Felix Salmon wonders:
[B]idders for the banks' toxic assets don't care particularly about the idiosyncratic risks of any given loan portfolio or CDO. Instead, they're worried overwhelmingly about systemic risks associated with the ongoing financial crisis.Essentially, we are not living in a world where investment prowess is repaid, and the fate of the private-sector participants in Geithner's public-private partnerships is pretty much out of their hands. Either all of these assets are going to appreciate in value, or all of them are going to decline in value. And that's largely a function of what happens to international financial markets and to the global economy as a whole. The potential buyers of these assets can do all the homework they like, trying to bid on slightly better assets rather than slightly worse ones, but the big risks -- to both the downside and the upside -- are systemic In other words, the private participants in the Treasury plan aren't really adding value, they're just gambling that things are more likely to get better than they are to get worse. For this we need to pay them much more of the profits than their share of the total investment? Eventually, if things get better, then this kind of plan might make sense: correlations will come back down from 1, where they are presently, and private investors will be able to play a useful role in separating the wheat from the chaff when it comes to those legacy assets. For the time being, however, the days for such sifting remain far in the future. And it's not at all clear why it pays to bring private investors in at this stage.
I agree with everything that Salmon says. But I can also think of a couple other reasons Geithner would want private investors in the market. First, it gives the prices outside credibility. If the banks really are insolvent, better that be the judgment of the market than the decision of the government. Senator Nelson can argue with Geithner's estimation of the banks. It's harder to argue with outside investors. Second, they will manage the investments. This seems a job Treasury and the FDIC really want to avoid. Third, getting private investors to buy-in to this stage of the recovery plan might make it easier to ensure their cooperation with later stages. It may effectively co-opt the participants. Nationalization is one example. If TIAA-CREF vouches for insolvency, the market is likelier to think nationalization an act economic necessity than political capriciousness. Fourth, the private investors aren't putting up much equity. But they are putting up some equity. Without knowing the FDIC's leveraging decisions in advance, it's hard to pin down a number, but looking at the plans, something between 15 percent and 30 percent seems reasonable. And given that Geithner is trying to stretch every existing dollar to avoid asking Congress for more funds, that might be more important than we give it credit for. Fifth, they could simply be afraid of the market. More so even than they fear pundits. Though plenty of folks talk about the need to ignore the daily whips of the Dow, Geithner certainly took a lot of damage from the market's reaction to his initial announcement, and you could argue that the administration economic hand remains weakened as a consequence of that damage. Maybe they feared a repeat and so built a bill they knew the market would like. You could probably think up more reasons than this. And it's not clear to me that any of them justify the amount we're paying private investors to involve themselves. But it's possible that the pricing function that's being sold as the primary reason for private involvement is not, in fact, the primary reason for private involvement. After all, the government looks to be doing a lot of the pricing itself.
