Monday, March 23, 2009

Tarp II: Early Reactions

From Alea:

Except the private investors’ equity participation is higher at 1 for 1 with treasury

The Public-Private Investment Program will be designed around three basic principles:...

...Private Sector Price Discovery: Third, to reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.

Sample Investment Under the Legacy Loans Program

Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages....MORE
From Paul Krugman at the New York Times:

Brad DeLong’s defense of Geithner

Brad gives it the old college try. But he shies away, I think, from the central issue: the non-recourse loans financing 85 percent of the purchases.

Brad treats the prospect that assets purchased by public-private partnership will fall enough in value to wipe out the equity as unlikely. But it isn’t: the whole point about toxic waste is that nobody knows what it’s worth, so it’s highly likely that it will turn out to be worth 15 percent less than the purchase price....MORE
And "Geithner plan arithmetic"

From Brad DeLong's Grasping Reality With Both Hands:

I Think Paul Krugman Is Wrong

I find that a scary sentence to write. If the past decade has taught me anything, it has taught me that mistakes are avoided if you follow two rules:

  1. Remember that Paul Krugman is right.
  2. If your analysis leads you to conclude that Paul Krugman is wrong, refer to rule #1.

So why do I have a positive and Paul a negative view of the Geithner Plan? I see three reasons:

  1. The half empty-half full factor: I see the Geithner Plan as a positive step from where we are. Paul seed it as an embarrassingly inadequate bandaid.

  2. Politics: I think Obama has to demonstrate that he has exhausted all other options before he has a prayer of getting Voinovich to vote to close debate on a bank nationalization bill. Paul thinks that the longer Obama delays proposing bank nationalization the lower it's chances become.

  3. I think the private-sector players in financial markets right now are highly risk averse--hence assets are undervalued from the perspective of a society or a government that is less risk averse. Paul judges that assets have low values beceuse they are unlikely to pay out much cash.

More on this third later...

UPDATE: LATER: One way to think about it is that the privates are placing a low market price on distressed securities because they place a high weight on future scenarios in which the prices of distressed securities fall still further...MORE

HT on the DeLong/Krugman conversation: Marginal Revolution who writes:

Paul Krugman thinks Brad DeLong is wrong. Brad DeLong thinks that Paul Krugman is wrong. Robert Waldmann thinks that Brad DeLong is wrong. The topic of course is the Geithner plan.

I'm not so far from Kevin Drum's view, as stated here and here. It has some chance of succeeding and the relevant alternatives are also bad for the taxpayer.

But can the government itself be trusted? Here is some of the recent fallout:

...some executives at private equity firms and hedge funds, who were briefed on the plan Sunday afternoon, are anxious about the recent uproar over millions of dollars in bonus payments made to executives of the American International Group....MORE