Ezra asks important questions about the new financial plan, and since we've been shouting at each other here in TAP HQ all day, it's time to take it to the blog. Here's the crux of Ezra's concern:
The question, at some point, becomes what value the private investors are adding. Some, to be sure. They're also going to manage the investments. But you have to ask: How much is it worth to say that the price of the asset is a "private price" after Treasury has systematically biased the pricing in a particular direction -- which explicitly suggests they don't trust the private market's natural pricing mechanism -- and the FDIC has assessed the asset's integrity and decided on the leverage offer that will further influence the private investor's pricing decision? Is it really worth giving up fully half the profit the taxpayer could otherwise expect and subsidizing most of the debt?
Short answer: yes. Or so the administration would tell you. Obviously this new market isn't a perfect free market, but you start to walk down a very laissez-faire path when you start worrying about government interventions distorting the prices of things. Of course the government doesn't trust the private market's natural pricing mechanism -- it's broken right now. There is no market for these assets and loans, and thus we have no idea how much they cost except that it is probably less than their original value but likely, in the long run, more than fire-sale value, and certainly more than zero. But they are sitting on banks' balance sheets, promoting both insolvency and uncertainty.
The administration sees this problem: People are not willing to take enough risk right now. The investments in question with this plan, which are based in various ways around the failing mortgage market, are likely undervalued, especially given the amount of money and effort the government is just beginning to put behind improving the housing market through nearly every possible avenue. It's hard to imagine that an investment fund could find any bank to finance an investment in them today, so the FDIC (or TALF, in the case of securities) fulfills that role. The fact that they are going to adjust the subsidized loan agreement on a case-by-case basis is a good thing, since it helps control government risk by ensuring that subsidies are as close as possible to the point where they create incentives and aren't overpriced themselves. Yes, all of that information will play into the private manager's bidding decision, just as availability of financing from a regular bank would. But they still make the ultimate decision about what price to accept within those constraints, and still stand to lose their money and their fund if they choose wrong.
Why does the government need the private sector? First, they want to share risk. An entirely public plan would leave all of the risk on the government's books; including private investors offers at least some risk sharing, even if the ratios may not be perfect. Second, they want to leverage their limited funding for maximum impact, and so any extra capital helps even if the debt structure leans on the government. Third, they do need the market pricing. While Ezra rightly recognizes that this system does have biases, a properly managed auction will do a quicker and cheap job of setting prices than the various forms of nationalization, which will either rely on fire sales or long-term management of these assets. While critics of the new plan like to point out single cases where the investor can calculate very carefully how to maximize their profit, I haven't seen anyone model what happens when two -- or more -- investors reach that same calculation over the same asset pools in the bidding process, save that they could increase their risk. Finally, Treasury is not confident in their ability to manage these funds, especially with the numerous political problems that would undoubtedly arise.
Ez is chiefly concerned with profit, as in, why should we help those financial-industry bastards make all the money when we could just do it in a public vehicle? It's a compelling critique, though I think the reasons above represent a good response to it. But in a bigger sense, this isn't about profit. It's about improving credit flow. The most important thing about the program is to create incentives for people to start buying and selling these assets. Many critics are complaining that these are subsidies for bankers, and yes, they are -- although they are also subsidies for regular people as well, since the government will include mutual funds, pension funds, and other long-term institutional investors in the plan -- but they are toward a goal that is not profit, it is toward macroeconomic health. So if prices are biased to be a little higher, that goes toward the problem of bank solvency in a more profitable way for taxpayers than capital injections.
Oh, and a final note on this plan from Noam Schieber:
But what if you set up the market and the prices are still so low they leave the banks insolvent? Even if the banks don't sell, you've not only revealed what a lot of people believe to be true, you've also stamped that belief with your imprimatur.
It may be an intentional exit strategy which just happens to leave you, really, with only one policy tool left. It happens to be popular with Paul Krugman.
-- Tim Fernholz
