Monday, March 23, 2009

With Assumptions Like These....

I've been debating with CWD about whether or not I should have suggested that Geithner could be a "dedicated, hard-working public servant who means well, and who believes in this approach to the problem". (Note, it's possible for him to be all of that and also be wrong.) Geithner appears to be taking CWD's side:
Many banks, still burdened by bad lending decisions, are holding back on providing credit. Market prices for many assets held by financial institutions - so-called legacy assets - are either uncertain or depressed. With these pressures at work on bank balance sheets, credit remains a scarce commodity, and credit that is available carries a high cost for borrowers.
That's simply not true. Market prices for many of those securites are established, and it's easy enough to establish market prices for the rest simply by putting them on the market and seeing what people are willing to pay for them. To the extent that there's uncertainty, it's in the banks' book values for the assets, and within that context there's obvious inflation, not deflation, of the values.

The idea that market values are "depressed" is an assumption, not a fact. It is perfectly reasonable to assume that market values are where they are because of the enormous risk involved in the assets. Geithner's entire "shift the risk to taxpayers" plan is built on that premise - his proposal enables investors to "buy" toxic assets for more than market value while funding the purchase primarily with taxpayer money, find out they're completely wrong, then walk away (potentially with a decent profit) while leaving taxpayers with increased exposure due to their overpayment. So when Geither says,
private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.
it's simply not true. For example, we could require banks to sell on the market some percentage of their toxic holdings at arm's length, under an agreement that we would then purchase a greater percentage of those same assets at their market value. Geithner's plan is designed to prevent the market from setting a price and to inflate the value of assets he's already told us he assumes to be depressed. The enormous subsidy and moral hazard is made necessary by Geithner's quest to have the assets purchased at or above the banks' book values, so as not to harm their balance sheets, as otherwise the banks might not sell.

Geithner professes,
We cannot solve this crisis without making it possible for investors to take risks. While this crisis was caused by banks taking too much risk, the danger now is that they will take too little. In working with Congress to put in place strong conditions to prevent misuse of taxpayer assistance, we need to be very careful not to discourage those investments the economy needs to recover from recession.
If the big concern here is "risk", there are plenty of ways the government can reduce risk to investors without running up the cost of these securities or putting taxpayers on the hook for investment losses. But the problem is, they aren't likely to provide the type of price inflation that Geithner hopes to obtain with this plan.

Geithner completely overlooks the nature of the "risk" that got us into this mess. He seems to be claiming that banks were making prudent investments that were a bit too risky, and somehow managed to make so many simultaneous mistaken assessment of risk that we ended up with a multi-trillion dollar bubble. That's not the story of this crisis. This mess was built on the passing of the buck - shifting risk onto somebody else. The broker sells the loan to a mortgage company, that sells the loan to a bank, that sells the loan to a financial institution, that slices and dices its loan portfolio and sells it to investors, and a bunch of institutions buy cheap insurance against losses from AIG, which... can't cover its debt, so it gets billions handed to it by Geithner.1 But up to the point of collapse, everybody was looking at a commission or short-term profit, coupled with shifting the risk on to the next guy.

Geither's plan shifts risk onto the taxpayer - that's not a distinction from the calamitous environment that led to the bubble; it's an extension of that calamitous environment. Once again, institutional investors get to take huge risk for potentially huge profit with other people's money, but with an even greater assurance that somebody else will cover them if the investments go bad. (There's a part of me that wonders if the goal here is to obfuscate - that Geithner doesn't care if the plan succeeds in the sense everybody else is talking about, and that he's more than content to have taxpayers absorb losses on toxic assets at the rate of $100-$200 billion per year.)

Geithner's sprinking of platitudes about how working people are suffering, the need to be responsible with public money, "never again", whatever, aren't even slightly convincing. Geither doesn't walk that walk. Obama must believe in Geithner, and maybe in a year they'll both look like geniuses, but Obama's praise of Geithner may turn out to be a "Heckuva job, Brownie" moment.

1. Yes it's more complicated than that, but the gist remains the same. As long as profits were to be made, nobody cared about risk.


  1. To give the devil his due, at least somebody liked this version of his plan. The market was up seven percent.

    Although I'd like to be wrong, my hunch is that this has more do do with the market having dropped earlier due to its dislike of the uncertainty that was surrounding the old "I've got a plan; I just can't tell you what it is" situation more than it does the market reacting favorably to the details of this plan.

    In the alternative, the markets reaction may be driven by the fact that the current plan is "really, really" good if you are a billionaire investor/institution with some money you'd like to put into a "no lose" government insured investment . . .


  2. I agree with your second paragraph. I may post about that later.


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