The idea of a public-private partnership to buy up so-called toxic assets sounds nice, since it gives the impression of being market based. It suggests that risk is borne by the private side and it even suggests that it’s not a bailout — again, because it’s market-based. But the vexing issue of how to overpay for toxic assets without, you know, overpaying for them, remains.
Last night on Charlie Rose, Tim Geithner explained the TALF-like mechanism
So what this plan will do is to make financing from the government available alongside public and private capital so that we can get these markets open and up again. The reason why these markets are not moving now is because there’s no financing available and no confidence in people’s capacity to make judgments about ultimate losses. And so by providing financing, government leverage alongside public and private capital, we think we can make a meaningful difference in starting to open up these markets and starting to trade again. There’s capital that wants to come into the system, but it just can’t get financing. So as an example, just make this one example, so if you had to sell your house tomorrow in a market where nobody could get a mortgage, then your house would be worse much much less in that context, and that’s partly why these markets aren’t moving and why people aren’t selling stuff that otherwise would sell. And we need to break that process and unfreeze it, but it requires all these things. It requires making sure there’s capital available to the system, that these banks have the incentive to start to move this stuff, that there’s a mechanism available to broad financing for those things. That has to happen all together.
So this relies on a few ideas. The key hope is that when leverage buyers are in these markets, the price of the assets will rise enough such that banks feel it’s worthwhile to unload these from their books. It also depends on the (possibly dubious) notion that the lack of leverage being provided currently to buy toxic MBS is merely a matter of there being a credit freeze, rather, than say a fundamental judgment by capital markets that extending leverage in these areas isn’t a particularly good idea.
This isn’t impossible. You could have a market-for-lemons type situations, whereby it would make sense for many buyers to lever up purchases of various assets, but out of fear of bad apples (sorry for the mixing fruit metaphors) nobody will lend to anyone. Hence, only the government has the balance sheet to ignore this risk.
That being said, anytime anyone’s tried second-guessing the market, it’s blown up and, the system rests on the idea that what the problem is is a lack of leverage in the system, rather than too much.
If those bets are right, then Geithner’s public-private partnership could be a winner. The banks get to sell assets at prices higher than the current market, the government gets paid back, and some well-connected investors get a big payday buying distressed assets with help from the government.
On the other hand if extending so much leverage to buy toxic assets doesn’t work out so well, then… well, let’s not talk about that.