Oh dear. Something of a blogging war has erupted over the leaked outline of Tim Geithner’s toxic asset plan.
The New York Times outlined the skeleton of the proposed programme on Friday:
WASHINGTON – The Treasury Department is expected to unveil early next week its long-delayed plan to buy as much as $1 trillion in troubled mortgages and related assets from financial institutions, according to people close to the talks.
The plan is likely to offer generous subsidies, in the form of low-interest loans, to coax investors to form partnerships with the government to buy toxic assets from banks.
To help protect taxpayers, who would pay for the bulk of the purchases, the plan calls for auctioning assets to the highest bidders.
…
The plan to be announced next week involves three separate approaches. In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.
In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.
In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Securities Loan Facility, a joint venture with the Federal Reserve.
The goal of the plan is to leverage the dwindling resources of the Treasury Department’s bailout program with money from private investors to buy up as many of those toxic assets as possible and free the banks to resume more normal lending.
The move has already sparked outrage amongst a host of bloggers, most of their rage centring on the idea of the US, in effect, subsidising the banks by overpaying for toxic assets and the associated moral hazard of such an exercise.
Here’s economist and NYT columnist Paul Krugman on the matter:
… The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system – that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.
To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad – I mean misunderstood – assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.
But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating – deliberately! – the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.
Calculated Risk sees a similar problem.
With almost no skin in the game, these investors can pay a higher than market price for the toxic assets (since there is little downside risk). This amounts to a direct subsidy from the taxpayers to the banks.
While Baseline Scenario outlines the best- and worst-case outcomes of the proposal.
In the best-case scenario: (a) the government’s willingness to bear most of the risk encourages private investors to bid enough to get the banks to sell; (b) the economy recovers and the assets increase in price from the prices paid; (c) the investment funds pay back the Fed (which makes a small spread between the interest rate and the Fed’s low cost of money); and (d) the government gets some of the upside through its capital investments. (I think the main purpose of that government capital is to deflect the criticism that all of the upside belongs to the private sector.) In the worst-case scenario, the market stays stuck because the banks have unrealistic reserve prices. Perhaps the idea is that, in that case, the TALF will allow the government to (over)pay whatever it takes to bail out the banks.
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This quick and sharp outburst of Geithner-negativity has provoked outrage amonst other blogs.
Economics of Contempt is probably the harshest:
When the broad outlines of the Geithner plan first leaked yesterday, I noted that “it’s impossible to offer an informed opinion based on the extremely sketchy details in these articles.” The descriptions of the Geithner plan in the WSJ and NYT are so broad and so vague that they can’t serve as the basis for any remotely serious analysis. As someone who has practiced structured finance law for many years, the one thing I can tell you for sure is this: the details matter.
But that hasn’t stopped a host of bloggers (who I normally agree with) from vocally condemning the plan. Yves Smith is calling on people to contact their Congressmen to express their opposition, and thinks she already has analysis that’s “damning on its face,” despite the fact that she hasn’t even seen the plan yet. Yves is either being lazy or intellectually dishonest, and it’ll be hard to take anything she says about the Geithner plan seriously. …
The bottom line is that anyone who thinks they already have enough information about the Geithner plan to offer informed analysis doesn’t deserve to be taken seriously.
Meanwhile finance blog Alea dismisses the posts by Paul Krugman, Calculated Risk and Baseline Scenario as “nonsense by the usual suspects”.
But, the Alea blogger also provides a rare bit of commentary too.
Subject to the leaked plan being correct, this works like a simple cash-flow CDO, where, to take the FDIC example, funding is non-recourse and equity is held by a joint venture between treasury and private investors. This is a GOOD idea, private investors won’t overpay because they are in a first-loss position, furthermore this crisis being of a systemic nature, correlation is high, this means equity is risky because yields are lower than normal relative to more senior tranches and would sell off sharply if conditions were to normalize, a rational investor will bid assuming low or 0 correlation.
So there is likely to be a gap between the mtm value of the toxic assets and what a rational investor would pay, reducing or eliminating the incentive for banks to participate.
This is a “pingouins sur la banquise” problem, only the truly starving for capital will jump.
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We think there’s a point to be made about waiting for details of the plan. Monday’s FT, for instance, notes that some purported aspects of the proposal may have been incorrect.
The Federal Deposit Insurance Corporation (FDIC), which, with the Federal Reserve, will add its own financing to the public-private partnerships that will in effect subsidise private sector purchase of toxic assets, denied on Sunday it was the source of the latest leaks, some inaccurate, said Treasury officials.
However, it’s difficult to see how any toxic asset plan won’t involve overpaying for the assets. These aren’t necessarily toxic because they are impossible to sell — they’re toxic because they’re impossible to sell at prices banks are willing to sell them for. Paying purely mark-to-market prices on such assets would likely cause a ripple of further writedowns (only something like 30 per cent of bank assets are currently marked-to-market) — exactly what the US administration is trying to avoid.
In any case, the Treasury Secretary is due to speak at 8:45 a.m. US ET, or 12:45 p.m. in London.
Related link:
The Geithner plan FAQ – Brad DeLong