Saturday, March 21, 2009

Uh Oh - Initial Details of the Treasury's Toxic Assets Plan


The first details of the treasury plan have leaked, covered by the NYT here.

The Times does a nice job of explaining the objective of this plan:

Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60cents on the dollar.

The result has been a paralyzing impasse. Banks, unwilling to sell their loans at fire-sale prices, have had less capital available to make new loans. Mortgage investors, unable to leverage their investments with borrowed money, have been unwilling to pay more than fire-sale prices.

To break that impasse, the government’s crucial subsidy is meant to provide investors with the kind of low-cost financing that has been utterly unavailable in today’s credit markets.

A Friday evening leak, and if the initial reaction is any sign, this probably won't go over well. Although, the press has decided that Geithner can't do his job and is going to go after anything he puts out. I'm not going to defend Geithner, and I think he obviously needs some political/PR training, but people need to understand that there are no "good options" in the current crisis.

Krugman sums up the opposition to the plan, more below:

The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.

To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad — I mean misunderstood — assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.

Krugman's charge that the Obama administration thinks "there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank" is a leap. Unless I'm missing something, this plan means that they think the assets are worth more than 30 cents on the dollar but also that they are worth less than 60 cents on the dollar, far from "nothing fundamentally wrong" with the assets. In the links below, you can see that there are some gaps in the details released so far, people are just assuming the worst.

Everyone agrees that these toxic assets are choking the system, and the fact remains that if you don't do something like this, you either take over the banks and their bad assets (huge cost to the taxpayer among other complexities) or pay the 60 cents on the dollar for the bad assets that the banks are willing to sell for (again, huge cost and a bad investment). The key thing to watch is if the banks are allowed to set a reserve price at the auction of the assets, say at 60 cents on the dollar. If they can, then I agree that this plan is probably the wrong one.

There are some credible supporters of a plan like this, Lucian Bebchuk, an economist at Harvard is one.

However, there are many detractors, below is a roundup of respected economists who have panned the initial details:
Krugman is unhappy. Really unhappy.

Calculated Risk is not enthusiastic

Yves Smith at the Naked Capitalism Has a Detailed Rebuttal. And a follow up.

Are they right? Let's hope not.


Anonymous said...
March 21, 2009 at 10:00 PM Delete Comment

The whole idea rests on giving C, BAC, WFC about $0.80 or more for assets trading at $0.20 and probably at most worth $0.50.

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