Tim Geithner may finally have done it.
Done what, you ask?
Figure out how to transfer hundreds of billions of taxpayer dollars to insolvent banks and Wall Street without the taxpayer screaming bloody murder about it. (Geithner has been trying to figure out how to do this since last fall with no success, so it’s no mean feat.)
What do we mean? Doesn’t the Geithner plan use the private market to set the prices at which investors will buy crap assets from banks, thus ensuring that the banks don’t get overpaid and taxpayers don’t get screwed?
Yes, Geithner’s plan will use private investors to set the prices, but they aren’t market prices. Rather, they will be highly subsidized above-market prices.
Paul Krugman explains:
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 per cent 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 per cent of the price — 19.5, if the asset costs 130. That’s the most I can lose. On the other hand, if the asset turns out to be worth 150, I gain 20. So it’s a good deal for me.
Notice that the government equity stake doesn’t matter — the calculation is the same whether private investors put up all or only part of the equity. It’s the loan that provides the subsidy.
And in this example it’s a large subsidy — 30 per cent.
These above-market prices, of course, will encourage banks to sell crap assets…and protect them from being rendered worthless as a result. Thus, it will secretly recapitalize them at taxpayer expense.
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