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

Monday, March 23, 2009

The Stock Market Is Not The Economy

Well, Tim Geithner released his plan to buy up Big Shitpile today (a better article explaining the details is here), and the market responded with a 300-point rally, because I imagine investors quite like getting free tapayer money with no downside risk. Predictably, Drudgico connects the wrong dots.

It was bound to happen sooner or later.

Treasury Secretary Timothy Geithner – who hasn’t had many winning days in his short tenure on Pennsylvania Avenue – scored a big political victory Monday, as Wall Street traders breathed new life into his career with a stock market rally of more than 300 points.

I mean, good grief. This notion that the stock market is any kind of predictor of economic policy should have been tossed out long ago. It doesn't take a genius to realize the existence of a very visible hand at work - the biggest money in the market wants a bailout, and a bailout they're getting, essentially.

In addition, there's a media movement to ghetto-ize the critiques of the plan by the likes of Paul Krugman, painting him as a reflexively shrill hater who sees red at anything Obama proposes. There is of course no effort to actually engage with the material of his critique. I know these media stars aren't economists, but this actually isn't all that hard to understand. Heck, even Eric Cantor can come up with a Cliffs Notes version of Krugman's basic argument, which is below.

The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks’ books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn’t be in trouble.

And so the plan is to use taxpayer funds to drive the prices of bad assets up to “fair” levels. Mr. Paulson proposed having the government buy the assets directly. Mr. Geithner instead proposes a complicated scheme in which the government lends money to private investors, who then use the money to buy the stuff. The idea, says Mr. Obama’s top economic adviser, is to use “the expertise of the market” to set the value of toxic assets.

But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.

What's more, plenty of smart people actually have engaged Krugman and other liberal economists on their critiques. Christina Romer of the Council of Economic Advisors says that the Administration merely seeks to use the market to effectively price the bad assets (I'm sorry, legacy loans) and the taxpayer is protected by sharing in the rewards. I don't agree, mainly because all the subsidies artificially inflate the price in the market, but those two could easily have it out. So could Krugman and Brad DeLong, who is mildly bullish on the plan.

Q: Why isn't this just a massive giveaway to yet another set of financiers?

A: The private managers put in $30 billion and the government puts in $970 billion. If we were investing in a normal hedge fund, we would have to pay the managers 2% of the capital and 20% of the profits every year. In this case, the private managers' returns can be thought of as (a) a share of the portfolio's total return proportional to their 3% contribution, plus (b) a "management incentive fee" of (i) 0% of the capital value and (ii) between 0% (if the portfolio returns 3% per year) and 9% (if the portfolio returns 10% per year)--much less than hedge-fund managers typically charge [...]

Q: So the Treasury is doing this to make money?

A: No: making money is a sidelight. The Treasury is doing this to reduce unemployment.

Q: How does having the U.S. government invest $1 trillion in the world's largest hedge fund operations reduce unemployment?

A: At the moment, those businesses that ought to be expanding and hiring cannot profitably expand and hire because the terms on which they can finance expansion are so lousy. The terms on which they can finance expansion are so lazy because existing financial asset prices are so low. Existing financial asset prices are so low because risk and information discounts have soared. Risk and information discounts have collapsed because the supply of assets is high and the tolerance of financial intermediaries for holding assets that are risky or that might have information-revelation problems are low.

Krugman responded to DeLong, and DeLong responded back. And though all that I did discern a case that COULD plausibly be made for this plan. Even if the assets are artificially priced, at least they'll be priced at all. And then the banks will truly have to put up or shut up, either selling the assets or holding out because the spread between their imagined value and what investors are willing to pay will reveal them to be insolvent. I agree with DeLong that Swedish-style nationalization would certainly be an option should this fail, and while I prefer going ahead with taking over the insolvent banks now, that's not free, and so we cannot with certainty say what option represents the biggest tax giveaway. And the downside of screwing up receivership hasn't been priced at all (though the FDIC's facility with the practice shows that to be a somewhat low risk).

I remain dubious, but the blogospheric debate enhanced my knowledge of the issue. A task that modern media never rises to perform.

...Atrios sez everyone's overthinking it:

The Geithner plan will:

1) Funnel more government money to the banksters.
2) Allow the banksters to pretend for a bit longer that their hunks of big shitpile aren't quite as shitty as we thought by using the bullshit price that this process comes up with, allowing too big to fail businesses to stay in business for a bit longer.

This might make sense if you truly believe the magic market you believe in fervently is genuinely incorrectly pricing the assets, perhaps because you genuinely believe that if you could turn around the economy fast enough that you could massively reduce expected foreclosures.

But if you genuinely believe that, I don't think you've been paying too much attention to just what's been going on in the housing market. I don't think you paid too much attention 3 years ago when you didn't realize that it didn't quite make sense that so many people could afford $700,000+ homes in Orange County. I don't think you paid too much attention to the degree of speculation and outright fraud that was happening in parts of the country.

Of course, the Administration has several programs to mitigate foreclosures, which would mean people still making mortgage payments, which would mean that these securities aren't worthless, because every payment adds to their value. But nothing thus far has succeeded on that front.

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