Posts

Showing posts from March, 2009

Overpaying Under the Geithner Plan: A Tough Nut to Crack

Warning: This is LOOOONG and a bit GEEKY.

It's been almost a week since Treasury Secretary Geithner took the wraps off his plan to rescue the U.S. banking industry from an onerous backlog of toxic assets. Geithner sketched out a scheme (PPIP, for short) wherein public and private investors would buy assets jointly, with the FDIC kicking in a large non-recourse loan. That fat FDIC loan sweetens the deal for private investors (such as hedge funds) because (1) the FDIC loan is very low-interest (2) The FDIC eats all the deep losses (the public and private investors take the “first loss”).

Immediately the financial engineering-minded types started to sort through the problem of how much overpaying would result. It’s been a wacky week in blogland. Estimates are coming in all over the place, based on differing approaches, differing assumptions. I like the work done by Rortybomb, and Nemo (after recovering from following Krugman off a cliff with a badly oversimplified model) has produced…

Who Does Really Run Things? Seriously.

My wife is Chinese. When she showed up one day toting a copy of a book, in Chinese, called Currency Wars, I was encouraged. Perhaps this meant we could have discussions about one of my favorite topics, how China manages its currency and what that means for its economy. Of course I knew nothing about the book itself.

It turns out that Currency Wars -- a bestseller in China -- is one of those far-fetched, conspiracy theorist takes on U.S. finance: According to the author, there is a cabal of powerful bankers and banks that controls America's financial policy behind the scenes. I’m sure he includes in his cast of villains quite a few hook-nosed Jews who like to salivate over the clink of gold coins. When my wife began describing the contents, I just began to laugh.

Now my laughter feels a little hollow. Not about the stereotype of the wicked Jew; that’s clearly ludicrous. (Accused Ponzi schemer Allen Stanford is about as Jewish as Mother Theresa, for instance.) But more about the idea …

The Joys of Blogging on the Fly!

I will return to this subject later, when I have more time, but the issue of overpaying on bank assets under the Geithner plan is much more complex than meets the eye ... ah, so many wrinkles! I'm now wavering on how much overpayment we may see -- it may be considerable after all. See this blog entry (very wonky) for a scenario that's actually real world (unlike the misleading simple models that were floating around, like Krugman's), though it contains assumptions that may turn out not to be true. Also I think there's a "cost of money" element that could cause bids to come in higher that no one is modelling yet (everyone's looking at the risk angle).

So are banks still secretly terrified of the Geithner plan (preceding entry)? I still think probably yes, but I'm going to return to that subject sometime later. First I want to do a blog entry on the private investor advantage of "free money" and how that may skew the offered prices.

5 Reasons U.S. Banks are Secretly Terrified of Geithner's Plan

You’re a large U.S. bank. Crappy (er, “legacy”) assets are weighing you down. You feel like you're driving a Ferrari hauling an open flatbed piled with all the backroom junk from Uncle Clem’s double-wide trailer. Secretly, you know that you’ve marked the value of these assets too high on your books, but you also know the federal government (a big-money guy, not terribly bright -- the perfect mark) is hanging around, riffling a big wad of cash.

How could this not end happily for you?

Then some government guy, a bigshot named Tim Geithner, unveils a plan to buy your sort-of-blemished-but-cute-under-the-right-light assets. A public-private partnership will purchase them. Private investors (such as hedge funds) will bid against each other to set a price, then the government will stroll in with matching funds and generous financing.

The plan is announced to some fanfare. You should be elated right? But a couple of days later, you realize something.

You’re screwed now. Really, really screwe…

Bad Arithmetic Proliferates

Wow. That was my reaction on waking to a dreary Hong Kong morning, logging onto the Internet, and finding that Paul Krugman's flawed model on overpaying for toxic bank assets had grown wings. A blog site dangerously named “self-evident” had taken a Krugmanesque approach to show how taxpayers could get shafted under the Geithner plan. Scarily, the link appears to be spreading like wildfire through the blogosphere.

Okay, I don't like the Geithner plan either. But at least we should get the criticism right.

This blog entry, penned by Nemo, does have an admirable cleverness in that it tries to impale the Treasury Department on its own “Geithner Plan for Dummies” fact sheet. The Geithner plan of course proposes a partnership of public and private funds to buy the bad assets clogging up U.S. bank balance sheets. Here's the quick-and-dirty version of the Treasury Department example of how the program would work:

A private investor wins the bid for a pool of mortgages with a bid of $…

What's wrong with Paul Krugman's arithmetic?

I like Paul Krugman a lot. I like his skepticism a lot. Further, he has a magic touch for simplifying complex and arcane topics in economics. But in this blog entry, I think he goes a simplification too far.

He is attacking the “subsidy effect” of the Geithner plan. The Treasury Secretary unveiled a proposal Monday that would have the government partner with private investors to buy distressed banking assets. The FDIC would finance 85 percent of the purchases with non-recourse loans. That, Krugman argues with the following example, invites what looks like a great deal of overpaying:
Let me offer a numerical example. Suppose that there’s an asset with an uncertain value: there’s an equal chance that it will be worth either 150 or 50. So the expected value is 100.
But suppose that I can buy this asset with a nonrecourse loan equal to 85 percent of the purchase price. How much would I be willing to pay for the asset?
The answer is, slightly over 130. Why? All I have to put up is 15 percent o…

The Geithner Plan: One Big Problem, One Big Question

Uh oh. It's that time of the financial crisis again. A new plan is about to be rolled out to save the U.S. banking industry. Sketchy details have been leaked in advance of course. (The New York Times summary is here.)

Much of the blogosphere commentariat has been withering in its criticism. Paul Krugman hates the plan, as it currently appears to be constituted. Yves Smith hates it.

Superficially, the plan appears to take a giant step in the right direction. The government would partner with sharp-witted private investors to buy toxic assets that are weighing down the balance sheets of the country's major banks. The Wall Street guys would be the brains: they figure out how much the toxic dreck is really worth, then bid against each other for it. The U.S. government would be the money: taxpayers fund most of the purchase price, then ideally scoop up a nice profit at the end of the day.

Sounds good. What's wrong with this picture?

The one big problem:

Since the Geithner plan has a…

Bernanke Discovers a Weak Link in the System

The Financial Times reported that the chairman of the Federal Reserve Board is now concerned about the “use of tri-party repo and the systemic risks in this crucial, but little understood area of finance.” “Recent experience demonstrates the need for additional measures to enhance the resilience of these markets, particularly as large borrowers have experienced acute stress,” said Mr Bernanke this week.The tri-party repo market is indeed crucial but “little understood”? Perhaps only by the Fed. Witness the chairman’s comment about “experience demonstrates.”

This is no place for a discussion of categorical imperative, but I must insist that if you know anything about the tri-party repo market, you would not need experience to tell you what is likely to follow, in the same way that if someone is throwing knives at his friend, you would not need experience to know that eventually the friend is going to get hurt.

I wrote in detail about the tri-party repo market and its systemic implicatio…

A Coded Admission

Over coffee this Sunday afternoon (somehow this line reminded me of Aznavour’s “café-crème” line in La boheme) I read the reminisces of 5 former Bear Stearns executives in the New York Times. The paper had decided to visit them a year after the firm’s demise.

It was a wasted 10 minutes. Like a prime-time Hallmark sponsored TV special, it only confirmed my prejudices. Not one of the 5 – and except for one saleswoman they were all senior people – had any clue as to what had taken place. All focused on themselves and their hardship. Not one of them had a word about the larger issues that the Bear Stearns collapse signified. That included the firm’s ex vice-chairman who begged the readers to remember Bear Stearns for its – of all things – charitable givings. I only hope that when future generations think about Bear Stearns, if they do at all, they will remember its philanthropy. This “if they do at all” is incriminating. It speaks of a self-doubt that no one reaching vice-chairmanship of a…

A Haunting Picture

The Financial Times reported that cargo ships are being used as the storage place for new cars because: i) cars are piling up due to lack of demand; and ii) ships are idle due to lack of cargo. Two machines, expressly made for transporting commodities, are forced into a state of idleness – compound idleness, really, one inside the other.

This is beyond allegorical.

Motion is the form of the existence of the matter. It is also the form of the existence of capital; capital could only be understood as a thing in motion. A cargo ship is capital but only by virtue, and in consequence, of its capacity to move. A new car is also capital to the company that produced it. But for the profit to be realized, it must be sold. Unsold cars in idle cargo ships is capital laid to waste through and through. In a Capitalist system that functions on the basis of employment of capital, that is the picture of death on a grand scale, which is why a picture of idles ship is haunting. It is the out-of-ordinari…

The Education of a Reporter

To study the properties of sub-atomic particles, physicists use particle accelerators to smash the atoms at high speed. The ensuring destruction creates extreme conditions in which the particles reveal new properties.

The economic/financial destruction brought about by the speculative capital has likewise opened up opportunities to learn economics and finance, if only one is willing to look.

A while back, I wrote that the Financial Times’ Gillian Tett is among the keener observors of the global financial collapse. Recently, writing about the upcoming G20 summit in London where the main agenda is expected to center around containing the crisis, she commented on the difficulties of regulating the markets:
The past decade of frenetic financial innovation and globalisation has created a western banking system where numerous entities are entwined in some unpredictable and near-indefinable ways. Just think of the chain reactions unleashed by Lehman Brothers’ collapse.

Thus, the $64 trillion qu…

A Big Lie in the Banking Crisis: “It's a Liquidity Problem.”

I remember hearing this line early on, months before the catastrophic Lehman Brothers meltdown, when credit markets were starting to tighten. It later became all the vogue when the banks claimed they couldn't sell their stockpiles of crappy assets. At least not for a “fair” value.

“Liquidity problem” is a clever banker’s smokescreen. It basically means there's not enough liquidity, or money, available to meet the broader demand. That's the problem that you darkly hint of when you say things like, “credit markets are frozen.”

For a pathological finger pointer, it's a great excuse. You're not the one to blame. It's the system. “In a normal, liquid market, these assets would sell for much more,” the banker whines.

Now, if the banking industry can convince the government that the problem really is liquidity, here's what happens: The government cuts interest rates as low as zero and sets up a bunch of emergency credit facilities. (Sound familiar?) The market is awa…