I have already made brief objections to your view. The two points that seem important to me are, first, the MLEC aspect of the announced Public-Private Investment Fund. This is not the "stress test" or "audit": but it does purport to be about setting a price on the toxic assets. The private sector, Geithner says, will be better at setting that price than governemnt would be. (In passing, that reminds me that Hank Paulson brought private-sector boys into his evaluation team, presumably following the same logic, and the result was fail).
The obvious problem here is that private capital has no interest in buying these assets at a price that would save the banks, and Geithner's plan to "leverage" private capital with public opens him right up to the suspicion he spoke about to David Brooks:
"I was very worried about us looking like we're vulnerable to the charge that we're overpaying as a way to provide disguised subsidies to banks."
Perhaps more exactly, that private interests would buy the assets at their own evaluation, and the taxpayer would provide the difference needed to keep the banks afloat.
Roubini's RGE Monitor 10 February newsletter (e-mail, so no link) says this:
The aim is to involve private capital on a large scale that sits currently on the sidelines while also allowing private market forces to determine the price for currently troubled and illiquid assets. A similar experiment was tried before with the private sector sponsored M-LEC vehicle that ultimately proved unviable due to asymmetric toxic asset exposures of participating banks and due to still unresolved asset valuation issues. Commentators agree that for a similar plan to work this time, the government will have to assume a potentially substantial downside in order to induce otherwise unwilling investors to participate in view of the size of potential losses.
A similar experiment was tried before with the private sector sponsored M-LEC vehicle that ultimately proved unviable due to asymmetric toxic asset exposures of participating banks and due to still unresolved asset valuation issues. Commentators agree that for a similar plan to work this time, the government will have to assume a potentially substantial downside in order to induce otherwise unwilling investors to participate in view of the size of potential losses.
Jérôme now says this public-private toxic buy-out might be a fair proposition:
as long as public and private investors take the same risk pari passu
In circumstances where defaults are rising and banks' assets are deteriorating, getting private investors to participate with genuine good will in this exercise seems likely to be extremely difficult. And even were Geithner to obtain that good will, the onus is still on the government to make up the shortfall between what the private sector will pay and what the banks need to make their balance sheets whole.
The second point centres on the "stress test". Of course, there's nothing wrong with an audit (estimating "exposure" rather than price, as you insist, though what the metrics of exposure are remains unclear, and I'd point out that the FFIP part of the plan does in fact call for setting a price for the bad assets). The point is that (if it's not fudged) it will show the true state of the US banking system (and, by inference, that of other North Atlantic banks). Roubini:
RGE - It Is Time to Nationalize Insolvent Banking Systems
our latest estimates RGE Monitor (available in a paper for our clients) suggest that total losses on loans made by U.S. financial firms and the fall in the market value of the assets they are holding will be at their peak about $3.6 trillion. The U.S. banks and broker dealers are exposed to half of this figure, or $1.8 trillion; the rest is borne by other financial institutions in the US and abroad. The capital backing the banks assets was last fall only $1.4 trillion, leaving the U.S. banking system some $400 billion in the hole, or close to zero even after the government and private sector recapitalization of such banks. Thus, another $1.4 trillion will be needed to brink back the capital of banks to the level they had before the crisis; and such massive additional recapitalization is needed to resolve the credit crunch and restore lending to the private sector. So these figures suggests that the US banking system is effectively insolvent in the aggregate; most of the UK banking system looks insolvent too; and many other banks in continental Europe are also insolvent.
Even allowing for a Roubini Doom-squared Factor™, we have to assume the rot has gone far. So the audit will establish that. Then, you say, Geithner's brilliant plan is that he'll nationalise. My question about that was, why the need for the Trojan Horse? Even supposing it's a smart way of proceeding, why the need to announce the toxic-asset buy-up PPIF with up to a trillion to spend? Is involving the private sector in buying those assets with public money "leverage" part of the subtle plan to nationalise?
Is involving the private sector in buying those assets with public money "leverage" part of the subtle plan to nationalise?
Looks like it, wit hthe added fig leaf that it will be the private sector that gives a value to things, and not some evil bureaucrats, because one is so much more competent than the other at doing that for the common good. In the long run, we're all dead. John Maynard Keynes
Why the need for this separate fund, once the banks are nationalised?
Public-Private Investment Fund: One aspect of a full arsenal approach is the need to provide greater means for financial institutions to cleanse their balance sheets of what are often referred to as "legacy" assets. Many proposals designed to achieve this are complicated both by their sole reliance on public purchasing and the difficulties in pricing assets. Working together in partnership with the FDIC and the Federal Reserve, the Treasury Department will initiate a Public-Private Investment Fund that takes a new approach.
whether major financial institutions have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected
While banks will be encouraged to access private markets to raise any additional capital needed to establish this buffer, a financial institution that has undergone a comprehensive "stress test" will have access to a Treasury provided "capital buffer" to help absorb losses and serve as a bridge to receiving increased private capital.
I think the (scary) answer is that the US Treasury believes securitisation is a great idea and should continue
While the intricacies of secondary markets and securitization - the bundling together and selling of loans - may be complex, they account for almost half of the credit going to Main Street as well as Wall Street. When banks making loans for small businesses, commercial real estate or autos are able to bundle and sell those loans into a vibrant and liquid secondary market, it instantly recycles money back to financial institutions to make additional loans to other worthy borrowers. When those markets freeze up, the impact on lending for consumers and businesses - small and large - can be devastating. Unable to sell loans into secondary markets, lenders freeze up, leading those seeking credit like car loans to face exorbitant rates.
Banks create money when they make a loan. That's a privilege and that's why they are regulated.
But it's hard to see the compatibility of that with the <$1tn PPIF. Once the insolvent banks are taken under public control (involving capital injection, or following capital injection aka "buffer", I don't quite get), the government can choose what it wants to do with compromised assets, including keep them on the books.
In other words, what's the use of the PPIF, if backdoor nationalisation is indeed the aim?
So stabilizing the banks won't solve the credit squeeze. It will just stabilize the financial system. Which is no mean feat, but still only a partial solution to part of the problem. Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
Cleaning up banks will unclog several basic functions of the banking world which are very necessary and are still seriously constrained right now. In the long run, we're all dead. John Maynard Keynes
Or at least, to clean up the banking functions which they're supposed to perform - which may not be the same thing.
It is going to take a lot of time for this entity to get set up and find willing private partners and, together with them (or thanks to their superior market know-how), analyse the often very complex vehicles involved.
Meanwhile, an audit is going to estimate the banks' exposure to bad stuff. (How that is to be done convincingly without evaluating assets I don't see). There will then be an injection of a capital "buffer", and/or nationalisation (according to the Trojan Horse theory). This may well occur well before the PPIF has got far in its price-setting and allocation tasks. What use will it then be, what will be its role?
I think that if major American banks are nationalised, that will be because it becomes inevitable, not because this unclear, confused communication from Geithner masks a cunning plan to reach that goal without Wall Street seeing it coming.
But I'm not impressed by the very-cunning behind-the-scenes plan explanation. Once Obama's main project for dealing with an urgent financial crisis has failed, I don't quite see what extra leeway to introduce more radical policy he'll have gained.
We shall see.
What evidence is there that Obama works like that, or has ever worked like that?
Let the Chinese exchange (essentially) worthless pieces of paper (US IOUs) for the properties. The US declares that we put one over on them (Those stupid Chinese!) and the Chinese have a peaceful invasion of the US.
EVERYBODY WINS!!! (Throw confetti here) In the end, might makes right. Nothing has changed since the caveman.
So the banks will be stabilised with a convertible loan. Then the plan is that they'll try to sell off the toxic (um, "legacy" seems to be the new term) assets so the banks can lend again. They'll also try to get the asset-backed-security market going again to kick-start securitisation. What will happen if an when these attempts fail is anyone's guess.
I think it is necessary to stabilize the existing "bad" banks so that their spasms stop causing seizures in the broader economy.
Restarting the flow of credit is a different thing. Apart from the contradiction inherent in saying everyone is indebted beyond their means and immediately laying out a plan to start lending again, there is the fundamental problem that the securitisation mechanism involves selling loans to non-bank entities which are not required to have regulatory capital to cover the risk of default and so should possibly not be allowed to actually buy a loan. Hopefully Geithner doesn't intend for the stabilised banks to start creating SIV's and off-balance-sheet "conduits" again.
So, once the banks are stabilised I think there will still be a credit crisis in the "real economy". I am not quite sure how to deal with that. Also, after a debt binge there must be a monetary contraction unless the debt is inflated away. So it seems to me that a few months from now an expansion of unemployment benefits and of employment through public investment will still be necessary.
Somebody sitting on a large pile of cash could decide to set up a new private bank and start lending from it. There's not going to be much competition from the old banks, and apparently also not from direct government lending. Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
So we may switch one credit crunch for another... In the long run, we're all dead. John Maynard Keynes
Which is exactly what I propose through a "Capital Partnership"
1/ Put the assets and liabilities in custody.
2/ Share the revenues between Managers/Staff (Human Capital aka Labour) and Investors (Financial Capital) proportionally.
Share the defaults (ie losses of financial capital) proportionally aka pari passu among the investors. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
Institutions don't trade shares - they trade the beneficial interest in the shares...
Nothing new there. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
