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Plan B (C?).

The original TARP idea was to hold reverse auctions for mortgage-backed securities. The government would hold them to maturity or resell them. Whatever one thinks of this plan, it puts relatively little burden on government decisionmakers. However, one criticism of the plan was that government agents would not be able to set the price correctly, whether through the auction mechanism or in some other way, and therefore end up underpaying (in which case the plan would not work) or overpaying (enriching greedy investment bankers).

It is now clear that Treasury will take a more aggressive approach. Not only will it buy commercial paper; it will buy equity in banks. It may well be that liquidating the market in MBS's would not have been adequate, and more aggressive measures are needed. But if one has doubts about the ability or incentives of government agents to price correctly MBS's, then one ought to have even more doubts about the new agenda. To buy commercial paper, you need to distinguish among the various companies that offer it, and pay no more than its value, which requires a good knowledge of the balance sheet and operations of the seller, not to mention the market in which it operates and the health of the economy and financial system. Sure, it's short-term and therefore safer than other forms of debt, but it still needs to be priced correctly in light of its risk. To buy equity, you need to make similar judgments. And to exercise one's rights responsibly, one needs to monitor the company, its market, and the economy, and exercise any rights one has -- in the case of equity, to control the operations of the company. Good luck!

As the financial system collapses, the banks are increasingly becoming ventriloquist's dummies for the government. They remain as shells but the government calls the shots. In the case of the commercial paper market, the fiction is not even being maintained: firms borrow directly from the government. People call this process "restoring confidence" in the financial system; but it really just replaces one financial system (a more-or-less private one) with another (a government-run system). It's as if a hurricane hit a city and the national guard took over food distribution. We don't say that the government is restoring confidence in the private food distribution system; we say that it is operating the food distribution system, and will do so until the private system recovers on its own.

Related Posts (on one page):

  1. Bailout Analogy:
  2. Plan B (C?).
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Bailout Analogy:

I've been thinking about co-conspirator Eric Posner's analogy (see chained post) in regard to the recent Treasury Dep't moves in the banking bailout:

It is now clear that Treasury will take a more aggressive approach. Not only will it buy commercial paper; it will buy equity in banks. . . . People call this process "restoring confidence" in the financial system; but it really just replaces one financial system (a more-or-less private one) with another (a government-run system). It's as if a hurricane hit a city and the national guard took over food distribution. We don't say that the government is restoring confidence in the private food distribution system; we say that it is operating the food distribution system, and will do so until the private system recovers on its own. (my emphases)

Is the food distribution analogy the right one here? There is a difference between buying equity in banks [or food distribution companies] and sending out the national guard to do our banking/food distribution work. Among other things, we (i.e., the Treasury) participates in the upside (if there is an upside) in the one and not in the other. And more to Eric's point: it is not quite as absurd to call the former a "confidence restoring" move. Warren Buffett's purchase of Goldman Sachs equity was widely seen (correctly, imho) as a move that could "restore confidence" in Goldman, because buying equity is very stupid if the firm is going into bankruptcy but very smart if the firm is going to recover. The Treasury plan is not exactly the same, I realize, but calling it a move that might "restore confidence" in the banks doesn't strike me as so terribly over-the-top.

Related Posts (on one page):

  1. Bailout Analogy:
  2. Plan B (C?).
15 Comments