On the Contrary

The market reacted favorably to the Giethner Plan for the banks and some seem to think this is a good thing and proves we are moving forward.  But investors like what protects their asses, not what is good for the nation.  The real problem with the plan is that the average American is never going to understand it.  In fact if you asked the average American what has happened to the financial markets, most would give you some simplified half-truth because quite frankly it is very complicated.  But it doesn’t have to be.  Matt Tiabbi wrote a piece for Slate Magazine which should be required reading for all Americans because he fairly well nailed it in language most of us actually speak (The Big Takeover).

For those of you who really want to understand this thing and the real issues I would recommend several wonderful blogs in order of how much you need to already understand to understand the arguments, and by the way from real economists, not talking heads and political mouth pieces.  They are in order of easiest to read:
1.    Room for Debate Blog, Will the Geithner Plan Work, a discussion by Paul Krugman, Simon Johnston, Brad DeLong, and Mark Thoma
2.    Paul Krugman’s Blog, Conscience of a Liberal
3.    The Baseline Scenario, Simon Johnston and James Kwak.  There is a wonderful beginners section to get you up to speed
4.    The Economist’s View, by Mark Thoma

Let me try to summarize in one paragraph.  AIG is just the tip of the iceberg.  They bought and sold Collateral Debt Obligations (CDOs) which were nothing more than bundled loans, sliced and diced so they could convince, or more appropriately confuse, the rating agencies into giving them high credit ratings making them highly marketable.  But that is not the real problem.  They sold Credit Default Swaps (CDSs) which were really insurance that the CDOs would not default.  But because they were unregulated (long story) they, unlike a normal insurance company, did not have to have capital (read cash) to back them up.  They sold them to anybody.  It was great money while it lasted.  You did not have to have the CDOs to have insurance on them and there was no limited to how many they could sell (take bets).  Remind you of Las Vegas?  So when the market bubble finally went psst, they are holding these things they can’t pay off.  And everybody was holding them.  Now the trick in this is if you re-evaluate the CDOs to what they are worth today (estimates at 20 cents on the dollar) then the CDSs would kick in and you would have to pay out.  So everyone is dancing around holding all this stuff like hot potatoes which if evaluated in today’s market, makes everyone broke and unable to lend.  That is why when the Treasury gave a ton of money to AIG, they paid out to other companies, yet to be named, this money.  Some of the outrage is because they paid this out at face value worth when many think these numbers could have been negotiated down based upon today’s worth.  Again, no adult supervision.  Because of the domino effect, the belief is that many of these institutions are too big to fail.  Keep this in mind because it is also part of the solution.

Now there are a couple of problems with this handing over money for the private sector to resolve their problem without adult supervision.  First they are using taxpayer money to make bad bets whole.  So the firm that receives this payoff doesn’t suffer and neither does the firm, in this case AIG, that is making this payout.  The conventional wisdom in the banking community is that this is what it takes to save our financial system.  The conventional wisdom in the general population is this is highway robbery using taxpayer dollars to keep failed institutions alive.

Most of us recognize that we have a very bad situation and we have to fix it.  Only the most ideological or political Republicans believe we can let these institutions fail and possible collapse the whole system.  The best of all possible realistic solutions is that we balance the suffering among all the parties.  Every body get’s a bloody nose.  Right now the public perception is only they are being asked to suffer and they are right.  Enter the Geithner banking plan.  The idea is that these toxic assets are undervalued in today’s market.  Given time, and the market/economy recovering, the future worth of these assets is much greater than they are now valued.  The key is to get them off the banks balance sheet at their present worthless value so that banks will then be sufficiently capitalized to loan again, and hey, we are borrowing like fools again, a subject for a whole other blog.

Now one approach is to nationalize the banks/financial institutions, sell off the good stuff, and have the government take on the bad stuff, hold it, and hopefully make a profit in the future  Also, did I mention fire most of the morons that got us to where we are?  But Congress is in no mood to appropriate any more money for this action, and the Treasury has no authority to take over financial investment firms/insurance companies/hot dog stands.  So the other approach is to get private investors to buy this stuff by loaning them the money, and insuring the loan.  This is called non-recourse loans which says if they default, we get the toxic waste back.  They have to put very little of their own money.  It is kind of a heads you win, tails I lose situation.  They have some risk, but very minor compared to the taxpayers.  The plus side is that if the toxic assets do gain in price, depending on what price they bought them at, if a profit is made, the government gets some of it.  But if they go bust, we get almost all the bust.

Now here is where the problems lie.  First, because the taxpayers are insuring the money to buy this stuff, the price they will pay for it may be inflated.  Read that as the taxpayers are getting gouged.  Second, those banks/financial institutions that hold it have to agree to sell it at some reduced price from its face value.  There is no way to force them to do this.  Third, how does this solve the too big to fail issue?  And fourth, where is the pain for the investors in these institutions who let their management run wild, where is the accountability?

My own layman view is this is the best we can do in the political climate, but it won’t work and when things get dicey enough, enter the Sweden solution.  That is when we nationalize these institutions, take over the problem, break them up, and then re-privatize them.  This, by the way, is also the final solution because the banks/financial institutions can never be too big to fail ever again. The problem is, the longer we wait the more costly the problem.  But we are still living in the age of government is bad and this solution will only come about when we are face down in the gutter.  Looking forward to that.

By the way, heard any Republican solutions yet?  That is because they don’t have any.  They are throwing fire bombs at anything suggested, but have no plan of their own except be afraid of deficits, don’t take too much on, and lets cut taxes and spending, the government is the problem.  They really are irrelevant along with our “moderate” Democrats who are really Republicans.