Yesterday, we highlighted the many arguments against Tim Geithner’s latest banking fix. Today, finally, we’ve found someone who thinks that the plan isn’t just a big ineffective giveaway to banks and private investors.
John Hempton at Bronte Capital argues that Geithner is getting private investors to take a risk on buying the trash assets, so the taxpayer (which will fund most of the purchase price) won’t get screwed. Depending on how much risk Geithner requires private investors to take, this might be the case. Of course, the more risk Geithner requires investors to take, the less likely his plan is to work–because investors are less likely to pay the high fantasy prices the banks will demand.
[Krugman] appears vehemently opposed to the (still not well detailed) Geithner plan to price toxic assets by giving a bunch of hedge funds non-recourse finance to purchase them. He even refers to this a zombie financial idea – one that will not die.
This an illogical position. Banks are non recourse. Krugman acknowledges that and says that banks require adequate capital or they should be confiscated. (No disagreement there – but I am sure we would disagree about the quantum of capital and how to measure it and what the confiscation process should be.)
Anyway if there is new capital put in banking it will also be levered up non-recourse.
I hope (and maybe I read Paul wrong here) that he wants new capital in banking and he would prefer it be private.
Well isn’t that the Geithner plan? Lets finance the tough stuff (scratch and dint mortgages, some commercial property) with new capital – as per any other bank – leveraged non-recourse to the taxpayer.
The objection Paul makes is to it being “non recourse” – an objection which is illogical. He has made this objection repeatedly.
The debate should be – as this blog has made clear before – about the numbers (and possibly the confiscation rules). It is not whether the Geithner idea is good or bad – it is whether Geithner demands enough private capital to be a reasonable outcome for taxpayers.
If the government requires enough capital then hey it is real capital and it reduces risk to the taxpayer. If they require too much capital then the returns won’t be attractive enough. There is not much economic difference between just establishing new banks and the Geithner idea – spelt out in some detail in the “long post” – for providing non recourse finance to several toxic asset funds.
Just because it is non-recourse doesn’t mean it is evil. If there is adequate capital then – hey – its new capital to the banking system – something that many (but not all) of us strongly desire now. The issue is how much new capital for how much taxpayer risk. Read all >
The key point, then, is whether Geithner will demand that hedge funds put enough skin in the game to get a true market bid for these assets. If the hedge funds really do have a lot to lose, they’ll be careful not to bid too aggressively. This will protect the taxpayer (good), but it will also reduce the plan’s ability to get assets off bank balance sheets–because if the banks don’t get prices close enough to their fantasy prices (the prices they say they are worth), they won’t sell the assets.
We suspect Geithner will address this by giving the hedge funds a real sweetheart deal, one that encourages them to swing for the fences without the threat of major losses.
We ran Hempton’s comments by a guru friend. Here’s his response:
Hempton’s point is well taken. As he comments to one of his readers, “If I set up a new bank and borrow with brokered deposits I can lever 12 times non-recourse. If I win I keep the profit. If I lose the FDIC pays the losses. … Geithner lends the money to the special purpose fund. Not against the pool of purchased assets – but with private capital pitched in. Sounds like banking to me.” So Hempton objects to what he sees as Krugman’s inconsistency.
But Hempton’s analogy isn’t quite right. Krugman wants big banks nationalized, giving taxpayers the equity upside. The Geithner plan is at best an inefficient way of bolstering bank capital because some of the taxpayer funds go not to bank capital, but to bank shareholders and hedge funds.
In any event, it’s nice that someone smart thinks that Geithner’s plan isn’t a lousy idea.
*UPDATE: John Hempton was kind enough to follow up with a few clarifying thoughts, which make a lot of sense. Here’s hoping the Geithner plan includes them:
[M]y defence of the Geithner plan is a little more subtle than that – and does tell which banks to nationalise.
The problem at the moment is that there are plenty of assets you will not buy because you cannot fund.
If you liquidated banks you would get them all being insolvent.
So my version of the Geithner plan is:
(a) set up the funds – maybe 10 of them – with enough capital that the risk to the treasury is not large.
(b). Send in the regualators to the bank and say YOU MUST SELL A BIT OF THIS ASSET WHERE THE MARK DOWN IS QUESTIONABLE.
(c) having tested the capital THEN use that tested price to mark the bank’s book.
(d). Confiscate the banks that fail the test using the new market.
The key part of this idea is that it forces the banks to stop lying about the value of their assets. In Hempton’s plan, the banks MUST sell some of the assets in question, so regulators can get a sense of the real market value. Then they go back and revalue the bank’s entire book of assets based on this market price. This new “test” will likely render many banks insolvent. (At which time, one hopes, the government would seize them.)