Geithner 2.0

The fleshed-out Financial Rescue Plan hit the streets today, and the stock market loves it (Dow, Nasdaq, and S&P all up about 7% today).  As Dean Baker points out, why wouldn’t they? The plan is a huge gift to dodgy financial institutions, as the Treasury, Fed, and FDIC will be subsidizing gross overpayments for about $1 trillion (by Treasury Secretary Tim Geithner’s estimate) in toxic assets (or “legacy assets,” the latest euphemism.  I preferred “troubled assets” — sounds like a Capitol Steps number waiting to happen).

Paul Krugman has some unpleasant arithmetic about the plan, which takes as its starting point the way the plan would subsidize the private institutions (not individuals) that would buy those toxic assets.  Reportedly the subsidy would take the form of “non-recourse loans” in which the borrower (and toxic asset buyer) would only have to put up 15% of the price paid for the asset, the asset itself would be the collateral for the loan, and if the asset went bad the lender could default and owe only the bad asset.  Just like a 15% margin loan, except some margin loans allow the lender to demand repayment of the whole thing.

Krugman offers a simple coin-toss-like example of how this could work.  There’s a toxic asset that has a 50% chance of being worth $50 and a 50% chance of being worth $150 (expected value = $100).  If you can borrow 85% of the purchase price from the government, with the asset itself as collateral and as the only repayment needed if it goes bad, then Krugman says you should pay about $130.  This means you borrow .85*$130 = $110.50 and put up $19.50 of your own.  If the asset turns out to be worth $150, you’ve gained $20 (after repaying the government what you borrowed).  If it turns out to be worth only $50, you surrender it to the government and are out the $19.50 you put up.  So your expected gain is slightly positive (0.5*[$20-$19.50] = $0.25).

The example looks much worse if you flip it around and consider the same two scenarios from the government’s (and taxpayers’) point of view:  If the asset is worth $150, the government gets repaid and loses nothing.  If the asset is worth only $50, the government loses a lot:  it gets a $50 asset, but it lent out $110.50, so it’s out $60.50.  The government’s expected loss = 0.5*(0+$60.50) = $30.25.

So in this example we have an exact transfer of $30.25 from the taxpayers (their expected loss on the transaction), so that some lucky financial institution can win $0.25 and some extremely lucky bank can be overpaid by $30 for its asset ($130 for an asset whose expected value was $100).  A bodacious bank bailout by any other name.

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3 Responses to “Geithner 2.0”

  1. Phil Staudt Says:

    If we borrow more and throw it at the problem, eventually we will all be okay, and there won’t be any unemployment any more because we will all be working in Chinese compounds.

  2. democommie Says:

    Somehow, this all sounds like “Son of Sub-Prime”–The Movie, to me.

  3. Rearranging the icebergs on the Titanic « Blogging Through the Wreckage Says:

    […] the icebergs on the Titanic By Ranjit OK, the Geithner 2.0 plan officially looks wretched.  When I’m agreeing with the top Republican on the House Financial […]

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