As featured on p. 218 of "Bloggers on the Bus," under the name "a MyDD blogger."

Saturday, February 07, 2009

The OTHER Big Plan

Since the recovery package has dominated the news this week, little attention has been paid to a major announcement expected on Monday.

After weeks of internal debate, the Obama administration has settled on a plan to inject billions of dollars in fresh capital into banks and entice investors to purchase their most troubled assets.

The new financial industry rescue plan, to be outlined in broad terms on Monday in a speech by the Treasury secretary, Timothy F. Geithner, will not require banks to increase their lending. That is despite criticism that institutions that already received money from the Troubled Asset Relief Program, or TARP, either hoarded it or used the funds to acquire other banks.

The incentives to investors could be in the form of commitments to absorb some of the losses from any assets they purchase, should their values continue to decline. The goal is to relieve the banks of their worst assets so that private investors might then provide more capital.

Officials hope that that part of the plan is not labeled a “bad bank” administered by the government, although they expect that some might call it that.

No matter what it is called, the government would assume some of the risk of declining assets at the heart of the economic crisis. But by relying on a combination of private investors and government guarantees, the administration hopes to reduce its exposure to losses and avoid the problem of having to place a value on assets that the institutions have been unable to sell.

They don't want to call it a bad bank because that idea has been torched by all sides of the economic spectrum, including this amazing takedown by Yves Smith which will forever be the takedown by which all other takedowns will be measured. But I don't see a lot different from the above proposal and what Smith criticizes here. They seem to just be propping up insolvent banks.

In case you had any doubts, propping up dud asset values is a form of forbearance. Japan had a different way of going about it, but the philosophy was similar, and the last 15 year illustrates how well that worked.

What we have from Team Obama is a bigger abortion of a "throw money at bad bank assets" plan that I feared in my worst nightmare. And (when we get to the Post preview), they have the temerity to invoke triage to make what they are doing sound surgical and limited.

Those who remember the origin know that triage means focusing on the middle third of the wounded on the battlefield : abandoning the goners to die, leaving those wounded but stable to fend for themselves for the moment (they were in good enough shape to wait to be transported or hold on to be treated later). The middle third, those in immediate danger but who might nevertheless be salvaged, get top priority.

The concept of "triage" recognizes that resources are limited, tough decision need to be made, and some are beyond any hope. But in Team Obama Newspeak, triage means everyone can be saved because resources are presumed to be unlimited [...]

The problem is not a lack of price discovery, as the discussion above pretends, it's a lack of investor willingness or ability to take losses. And readers have said if a particular piece of paper doesn't fetch a bid, that's because its real value is not materially above zero. But per above, that's the sort of dreck that Team Obama would buy.

And what, pray tell, is the point of the guarantee? The loss exposure on a guarantee (versus a purchase) at the same nominal price is the same, although the initial cash outlay is considerably different. Ah, but if the paper is guaranteed, then your friendly bank welfare recipient can bring the junk to the Fed and get nice cash back.

So we the taxpayers are going to eat a ton of bank losses that should instead be borne first by stockholders and bondholders This program should be labeled the Pimco bailout plan, since the giant bond fund holds a lot of bank debt. That shows what a fiction Obama's populism is. It's mere posturing and empty phrases. Look at where the dough goes, and it is going first and foremost to the big money end of town.

This really makes a mockery of those "punitive" executive compensation limits, which banks are balking at anyway.

They don't want to take large ownership stakes of the banks in exchange for saving them, even though they are pumping in more money than the banks are materially worth, whether you look at it through stock or assets. It may be a smaller bailout, they may not have to ask Congress for any money, but without actually fixing the problem, it makes it nearly certain that they'll need a larger bailout down the road. In fact, they admit that in the NYT piece.

But lawmakers said they expected the administration to seek more money for the rescue program later this year.

So more taxpayer risk, more shareholder reward. I'm no economist, but that's insane.

I don't know that this will create moral hazard on the part of bankers, who will have no compunction against ringing up bad bets in the expectation that they'll be bailed out again; I'm not certain moral hazard exists in the conscious sense. I just think that these executives are greedy and self-important and feel entitled to stay rich and powerful, and will do whatever they can to keep that money and power.

The point is that another world is possible. We can do something different. We can nationalize the banks temporarily, instead of wildly overpaying for toxic assets. We can admit that most of the banks are insolvent, and we can let them remain in public hands until they can restore their balance sheets. We can actually look at what is coming in and what is going out of the banks and price the assets accordingly. We could even let the Fed lend directly to individuals and eliminate the need for these banks entirely. Whatever we do, we can use this standard:

Find out How Deep the Hole Is
Perform Triage: Bury the dead, help the injured, let those only mildly wounded fend for themselves
Make sure the damage to the financial sector doesn't spread any further beyond the financial sector

And in the future, we can re-imagine the revenue stream, paying for everything society needs by reducing inequality and ending corporate greed.

See also here and here. I fear this won't be part of the Treasury Secretary's proposal because it's beyond the limits of the establishment imagination. We're all going to have to learn the hard way.

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