Tuesday, March 24, 2009
The biggest problem with the Geithner plan
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assuming none of critics have hidden agendas nor are reflexive naysayers, doesn't the panaoply of flaws/criticisms elaborated both before and after yesterday by a host of serious thinkers (including you), most of which we have to assume the administration is aware of (nothwithstanding the disavowal of attention the the blogosphere) isn't it safe to conclude that this administration has concluded that the political cost of the failure of the plan is remote enough in time to be worthy of the risk?
You may have understood the actual goal in a previous post. As soon as a bank is in need of capital, the government says: Sell some assets.
Nationalization is just the natural consequence of a bank finding that selling assets is a non-viable solution to its problems.
I agree that the whole point of the Geithner Plan should be price discovery of assets. Banks continue to hide behind the "lack of liquidity" argument as an excuse not to mark down the value of toxic assets. A new $500b - $1 trillion market for these assets will eliminate this as a valid argument once and for all. Still, banks will not voluntarily sell assets if doing so renders them insolvent. A solution would be to force banks already benefiting from government guarantees on toxic assets (notably Citi and Bank of America) to sell the assets subject to the guarantees to the Funds through the auction process.
1. Price discovery will be tainted by government subsidies such as the low cost FDIC guaranteed funding. Although the FDIC will charge a fee for the guarantee, it would be unrealistic to assume this fee will be market based. The true market price will need to be adjusted to reflect the government subsidy.
2. Too much opportunity for both investors and banks to game the system. Any entity selling assets should not be allowed to participating as an investor. Otherwise highly toxic assets will be recycled with the taxpayer taking the majority loss. Further, Funds managers should be restricted from selling assets to affiliates.
3. I find it absurd that the Treasury will be paying management fees to Fund Managers on equity provided by the US taxpayer. The whole program gives Pimco/Blackrock/etc the right to make a small fortune. We almost had a class war over $165 million AIG bonuses. Lets see, a 1% annual management fee on $50 billion taxpayer equity for 5 years is $2.5 billion of fee income. Tell me this isn't happening.
I think that the conspiracy theories, while interesting, are not likely to play out. I can understand some of the motivation for these darker imaginings, because without some kind of conspiracy it's hard to see how this proposed plan can in itself rescue the banks. In fact, I think the more likely outcome is the more obvious one: this plan is not going to single-handedly rescue the banks. In fact it may have only a marginal effect on the solvency situation of the banks. Instead, I think it's main function will be to serve as a way for the government to dispose of troubled assets that it's forced to take on when taking insolvent banks into receivership. The terms and conditions for when and how a large bank will be taken into receivership are still somewhat fuzzy. So far it does not appear that this plan will be used as a mandatory method of price discovery. Instead it seems more likely that banks will be allowed to keep mis-marking their books, remain on life support, and hope to muddle through eventually, rebuilding capital through retained earnings.
The PPIP appears to me to rig the market so that the banks can appear solvent. I think the idea is to create a few high marks for banks to use for pricing their toxic assets, not for any meaningful purging of these assets from the banks. It would be like a public company giving out low interest non-recourse loans to anyone who would bid up their stock (using 6x margin). It probably will achieve the desired result in the short run. But it looks like a government sponsored pump-and-dump operation to me. And will probably have about the same effect in the long run as any pump-and-dump operation.
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