Having promised to do the really hard part which is to key the discussion on Our Hero's financial stabilization plan, I got side-tracked in talking about the Detroit debacle when low and behold, here comes not only the Wall Street Journal AND the New York Times to help me out in the form of a leading article and a learned piece from a Nobel laureate. Patience is indeed a virtue and good things come to he who waits. The Times is usually easy to dismiss so let us begin with Prof. Joseph Stiglitz.
I don't get it about these Nobel guys. How the dickens can you be that smart in one area and be so woefully uninformed is seemingly all others, especially when your success and fame has been a result of painstaking research. Yet, both Stiglitz and the new rock star of the op-ed page, Paul Krugman. I think they get in each other' head. Today, Stiglitz, parroting Krugman proclaims that nationalization of banks would be preferable to Our Hero's plan because the FDIC has taken control of failing banks before. "It has even nationalized large institutions like Continental Illinois...and Washington Mutual." Memo to Messrs. Stiglitz and Krugman: you haven't a clue. The FDIC has NO BOD EE to handle anything like the institutions in question. Dirty little secret: when the FDIC wants to get into a bank THEY HIRE AN OUTSIDE FIRM TO DO IT FOR THEM. THEY OUTSOURCE THEIR WORK JUST LIKE THE MILITARY WITH BLACKWATER. Got it guys? Con Ill and WaMu were a walk in the park...especially Con Ill. Con Ill failed because, limited by Illinois banking laws they were highly dependent on short term funding and failed when they lost their liquidity as a result of correspondent banks (many Japanese) pulling their lines. Lost liquidity. Now where have we heard that before? Restore the liquidity, allow some time and bingo, a new bank!
Aside from his preferred solution, Prof Stiglitz is not a bad read in as much it points out quite clearly that one of the terrible features of Our Hero's plan is that if it doesn't work the taxpayer foots almost all the bill. Then again, in for a Penny in for a Pound is what I say. Then again, there are a lot of Pounds...
The Journal has an extremely interesting take on the evolving tale. As I understand the plan in its present form, the Treasury is proposing to assist in the creation of a pool of "toxic assets" selected by participating institutions to be made available for sale by way of auction to selected "fund managers" chosen by Treasury under a set of guidelines proposed by Treasury. These guidelines go to the size and experience of the managers based on the amount of similar assets in their portfolios. From the get-go this is certain to severely limit the number of firms who could qualify as managers. Treasury, in what it refers to as a "partnership" with the managers would share in an equal amount of "equity" with the managers and make available debt geared to approximately 7x the equity to the managers to enable them to purchase the assets from the banks. This debt would be of a non-recourse basis: i.e. the Treasury--you Mr. & Mrs. taxpayer--will get it repaid ONLY from the assets purchased; the manager is not on the hook in any way save for its equity contribution. It appears that Our Hero has read somewhere that Wall Street is governed by fear and greed and this structure is designed in his mind to appeal to the greed part. Big pay-off if things go right for little risk. He is probably correct. From the standpoint of the participating institutions, if all this works they get this bad stuff off their books, are able to recapitalize and head off into the sunlight ready to make available massive amounts of new credit which will reinvigorate the economy, which will...well, you get the idea. A triumph of the market.
Of course, there is always some smart-ass that starts asking questions. If the object is to create a market for these thing as Treasury so states, why restrict the pool of potential purchasers to a hand-picked few, asks the WSJ? Wouldn't one wish to have as many potential purchasers as possible out there to obtain as much competition as possible on the bid side? I fair question I think. Oh, isn't this Washington and doesn't politics rule Washington and if so wouldn't politics play a (big) role in the choice of a limited number of managers--or to put it another was, it's the transparency thing. If you answered that question in the negative, stop reading. You're hopeless. Another thing also comes to mind: How are these assets to be priced and who gets involved? One assumes that we are in the midst of the famous stress test after which the Treasury and the Fed will know precisely what these institutions have and the value of the same (the Fed is added because you always need some poor slob to blame if things go wrong). And to add to the list of sure things, the Cubs will win the World Series.
You see, the institutions have already had their brains beaten in by being forced to mark these assets down with the resulting loss in capital. Having taken the medicine, if there is a chance that they might recoup some of those losses as the assets mature and pay off they are going to be loath to surrender the upside. Consequently, their offer price might result in a considerable spread from the managers' bid...remember, these guys are not the Little Sisters of the Poor. What happens? Well, in a real market, one side would say, "Nothing done," and move on. But is there a real market? I think not. What troubles me and I am sure more than a few of the participating banks is that this will be a government mandated and managed transaction. To work, there must be a bid and I can easily see The Leader with his crack team beside him announcing to the American People, "It is not our intention to run the banks, but bold new steps must be taken and in that spirit, Messrs Jones, Smith and Brown have resigned as CEOs and I have asked My Secretary of the Treasury..." There will be an offer that the managers can lift gang, bank on it. More on this tomorrow and oh, hey, isn't this G20 thing a kick!
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