Ptolemaic Bank-O-Centrism

Jeffrey Sachs has a primer on how banksters could game the PPIP and wind up rich at taxpayer expense:

Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.

Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.

Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.

Noam Scheiber is unconcerned, calling this the good bank/bad bank scenario by different means (the bank gets recapitalized, the government gets stuck with the asset), but A.L. shows how he's missing the point.

Even if your plan is to do a good bank/bad bank model and have the government buy up all the bad assets, you still don't want the goverment to be paying the banks near face value for assets that are worth pennies on the dollar. The banks would make out like bandits under that scenario, all at the taxpayers' expense. No one thinks that the government should be buying these assets at those prices. All that would do is ensure that the taxpayers bear virtually all of the banks' losses.

At that point, there is no excuse for not nationalizing and at least taking a piece of the upside in addition to all of the downside.

I've seen this scenario half a dozen times since the PPIP was announced, and yet there has been no official response to the charge. Even if the rip-off artist doesn't wind up being one of the big banks, the potential for fraud is obvious, and there doesn't seem to be any safeguard to deal with it. Mike Lux says we need to "be helping to save the Obama team from themselves" in that case, but I see no instinct for self-preservation from these folks. They seem more like protectors of the banks than even protectors of their own legacy.

A series of recent meetings with members of Barack Obama's economic team (including running into Larry Summers on my way to an appointment in the West Wing, leading to a spirited back-and-forth that made me feel like I was back at Cambridge, debating the smartest kid in the class), left me with a pair of indelible impressions:

1) These are all good people, many of them brilliant, working incredibly hard with the best of intentions to solve the country's financial crisis.

2) They are operating on the basis of an outdated cosmology that places banks at the center of the economic universe.

Finance should serve industry, not master it. The banks and the financial system may make the rest of the economy run, but they should not set the rules and design the relay course. We're talking about $4 trillion in asset debt, which is only growing worse due to job loss and increased foreclosures. The banks cannot employ 5 million people and reverse the job trend, so they shouldn't be capturing ALL of the economic gain from the various bailout plans. The US economic outlook is worsening, IMO, because of this fundamentally skewed view of the world, where what's good for the banking elites equals what's good for the country to the exclusion of all else.