More Money from Helicopters?
Today the Obama administration has finally released the details of its plans to jump-start lending. The core idea of the plan is to help finally put a value on 'toxic assets' while simultaneously removing them from banks' ledgers. The thought is that without such uncertain assets, banks will be more willing to lend - not only to the public, but to each other. But will it work?
Doom and Gloom
Many
bright economists seem to think not. Paul Krugman is a very widely read columnist for the New York Times. He is also a Nobel Prize winning economist. So yeah, we might want to listen to him. Well, if he had anything constructive to say, that is.
"This is more than disappointing. In fact, it fills me with a sense of despair. " This is how Krugman describes the new plan. "But the real problem with this plan is that it won't work. Yes, troubled assets may be somewhat undervalued."
Somewhat undervalued? Right now they are essentially worth zero, as no-one wants to sell OR buy them. Those holding assets don't want to sell them off at 10 or 20% of their face value, because they are
probably worth more. Those who might buy the assets don't want to pay for them, because they are
afraid that they might actually be worth zero. The result is a logjam - even if banks wanted to clear their books of such 'toxic' assets, they couldn't reasonably do it because nobody is buying.
Valuing the Invaluable
The push from Krugman and a lot of other well respected economists is nationalization. Take over banks that are insolvent, regardless of their size. Do some magical 'house cleaning' then re-privatize once the banks return to solvency. That still doesn't solve the problem of toxic assets, though, or putting a value on them. Even if the government assumes full control of the top 20 banks in this country, they will still have that problem to deal with. Without putting a value on assets, you can't ever balance the books or ensure solvency.
These assets must be assigned some sort of value. They're certainly not zero, as even an asset that was based entirely on foreclosed homes is still worth the value of the homes the loans were made against. But these assets are not all bad - that was the idea! The plan was to chop up the high-risk loans and put them together with safer loans to hedge the risk. But now a lot of these securities are so complex, and everyone has become so risk-averse, that if there's even a whiff of trouble with an asset it's 'hands-off'. That's just silly.
There is a lot of money to be made out of this, if people are willing to look at the long term. That's what the new plan is banking on, anyway. Since the market itself will not reach equilibrium on these assets, the government is going to offer incentives for it to do so. These incentives come in two forms - assistance with the initial outlay of the investment, and an assumption of the risk associated with the investment. The thought is that by reducing the risk, investors will be more willing to pay a higher price for the assets - a high enough price such that the holders will be willing to sell them. That will set a value for the assets, get money flowing again, and get the assets off the books of troubled banks so they'll be more willing to issue credit.
Political Realities
Maybe nationalization IS the way to go. In a perfect world devoid of politics, public opinion polls, and a
very vocal opposition, it might be the most effective way of dealing with the problem. That's not the world we live in, however. Just how expensive would bank nationalization be? Thanks to the torch-and-pitchfork response of the general public, and the media's fanning of the flames, there is literally zero chance of congress putting up any more money for the task. The time-honored tradition of keeping the public uneducated and uninformed is hurting us all in this case. Way to go, oligarchy!
And even if we
could afford it, who would the government choose to run the new nationalized institutions? These are not small, local banks - they are multinational behemoths. The argument that we shouldn't "reward the same people that got us into this mess" by bailing them out is horribly flawed. The same people that got us into this are the only people that can effectively manage the institutions once they return to solvency. It's not like we have a huge pool of banking talent that didn't have their hands in the pot when it boiled over - the entire industry is at fault, so there is no one clean enough to do the job. The same people will have to continue to do it, hopefully with much tighter oversight and regulation. It's time for the SEC to come back from its 8 year coffee break.
The reality is this - the administration has to fix the banking sector, and they have to do it without further help from congress. The only realistic way to relieve the banks of their bad debts is to buy them, and it will take both public
AND private money to do so.
Yes, It Could Work!
A major criticism of this program is that there will still be no-one willing to buy - even with the government's assumption of risk. The argument is that investors will continue to push down the price of the assets as much as possible to maximize their profit. Not every investor has their eyes on cashing out tomorrow or next week, though. Compare this potential investment with other existing investment opportunities. There is money out there - investors just don't know where to park it.
Pension funds and endowments, for example, are hungry for investments that promise long term growth with low risk. Just take a look at the 3-month treasury bill. Large investors are willing to take almost zero return in exchange for very low risk. Those are the kinds of institutions that will participate in this program. They'll get potentially much higher rates of return with roughly the same risk as the 3-month treasury bill. Who wouldn't go for that?
