Fifty ways to scam the tax-payer: Geithner plan link-fest
You all have a nice Paranoia Wednesday...
Background:
- Don't understand the Geithner plan? John Carney says: That's the point! (and by the way, here is your bill of 3 trillion dollars)
- Willem Buiter gives a good run-down of how the program will work
- A general discussion amongst Krugman, Delong, Johnson and Thoma of the various worries about the plan's viability.
- Matthew Yglesias worries about longer-term consequences of bailing out the banks - imposing regulation gets harder.
The Scams:
- Scam #1: Karl Denninger worries about banks bidding themselves (directly or indirectly) on their own assets.
- Scam #2: Zero hedge worries about incentives for private partners to massively overpay.
- Scam #3: Naked Capitalism worries about private partners betting against themselves, to the tax-payer's detriment.
- Scam #4: Steve Waldman worries about bank bondholders bidding as private partners, and thus bailing themselves out.
An excerpt:
Consider a hypothetical asset manager, PIMROCK. PIMROCK reviews a pool of loans held by the bank J.P. Citi of America, and its analysts determine they are worth 30¢ of par value. The bank holds them at 80¢ on its book. PIMROCK agrees to put down $10B to purchase loans from the pool at 82¢ thrilling stock markets everywhere. It was all just a bad dream!
Under Geithner's plan, PIMROCK's $10B permits a $10B equity investment from the Treasury. Then the FDIC levers the whole thing up, providing $6 of debt for every one dollar of equity. So, $140B of bad loans are lifted from J.P. Citi of America, nearly $90B of which is sheer overpayment to the bank.
Of course, as cash flows evolve, PIMROCK's $10B is wiped out entirely, as is the Treasury's investment. The FDIC gets repaid in a bunch of securities worth about $50B, taking a $70B loss. But, as Calculated Risk, likes to say "Hoocoodanode?" These were real market prices, Geithner or his successor will argue. Our private partners lost everything. There was no subsidy here.
Meanwhile, taxpayers will be out around $80B.
Why would PIMROCK go along with this? Because they feel it is their patriotic duty to work with the government for the good of the financial system, even if that involves accepting some sacrifices. And because they hold $100B in J.P. Citi of America bonds, and they've received assurances that if we can get the nation out of the financial pickle it's in, there will be no haircuts on those bonds. "Shaking hands with the government" means that nothing ever has to be put in writing.
I don't know how bad this is - it could be worse. It is a blatant bondholder bail-out (btw, I see my bank bond portfolio is up 10%!), but note two things: (i) it is more politically palatable than a direct bail-out, because we only realize it is a bail-out after the fact. (keyword: deniability). So this gets around the huge political problems of getting bail-out legislation passed. And I have a slight preference for doing something rather than nothing. (ii) It involves an implicit haircut on bondholders of 10 cents on the dollar. Not much, but it's better than nothing.
I still think it is one ugly beast.
Update: via Felix Salmon, Nemo offers the finest example I have seen of how easy it could be to scam the Geithner plan. (NB. its success depends on the structure of the auctions).
Late Update: A great summary of Geithner's general strategy in cleaning up the banks from the FT. One seeming flaw in the new plan was that the asset sales remained optional for the banks. And given sales would lead to write-downs, it seemed they lacked incentive to bring the toxic securities to market. However, the FT piece has this nugget
But while banks in theory have discretion over whether to sell loans, Sheila Bair, chairman of the Federal Deposit Insurance Corporation, said this decision would be made "in consultation with regulators" - a sign that the authorities might put pressure on banks to sell toxic assets.
Policymakers say the Geithner strategy is intended to fix the disconnect between the market and the banks by restoring investor confidence in their financial statements.
This is a very good sign.
Heads are now exploding amongst some progressives. Nouriel Roubini gives a tacit endorsement of Geithner's plan.
NY Daily News
March 25, 2009 10:15 AM | Reply | Permalink
Thanks for that JSF. Interesting to see Geithner's old colleagues Roubini and Delong kind of on board with this idea. To me that's a good sign. Bizarre, but good.
March 25, 2009 10:23 AM | Reply | Permalink
I'd like to believe Geithner et al would have thought about scam potential, but until I see evidence of this I'm sticking with Prudent Paranoia.
OTOH, it's only money and not mine unless I buy into some fund designed to buy into this strange notion that we should push up asset values rather than establish the fundamentals in a way which lets the private market decide.
Good post, Obey. I hope TPTB are not ignoring such concerns.
I could not quite follow the Pimrock story. FDIC adds $5 for every $1 of equity, and that's $.50 of private equity, right? So the buyer equity could be as little as 1/12 of the purchase price. The gist is that the banks could overbid on their own assets (perhaps through a third party, or on each other's assets), have the 1/12th part wiped out but get the full current price of 12/12ths, thus ending up with net 11/12 reimbursement. The government ends up paying the 11/12 and owning assets whose real values remain unimproved.
Goldman for instance supposedly has $100B in cash just waiting to buy stuff. And for every purchase, the asset coming off the books frees up more capital for more purchases, right? So even weaker "banks" can play here, in increments. It's pie in the sky bootstrapping, in my view. This really is a shell game.
Geithner must be in cahoots with the banks. I'm pretty close to capitulating on the benefit of the doubt here.
March 25, 2009 1:26 PM | Reply | Permalink
Yeah - my real problem is with Bill Gross doing the buying. He has OBVIOUS conflicts of interest. The Pimrock scenario only works if Geithner lets bondholders participate in the auction. And, insanely (or corruptly) he is.
March 25, 2009 1:44 PM | Reply | Permalink
DeLong on Krugman is criminally incompetent:
"Both things are going on. And I suspect that in the end we will be driven down the road to some form of bank nationalization — and if that is where we are going Paul Krugman is correct to say that it is better to get there sooner rather than later. But unless Paul Krugman has 60 Senate votes in his back pocket, we cannot get there now. And the Geithner Plan seems to me to be legitimate and useful way to spend $100 billion of TARP money to improve — albeit not fix — the situation."
It's not spending $100B. It's spending 11/12 of $1T, when you include the "loans".
To make this out as a political problem, as DeLong does, is moral bankruptcy. And "nationalization" is AGAIN, not the only option.
DeLong answers "Yes [both Krugman's 2 options]" but doesn't look at the relative importance of both factors. He's clearly on the "less thinking and planning is better" bandwagon here.
Brad gets an F here.
March 25, 2009 1:59 PM | Reply | Permalink
I think Delong and Roubini got a call from Geithner, begging for back-up. They trust him. don't know if that discredits them or gives him some credibility...
March 25, 2009 2:04 PM | Reply | Permalink
I think that you and I are doing more thinking about this than are those folks. I'm sure we're talking out loud a lot more, and what we're saying isn't just hot air even if some of it is.
Given DeLong's dishonest reply to Krugman (he may be sincere but he's morally, intellectually and political corrupt in that reply) he's not judge to rely on. He's as entrenched in his polyanna mindset as some people think Geithner and Paulson were mere tools of the Goldman Sachs mindset.
March 25, 2009 2:15 PM | Reply | Permalink
I usually quite like Delong, but this is a bit odd...
March 25, 2009 7:00 PM | Reply | Permalink
"tacit endorsement"? Did you read Roubini's article? It was a lukewarm endorsement at best, with major caveats, and he only endorses it as a road to "receivership".
March 25, 2009 1:47 PM | Reply | Permalink
thanks for that joseph. I'll have to go read it now...
March 25, 2009 6:44 PM | Reply | Permalink
You and your friend write 80 pages on the origin of the universe in the middle of the night, and then you put together 50 links here.
You need to take a nap. hahahahah
I have some reading to do. ON THIS BLOG.
March 25, 2009 10:54 AM | Reply | Permalink
oh dear, Dick. Don't waste your time. It's all niggling detail stuff fun for those who want to get wonky. Just dumped my morning reading here as links. I'm not sleeping much these days. Maybe has to do with the dream I had monday, where Rush Limbaugh showed up as my new father-in-law, speaking French and being really nice. The dream was fine, but it was Having had that dream which was scary. You think it's an omen...?!
March 25, 2009 11:21 AM | Reply | Permalink
Carney does give us the dumbest line I have read in a long time, at least on those days when I don't review my old blogs:
If you say you have a bazooka in your pocket, eventually the market will demand you produce it and start blowing things up.
Is that a bazooka in your pocket or are you just glad you can blow me up? hahahahaahaha
Ok, guarantees work politically because no checks are written.
March 25, 2009 11:02 AM | Reply | Permalink
HAHAH! love the joke. What is it with these finance types and their obsession with having bazookas in their pants...
March 25, 2009 11:23 AM | Reply | Permalink
Check this out:
Brad Delong, Krugman and others "debate" on this NYT blog:
http://roomfordebate.blogs.nytimes.com/2009/03/24/will-the-geithner-plan-work/
I think Delong has the most measured and balanced view so far. Nationalization may be necessary but this will help some. Anything that reduces the liabilities vs. assets problem for banks is a good thing -- the less insolvent, the fewer toxic assets they still own, the better. It might not be enough but that's different than saying it is an awful plan.
March 25, 2009 11:18 AM | Reply | Permalink
Thanks for that observer. (I actually included this as the third link in the blog above). Check out the Kwak-Delong-Thoma discussion (Salmon is there too), it's got a lot of good back and forth on different aspects.
As for the 'awfulness', there are two criteria: (i) will it get credit moving again? and (ii) to what extent are bank stakeholders bailed out by the tax-payer? It's pretty awful on the second point, and I'm pretty skeptical as to the first point. Better to prop up the regional banks in my opinion...
March 25, 2009 11:28 AM | Reply | Permalink
If I understood old Willem (what kind of name is that anyway. I mean sure, he represents the London School of Economics, but he appears more Saxon and Anglo if you get my drift)I should be awarded some honorary degree, do you not think.
Like Carney, he is underlining the fact that guarantees are dangerous but politically advantageous because no checks are written.
He talks about the part where we (USA) risk 84 bucks to the 6 bucks risked by the private sphere. In another provision, we risk 300 bucks and the private sphere risks 100.
But are we not in fact just saying to the world, WE STAND BEHIND OUR CAPITALISTS? I mean is not the Administration logically concluding that if our capitalists go down, we do anyway?
I am going to continue reading these links throughout the day. I guess I am looking for structural change in the sense of breaking up some of the capitalist links so to speak.
If you are a mortgage lender, then be a mortgage lender. You are not allowed to bet in other markets.
If you are a credit card usurer, that is your new occupation. And by the way, here are some new limits on percentages that can be charged.
March 25, 2009 11:31 AM | Reply | Permalink
"But are we not in fact just saying to the world, WE STAND BEHIND OUR CAPITALISTS? I mean is not the Administration logically concluding that if our capitalists go down, we do anyway?"
- Well, they're saying 'we stand behind you' to the capitalists in any rate. Which is kind of like telling them 'L'Etat, c'est VOUS!' Which means it's kind of silly to call them 'capitalists'. Capitalists by definition do not work on, for, or with the state's dime. oh, I could start a rant now, but won't...
March 25, 2009 11:56 AM | Reply | Permalink
Oh, I forgot this:
"The Geithner plan can only work if view #1 is right. If view #2 is right – if the banks are really in deep trouble that goes beyond lack of confidence — subsidizing investor purchases of toxic assets, many of which aren’t even held by the most troubled banks, has no real chance of turning things around.
As you can guess, I believe in view #2. We had vast excesses during the bubble years, and I don’t think we can fix the damage with the power of positive thinking plus a bit of financial engineering."
I mean Krugman (where do all these Krauts come from anyway?) really knows how to cheer a guy up.
March 25, 2009 11:33 AM | Reply | Permalink
DICK!!! stop reading this stuff! (except maybe the Yglesias which is a bit more big-picture) AND write my goddamm lunch reading!! WHERE'S SHITEFACE!!
March 25, 2009 11:49 AM | Reply | Permalink
I went to The New Yorker site to look something up and found that Surowiecki, their financial columnist, has doing a very un-New Yorker-like exuberant amount of posting, reacting as he scans the op-eds blogosphere on the Geithner plan, my gawd, 4 posts in a single day! He comments on several you have, including Waldman, Thoma, the Angry Bear, DeLong, Krugman of course....
http://www.newyorker.com/online/blogs/jamessurowiecki/
March 25, 2009 12:21 PM | Reply | Permalink
Great link! thanks a lot. Missed this...
March 25, 2009 12:25 PM | Reply | Permalink
He's corrupt too. http://www.newyorker.com/online/blogs/jamessurowiecki/2009/03/the-blogosphere.html
He gets FRB wrong.
It isn't Geithner vs. Nationalization, that's a false frame intended to force the debate, to narrow thinking and drive it away from possibly better approaches.
He compares G. plan to normal FDIC covering of small depositor assets. But that's for highly regulated nominally conservative banking. We're not looking at that here. We're looking at shell games and criminal bootstrapping.
The thing is, if the FDIC will be on the hook for something 11/12 of the assets anyway, maybe it doesn't matter.
Maybe I'm wrong to think that bank bondholders should be placed in front of the FDIC in taking haircuts. That is, bank bondholders should be required to take losses before the government does. In G's plan, if bank bond holders have to invest openly to save their own skins, that sorta makes moral sense to me. This is like converting debt to equity in a bankruptcy.
March 25, 2009 2:39 PM | Reply | Permalink
Good points.
The issue isn't whether banking benefits from guarantees (Suriowecki) but who's getting those guarantees (Krugman).
I can accept recapitalizing banks -- sort of. What I can't accept is bailing out banks' unsecured creditors and shareholders.
And, although Suriowecki's argument doesn't touch upon it, the FDIC never bails out those two capital levels. They get whatever's left over after the FDIC's been made whole.
March 25, 2009 4:34 PM | Reply | Permalink
Ellen, don't you think that a debt for equity swap will cover any capital needs after the stress-test write-downs? They tend not to do that with senior debtors, but how about making a deal with the subordinates?
March 25, 2009 6:54 PM | Reply | Permalink
Does Roubini have it backwards?
March 25, 2009, 9:21PM
My blog. Who has it backwards here?
March 25, 2009 9:49 PM | Reply | Permalink
I've read that link. Nice evaluation. Just to clear up any possible confusion. There are two Waldmans - Steve Waldman at Intefluidity, who I find brilliant (that's the cited piece in the blog), and Robert Waldman at Angry Bear, who I find meh...
March 25, 2009 12:31 PM | Reply | Permalink
. . . — Geithner, Larry Summers, and Ben Bernanke — are well-versed in the problems of the banking system . . . The Geithner plan may be a mistake. But . . . . It won’t be because they didn’t understand the problem. James Surowiecki
The history of their dealings with past financial crises -- at least for two of the three -- doesn't give one a lot of confidence.
I think I'll stick with Krugman's claim that their actions (whatever they believe/understand) says they don't get it -- just as they didn't get it when it came to responding to the "Asian flu."
March 25, 2009 1:47 PM | Reply | Permalink
Great links, Obey, and thanks for the efforts; much appreciated.
Quaere: Non-recourse loans are the equivalent of a put. Have you run into anyone doing a Black-Scholes evaluation of the "Geithner put"?
March 25, 2009 1:25 PM | Reply | Permalink
No, let me know if you find out...
March 25, 2009 1:41 PM | Reply | Permalink
Let's see. I could read this or do my taxes. I could read this or take calculus.
I have to say that I admire all of you who can write and understand this because my cells won't sputter it.
March 25, 2009 2:42 PM | Reply | Permalink
Yeah - sorry about this Doomer. I've written clearer blogs...
March 25, 2009 6:50 PM | Reply | Permalink
Karl Denninger worries about banks bidding themselves (directly or indirectly) on their own assets.
Wouldn't that be something?! Redefining chutzpah...
March 25, 2009 3:24 PM | Reply | Permalink
Well, if they have anything left on Wall Street, it's chutzpah! Have you seen Josh's little discussion today on the return of Wall Street. Unbelievable.
March 25, 2009 6:51 PM | Reply | Permalink
"Got my mojo workin'
But it just don't work on you..."
Muddy Waters
March 25, 2009 10:01 PM | Reply | Permalink
. . . many [shrewd] investors will see the [PPIF] subsidy and decide to dive in, recognizing that most of any potential loss will be born by the government. This route might prove especially attractive for one of the zombie banks, who would effectively have nothing to lose anyhow, since they are already bankrupt. Dean Baker
They're already doing it!
Via Clusterstock, "CITI, BOFA BUYING BACK LAUNDERED LOANS AT LOWER RATES" New York Post 3/25/2009*
* More than two links holds for approval the comment and then, flushes it, so link can be found at Clusterstock.
March 25, 2009 10:33 PM | Reply | Permalink
This is crazy. This is why firing management and getting the tax-payer's interest as shareholder to actually have some effect on trading policy. I wrote about this a while ago - Citi bulking up on their proprietary trading...
thanks.
March 26, 2009 1:36 AM | Reply | Permalink
Who is selling 30% assets for 35% or whatever?
PPIP must be made "gameproof" or abandoned. How about having it apply only to "legacy assets"?
Or is the game simply the bet that if legacy assets get upgraded then these newer acquisitions will increase in price so that a 35% might be flipped at 50% in a month?
March 26, 2009 4:29 AM | Reply | Permalink
Clusterstock's (John Carney's) reading of DeCambre's reporting is that Citi and BAC are buying old paper -- "legacy assets" in Summers and Geithner's parlance.
"Instead of stimulating the economy by making new loans, B of A and Citi seem to be spending money to buy up old loans." Clusterstock
March 26, 2009 10:11 AM | Reply | Permalink
I understand that. My comment builds, or tried to build, on that.
March 26, 2009 2:05 PM | Reply | Permalink
Obey, another great post.
I hadn't noticed your change in politics. You might need bigger bathtub.
I always loved the lady, but don't forget to clean the tub before you invite her back.
March 26, 2009 2:01 AM | Reply | Permalink
Hi Sal, hahha - yes, just thought needed a different use for the tub these days. Hopefully have that lady back for a visit some day...
"You might need bigger bathtub" - LOL!!
March 26, 2009 2:22 AM | Reply | Permalink
Hey Sal, I got the Kevin Phillips book...
March 26, 2009 2:41 AM | Reply | Permalink
I am in the the camp of persons who decidely and unreservedly don't like any of the plans put forth so far.
The biggest problem I see is many seek to cover the bets of those persons or big money entities who played the game their way and lost.
The individuals who get to recover losses are mostly limited to these big players and doesn't do a thing for working class persons who lost serious money (in relative terms) on a 401K or other retirement vehicle.
This is so about the double standard that has so become a part of what defines this nation. No matter where I look or how I filter and examine how this coutry has decided to operate I see this double standard at work. And in most all cases it is about money and nothing else. The undeniable, factual and numerically verifiable shift of wealth to a very small percentile of the population is very disturbing. This trend is endorsed by every action our government has taken over several decades and absolutely denies any notion of equality of representation. And this is particularly disturbing because the vast majority of citizens are the losers. This pattern is the antithesis of democracy.
March 26, 2009 3:07 AM | Reply | Permalink
I think I agree with most of what you say. That said, if this plan works ideally, then it won't be a bail-out. It's just providing price-discovery and thus transparency about the banks' balance sheets. But my post was about all the ways in which it may very well fall short of that ideal.
March 26, 2009 3:37 AM | Reply | Permalink
The notion of an ideal in this probably isn't able to be expressed in a way that is agreeable to all persons.
Where our system is falling short is the ways in which it has been altered over the years. The alteration has introduced an increased level of risk for persons who don't have the means to accept that risk.
Wage earners can and do save but their income level makes their modest savings crucial in later years. The funded retirements that once were normal have been replaced by the present scheme. Our government and the financial marketplace changed this scheme for retirement funding and thus caused this inappropriate risk escalation. Working class people have no training or specific knowledge that allows them to make sound investment choices and having profit driven outsiders advise them has proven an unwise choice.
I am of the opinion that this has been and is more about making a vast pool of money available to large financial players for them to do as they wish. This gives them great gobs of leverage without risking their own capital. If this isn't a recipe for disaster I don't know what is. It is a forced rearrangement of the relationship between workers, government and business where workers didn't have a say in the negotiations.
March 26, 2009 6:33 AM | Reply | Permalink
Good points People. And I wholeheartedly agree. I was merely talking about the much narrower issue of this plan and its ostensibly narrower aim...
March 26, 2009 7:07 AM | Reply | Permalink
I think the logic of the statement "you can not serve two masters" is so revealing.
Serve the rich or serve the poor.
Serve the Minority Elites or Majority peasant class.
It is clearly, evident which class is being served.
March 26, 2009 5:10 AM | Reply | Permalink
Excellent post, Obey, and very helpful to those of us still trying to understand all the options and decide which is best.
A few comments:
Theoretically, I think nationalization is the best option.
Pragmatically, I have doubts it would ever get through congress. I think there will be massive opposition to nationalization from Republicans and right-leaning Democrats. Just as important, I fear the threat of nationalization will cause the markets to drop, thereby creating fear and doubt about nationalization among the public, and therefore giving potent ammunition to the opponents of nationalization. This will make it even more difficult to push through. Obama might be able to force it through, but he'd be betting his whole presidency on nationalization succeeding fast. If it failed--or even appeared to be failing for some time--his presidency would be over and he'd be a lame duck.
So Obama has, as is his nature, taken a very pragmatic course in pushing the less radical Geithner plan forward. If the problems are not as deep as some think, then the Geithner plan may succeed in restoring the financial system to equilibrium. That won't erase the systemic flaws in the system, however. So assuming the Geithner plan can restore equilibrium, then what we need to hope for is that Obama and his administration don't rest on their laurels once the plan succeeds at this limited goal, but move forward into a phase II of re-regulating to completely reform the banking system. If this is the path Obama takes, then I'm all for it. If he stops after the Geithner plan restores equilibrium (assuming it does that), then I'll be disappointed (and also expect yet another catastrophe down the road).
Of course, there's a good chance the Geithner plan won't work. If that's the case, then Obama will I think be forced into pursuing nationalization. Personally, though, I think the mortgage crisis is easing . . . and the Geithner plan may be just enough to restore equilibrium. What we need to hope for--in fact lobby for--is that once the Geithner plan works, the Obama administration moves forward aggressively to enact real financial-system reform.
March 26, 2009 7:32 AM | Reply | Permalink
Thanks for those thoughts PS. There are so many moving parts - dozens of programs, different aims for each, different complementary roles for each, unquantifiable risks and asset prices - that it is all very difficult to evaluate. If you take one limited goal for this program, price discovery, that it is supposed to achieve along with the stress test, then these different 'scams' really are very important. Because no one will believe the booked values for these assets even if they are trading thanks to the PPIP, since they will suspect the program is overpricing the assets. If you take another goal - getting them off the banks' books - then a whole other series of factors come into play: solvency, tax-payer exposure, effective pressure on banks to bring the assets to market.
Anyway, just trying to grab one little corner of this whole mess...
March 26, 2009 7:58 AM | Reply | Permalink