Krugman self-servingly links to a much, much better discussion in a later post: Great minds (March 23, 2009)

Felix Salmon links to a post by Nemo offering a numerical example of the subsidy provided by the "Geithner put." I like it -- because it's almost identical to my own example. That's not a criticism, by the way: the natural way to think about these things is in fact in terms of simple two-state numerical examples.

Here are the links to Nemo's articles on the Geithner plan.

self-evident » The "Geithner Put", part 1

Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.

Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.

IMHO, if a bank approaches the FDIC with a pool of residential mortgages that it is seeking to divest, the FDIC should forthwith add the offending bank to this list.

self-evident » The "Geithner Put", part 2

Step 1: Treasury will launch the application process for managers interested in the Legacy Securities Program.

Step 2: A fund manager submits a proposal and is pre-qualified to raise private capital to participate in joint investment programs with Treasury.

Step 3: The Government agrees to provide a one-for-one match for every dollar of private capital that the fund manager raises and to provide fund-level leverage for the proposed Public-Private Investment Fund.

This one is about making (hedge) fund managers work for the treasury as if their skill set were critical to getting us out of this mess.

Then he addresses the kinds of criticism of his first post that rootless2 presents in this diary

self-evident » Fun with uniform distributions

(Update: If there are too many numbers and equations below, Mike at Rortybomb has created a fantastic post illustrating the principles graphically. And he even uses lognormal distributions like a real financial engineer.)

In my earlier post on the "Geithner Put", some people objected to my model as unrealistic.  Which is true.  So, using ideas from Andrew Foland (via private mail), I decided to grind out the math for a uniform distribution. Yes, a Gaussian might make more sense, but I doubt the answers would be all that different.  And besides, that might not lead to a nice closed-form solution.

Anyway, here is Andrew's model.  Assume lots of identical assets.  Assume each has an unknown value uniformly and independently distributed between m-a and m+a.  In other words, m is the average value and 2a is the range of possible values, and everything in the range is equally likely.  Let k be the "leverage factor"; i.e., the fraction of the purchase price that consists of equity.  So for 6:1 leverage, k is 1/7.

And finally

self-evident » On bags and their holders

OK, so we know that high-leverage non-recourse loans may result in the lender losing a lot of money to the borrowers. The transfer is large when the leverage is high and when the value of the assets is very uncertain. The transfer is largest when the possible outcomes are heavily weighted toward the extremes; what statisticians call "fat tails" or "platykurtosis". (If these terms mean nothing to you, relax; I am just throwing words around that I barely understand myself. This is a blog, after all.)

Perhaps the leverage and probability distributions are such that there will be no massive subsidy. More sinisterly, perhaps the transactions will not be at arm's length, and the banks (and in particular, their creditors) will effectively be both the buyers and the sellers fleecing the FDIC/Fed, and the whole point of this complicated structure is to hide this from the average person. Interfluidity has an excellent piece espousing this view. I am not quite so cynical as to think he is right, but nor am I so trusting as to think he is wrong.

Regardless, we know that the FDIC and Federal Reserve are making these loans. So what happens, exactly, should one of these organizations lose a lot of money?

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith