Posted by: mutantpoodle | March 24, 2009

As the shoes fall from the sky

So the Treasury plan to apply an economic Superfund to the toxic mortgage assets is officially out, and it’s essentially the plan that Krugman et al trashed over the weekend. Meanwhile, Berkeley economist Brad DeLong was a bit more favorable.

IANAE*, but I have, nonetheless, been trying to assemble all the pieces to figure out whether this makes sense.

Let’s review:

  • Banks made large, highly leveraged investments in what Atrios pithily describes as The Big Shitpile.
  • The assets the banks have on hand are not sufficient to pay back their debt obligations – including the loans they took out to purchase their pieces of TBS. (In a corollary, AIG insured people against the failure of pieces of TBS – some of whom actually owned pieces, and some of whom were essentially gambling with, otherwise, no skin in the game.) The banks are, therefore, technically insolvent, which is why the credit markets froze up last fall.
  • However, as the banks in question aren’t the local ones down the street (not that there are lots of those left), but multi-faceted financial institutions which spill past the borders of the FDIC’s takeover authority, there is, apparently, no existing statutory authority that would allow the government to place these so-called “zombie” banks in receivership.
  • The original TARP proposal was for the government to buy the Toxic Assets (hence the moniker Toxic Assets Relief Program); over time, as the foreclosures settled out, the Government would get some portion of their money back.
  • TARP was modified allowing the government inject capital in the banks rather than buying their assets, the theory being (I think) that keeping the banks afloat until the market could price the bad assets was a better option than trying to price them prematurely. Furthermore, there was likely to be a substantial gap between what the government might be willing to pay and what the banks would insist on receiving for those assets.
  • We’ve been in the stage above for several months now, and in that time our cash injections into banks have gone to bonuses, multi-million dollar office remodels, and political contributions. They have not reanimated the zombie banks, largely because they still have assets on their books no one is willing to buy. (One proposal to alleviate this condition was to relieve banks of the accounting rule – called “mark-to-market” – which requires them to value an asset they intend to sell at some point at the price they’d likely receive for it today. That suggestion has, thankfully, so far gone nowhere.)
  • Absent an in-place mechanism to take over the mega-banks, Treasury has devised a system – with lots of help from Wall Street – that incentivizes hedge funds to buy these assets with a lot of help from the Federal Government.

Which brings us where we are today.

It seems to me there are two questions to ask about this plan.

First, is it disproportionately generous to the hedge fund managers who will be managing it with merely $30 billion (1/6 of the equity involved in these purchases) of their own money?

Second, will it work?

And the answers are, quite probably, and who the heck knows.

After a few days of stewing, I’ve come to regard the first question as far less important than the second. I am not happy that some folks might get incredibly rich off of this program; that said, if they do, that means the Treasury has gotten its money back, banks will be much healthier, and the economy will be on its way back.

The gripe most people have is that the downside risk is disproportionately with the taxpayer and not with the hedge fund. This becomes an argument over proportions, because I don’t think anyone thinks you’d get private investment without some form of disproportionate reward. (I am ignoring nationalization for now – what Krugman argues for – but I’ll come back to it.) But much as it would be highly satisfying, making money (as DeLong points out) is not the goal of the Treasury Department. It’s unsticking the economy.

There’s another issue, and it does need to be addressed and probably will, at some point. It’s the bankers lack of patriotism, as Ezra Klein puts it:

They should be begging for a shot at redemption. They should work without pay, without sleep, without credit. They should wear sackcloth and ashes. But more than that, they should be trying to help. The damage they wrought might have been unintentional, but that doesn’t absolve them of responsibility for the aftermath. What we’ve got, however, is an economic hit-and-run, with one wrinkle: The collar-popper peeking out of the bloodied Porsche is willing to stick around if we pay him for his time. Give him a bonus and he’ll dirty his hands with CPR. [Emphasis mine.]

It’s a worthy rant. But I digress.

The other shoe that’s dropping is this: the Obama Administration is seeking new powers to take over these larger financial institutions in the future:

“The United States government does not have the legal means today to manage the orderly restructuring of a large, complex non-bank financial institution that poses a threat to the stability of our financial system,” the Treasury secretary, TimothyF. Geithner said in a statement prepared for delivery before the House Financial Services Committee.

The proposal could help deflect some criticism of the government’s handling of A.I.G., which is not a bank but an insurance company, including allowing the company to pay big bonuses to executives after receiving government financing as part of the bailout of financial institutions.

Had the Treasury Department had the expanded authority last fall, administration officials have said, the government could have seized A.I.G. and more efficiently wound down its operations in a less-costly manner. At the hearing, Ben S. Bernanke, the chairman of the Fed, said that he had wanted to sue A.I.G. to prevent the bonus payments but was talked out of it by lawyers who warned that if the lawsuit failed, the government might have to pay double or triple damages in addition to the bonus.

And so now the pieces are in place, and you the long-term plan takes shape. Kevin Drum:

If, several weeks ago, you had charged a task force with figuring out how to successfully nationalize a big bank, what do you think they’d say you had to do? Three things, at least: (1) you have to figure out a widely acceptable way to value the toxic assets on bank balance sheets, (2) you have to set up a fair and consistent test for evaluating bank solvency based on those values, and (3) you need to make sure you have the legal authority to take over a huge, multinational financial conglomerate in an orderly way. Is it just a coincidence that these are precisely the things Tim Geithner has set in motion over the past month?

On Sunday’s 60 Minutes, President Obama pointed out that the choices that come to him are usually between bad and less bad – anything straightforward gets resolved well below his place on the org chart. And right now, there aren’t a lot of good options available. If there were a great choice, it would become obvious.

So we have the Geithner plan, which will either work or it won’t. You can line up people on both sides of the issue, and they can make compelling arguments about whether the plan is or isn’t too generous, but no one really knows if it will make the underlying bank problems go away. Arguing that Geithner should have proposed a plan (nationalization) which he has no legal authority to implement misses the point. It’s like the joke about the economist stuck in a hole. His solution? “Assume a ladder.” You can’t assume the authority to do something when you don’t have it, unless, of course, you’re George Bush. Nationalization might be better than what Geithner proposed, but you’d need to get that authority through Congress, which will not happen anytime soon. Still, the Obama Administration is setting it up, anticipating, if necessary, the next play.

But there’s a larger issue. For the past eight years, we had to put our faith in a President who clearly was generally incurious and specifically uninterested in information that deviated from his biases. George Bush either ignored information he didn’t want to hear, or never heard it in the first place. If there’s one thing that gives me hope right now, it’s that Barack Obama suffers from neither of those attributes. It may be that Obama’s choice here is wrong, but if it is, it’s not because he never heard – or dismissed out of hand – the better one.

People who look at the plan and say were screwed are forgetting that we were actually screwed years ago. It’s the morning after, and the we need to figure out what to do now. If among those items on the to-do list doesn’t involve (a) some hefty regulation, both of mega-bank activities and compensation and (b) the ability of Wall Street money to bend the political system to their will, then we’ll be here again, and soon. But if I’ve learned one thing watching Barack Obama, it’s that he’s exceptionally good at the long game. It’s one reason he’s President, Hillary Clinton is Secretary of State, and John McCain is merely the cranky senior Senator from Arizona.

We’ll know if all this works waaay down the road, and if it does, the fact that some rich people got richer will fade in importance. If it doesn’t, we’ll have much bigger problems to address.

And, one can hope, the ability to take the next step and address them.

* I am not an Economist

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