If you think you understand how Tim Geithner’s public-private partnership plan will work, you are probably mistaken. It’s a horrendously complicated program with a range of confusing treatments of various types of capital, including equity matching, loans from the government and guarantees of loans from banks.
If we were more cynical, we’d say that the entire point of this complexity was to promote public ignorance. Complexity is an ally of bureaucracy because anything that the public cannot figure out is effectively autonomous and removed from public scrutiny. But let’s not jump to the conclusion that the regulators have set out to confuse us.
Instead, it seems more likely that this is a budget dodge by the Obama administration. Politicians love guarantees because they don’t require current expenditures. In fact, they often pretend a guarantee or a loan is free money—as if a guarantee something that probably won’t ever have to be paid off and all loans from the government will get paid back. As we’ve learned throughout this crisis, that’s a dangerous fiction. If you say you have a bazooka in your pocket, eventually the market will demand you produce it and start blowing things up.
Felix Salmon explains that this seems to be what is happening with the program by the Obama administration to mix small government equity contributions with huge government guarantees and loans to “private investors.”
It decrees the TARP money to be “equity”, and then goes off to the FDIC to provide “debt”. Both of these sources of funds are US government risk capital which will be used to buy up toxic legacy assets. There’s no economic reason to make the debt/equity distinction. But there is a political reason: Congress would have to approve any more equity spending, but FDIC guarantees can be issued to an unlimited degree without Congressional approval.
We explained the underlying dynamic in this space seven weeks ago:
We’d guess that the program to purchase assets turned out to be horrifyingly expensive. Banks are unwilling to shed the assets at steep discounts. Many bankers still believe that a lot of their troubled portfolios will be worth more once the “market dislocation” clears up. That assumption that these debt linked securities will be worth far more than current market pricing indicates we’re calling the Dislocation Ideology.
But even if they were willing to give up on this Dislocation Ideology, they wouldn’t sell their bad assets to the government at market prices because this would render them insolvent. When the government got around to figuring out what it would cost to overpay enough for the troubled assets that banks would come clean, the number was almost certainly beyond anything they had contemplated.
How big could that bill be? Senator Charles Schumer has said that the bad bank could cost $3 trillion to $4 trillion. We’ve heard estimates even higher. One banker we spoke to said the bad bank would have to be prepared to spend as much as $8 trillion.
Insurance provides a much more politically palatable way of bailing out the banks. Politicians won’t have to spend a dime on day one. They’ll claim that much of the insurance will prove unnecessary because the asset values will recover. We’re sure someone will say that taxpayers could even make money on the insurance, if the premiums charged to banks wound up being higher than the pay outs on the insurance. The budget makers will come up with a rose-tinted estimate of eventually payouts, and that estimate will be based on the idea that the troubled assets will recover their value. The Dislocation Ideology will become the official policy of the United States.
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