Belligerati

« Did they just start using their own product? | Main | What to do about corruption »

March 23, 2009

This thing is bad, really bad

The latest Geithner-Obama banking plan stinks. Do we really want to give these people 3% of the downside for 20% of the upside? Are they crazy? As others have pointed out, this is similar to funding a giant hedge fund with 5 to 1 leverage. It it is ever good to be the bank lending the 5 to 1 leverage, does anyone believe that

1) Proper controls will be in place to prevent inappropriate risk taking (just the opposite the whole plan seems to encourage it.

2) That this is the appropriate leverage for this asset class? Five to one might be okay for a government bond arbitrage fund, but this is highly speculative distressed mortgage products. This stuff moves around a lot depending on expectations of economic and property price growth.

3) That the banks organizing the funds won't game the auctions? Goldman participates in one of these funds. I'm not positive about this, but it seems If they overpay for Goldman assets, then they capture at least 80% of that overpayment. Say the new government fund has 100, 3 of which is from Goldman. Goldman's bond is worth 20 and the Goldman-US s hedge fund bids 50. Goldman makes 30 profit on the bond, the G-U loses 20, 3 of which comes from Goldman. Total profit for Goldman is 27, total loses for the US is 17.

This cannot be allowed. If subsidies are the only thing keeps the banks alive we must pull the plug. If we have to subsidize banks to avoid catastrophic failure, I want to subsidize banks that avoided these problems, not those that monkeyed with exotic junk or too much leverage.

How about we allow a list of banks and financial entities which have weathered the financial storm to bid on subsided long term loans up to and including negative interest rates. One way you could more easily allow rates to be negative is to make the positive in the present but allow the principle to not be fully paid back. For example, you borrow $100, you pay 5% in interest every year, but 10 years out at maturity you repay $88. If you want to combine this with the toxic asset auctions, you could additional require that no one could bid on assets they currently hold or you could force everyone to make two way markets.

One thing I don't quite understand about the plans like Krugman's to guarantee some or all bank debt is why it has to be for the debts total principal and interest. If you are going to guarantee assets, at the very most shouldn't they have the yields of similar duration US treasury bonds? These assets were attractive to investors because they had more return for more risk. Now that they don't they shouldn't. If you are concerned about the breach of contract aspect of it, make it voluntary. Anyone can trade in that asset for duration matched treasury.

Link round-up:
Geithner's Doomed Bailout Plan
At first I thought these numbers were a typo
Government Intervention in the Market for Toxic Cars
How will the Geithner Plan Ever Get Approved?
"Despair over Financial Policy"
The Geithner Plan FAQ seems to defend the plan.
Investor on Private Public Partnership: "One would have to be a criminal to participate in this" explains how to use this to turn the government into a money pump

Posted by OneEyedMan at March 23, 2009 8:24 AM

Comments

Post a comment