoping and praying that Obama falls flat on his face so that they can regain control of Congress in 2010. They won't be happy, they'll be orgasmic...
Posted by: Wild Bill | March 23, 2009 10:28 PM
Here we go again.
An anonymous Obama WH official dictates, and Ezra types.
I'm so glad we have the intertubes and don't have to restrict ourselves to those MSM stenographer hacks, aren't you?
Posted by: frankly0 | March 24, 2009 3:02 PM
There is no real risk that the private investors won't want to buy the assets for high enough prices. That's because there is no real market mechanism here. They will buy the assets for overinflated prices because the downside risk is so low and they can actually purchase protection to hedge the other way on the same assets. This plan is worse than the Paulson plan, as next to nothing is gained in terms of pricing and the taxpayer has just given up a lot of upside in exchange for minimal decrease in downside risk. Great.
Buying this garbage is no a no-brainer for the private sector. I just can't buy believe you bought this garbage from your White House source.
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