Wednesday, March 25, 2009

THE LATEST PLAN: GIVE US YET MORE OF YOUR MONEY

Last night Obama tried to suggest that Geithner's ability to actually propose a plan was some sort of step in the right direction. Me, I'd like to a see a plan that accomplish something without soaking the taxpayers. But hey, I'm so goddamn picky, demanding justice and fairness and democratic process and competence and all those silly abstractions.

Anyway, economist Willem Buiter of Maverecon breaks down some of the details of Geithner's Public Private Partnership Investment Program ("PPIP") (H/T Yves). He makes a lot of points, many of them very detailed, and not all of which I agree with at a policy level. Nevertheless, he explains some of the larger points of what Geithner's plan calls for, and who it really helps . . . and hurts. A few highlights:

The present and previous administrations have not helped themselves by failing to realise that it is possible to saving banking - the activities, that is, lending, deposit-taking and borrowing - without saving the existing banks. If they did realise this, they failed to act on the realisation.

The US Treasury is putting at most $100 bn into the PPIP pot. “Using $75 to $100 billion in TARP capital and capital from private investors, the Public-Private Investment Program will generate $500 billion in purchasing power to buy legacy assets - with the potential to expand to $1 trillion over time.” The programme is hoped to do up to $1000 bn worth of toxic and bad legacy asset purchases. Hope is good. Cash is better. Where is the remaining $900 bn going to come from?

The answer is loans or loan guarantees from the FDIC and the Federal Reserve and co-investment with private sector investors. The answer differs for the two components of the PPIP, the Legacy Loan Program and the Legacy Securities Program. I will take them in turn.

* * *

The total amount of money put at risk by the private investor [under the legacy loan program example of $84] is $ 6, the private equity investment. The Treasury would also be on the hook for $6, its 5o% share of the total equity investment. The FDIC would lend $72 or guarantee lending of that amount. That’s what meant by the FDIC being “…willing to leverage the pool at a 6-to-1 debt-to-equity ratio.”

First note that the public sector as a whole (Treasury plus FDIC) is at risk for $78 out of a total investment of $84. The public sector has the same upside as the private sector (through its $6 worth of equity). However, the private sector gets this upside by putting only $6 at risk, against the public sector’s $84 at risk. Small wonder the stock markets loved this. If there were a stock market for taxpayer equity, it would have tanked by a commensurate amount.

It must be recognised that the FDIC is in this picture only for cosmetic, window-dressing reasons. The FDIC has no resources of its own to spend on leveraging the PPIP. It cannot raise taxes and it cannot print money. It obtains revenue from the insurance premia paid by the banks whose deposits it insures, but that is hardly a secure source of income at the moment, let alone one that can be expanded drastically, should the need arise. What little money the FDIC has is earmarked to meet future claims of depositors insured under its Deposit Insurance scheme (Congress has temporarily increased FDIC deposit insurance from $100,000 to $250,000 per depositor through December 31, 2009). The FDIC has no money to spare. Indeed, if any major deposit-taking bank were to go belly-up, the FDIC would have to rush to the Treasury for money.

* * *
Under the Legacy Securities Program, the Treasury will provide equity of $100 for every $100 of private equity put in. The Treasury will also lend up to $200 for each $100 of private equity. So the Treasury puts at risk $300 to gain the same upside that the private sector will only put $100 at risk for. Nice work if you can get it (if you work in the private sector). Again, the tax payers’ stock takes a hammering.

* * *

The Legacy Securities Program further enhances the quasi-fiscal role of the [Federal Reserve], and turns the Fed even more blatantly into an off-balance sheet and off-budget special purpuse vehicle of the US Treasury. It does this by extending the scope of the Term Asset-Backed Securities Lending Facility (TALF) to legacy asset-backed securities (especially mortgage-backed securities, residential and commercial and consumer debt-backed securities). The original TALF was created to lend up to $1000 bn to private institutions willing to invest in newly originated mortgage-backed securities. The US Treasury only guarantees up to $100 bn of this proposed lending, so in the worst-case scenario, the Fed could be in the hole for $900 bn, through its exposure to private credit risk.

* * *

The role of the Fed in the PPIP, through the expanded TALF, is deplorable. First, the main redeeming feature of the TALF was that it was focused on new securitisations of mortgages, in an attempt to revive the market for new securitised mortgages and through it new mortgage lending. Diverting these resources to the ex-post insurance of losses that have already been made on legacy MBS (commercial and residential) and legacy consumer debt-backed securities is a serious waste of scarce public resources.

* * *

None of this addresses the issue of the massive private sector credit risk the Fed is taking on its balance sheet, a risk greatly enhanced by the modification of the TALF to include legacy toxic assets. Even if the short-run consequences for the monetary base of enhanced Fed operations under the TALF are sterilised, the Fed will, should it suffer major capital losses on its investments in private sector securities, have no option but to expand the monetary base to maintain its solvency, unless the US Treasury comes to its rescue. The terms of the TALF (with the US Treasury guaranteeing only 10 cents on the dollar, if the full $ 1 trillion is lent by the Fed) suggest that the US Treasury cannot and will not come to the rescue of the Fed. Monetisation of the Fed’s capital losses and inflation will be the inevitable consequence of the lack of fiscal firepower of the US sovereign.

This threat of future inflation from Fed decapitalisation through losses on its portfolio of private assets is in addition to the threat of future inflation caused by doubts about the reversibility of the Fed’s forthcoming purchases of Treasury securities through its quantitative easing (QE) policy. The recent Chinese comments on finding/creating a substitute for the US dollar as the international reserve currency demonstrate that concerns about the medium-term and long-term inflation consequences of the Fed’s QE, its credit easing and its quasi-fiscal rescue efforts of large US banking and shadow-banking institutions, are growing.

That last point is especially important, as it explains why this is not just about "tax dollars." It's ultimately about the "hidden tax" of inflation that will destroy our wages, our savings, and our equity (if we're fortunate enough to have any of those things!). Not only are we paying now to save the banks, but we'll pay later for the privilege of having saved them.

And as to whether any of this will save the banking system, that remains to be seen. As does the larger question of whether saving the banking system will even help the economy.

Maybe I'm being overly reductionist, but as for Geithner Plan II (aka, Paulson Plan III), I ain't seeing it.

Labels:

13 Comments:

Anonymous Applesaucer said...

"the Fed will, should it suffer major capital losses on its investments in private sector securities, have no option but to expand the monetary base to maintain its solvency, unless the US Treasury comes to its rescue. "

I've wondered how the Fed could recapitalize itself other than issuing Federal Reserve Notes in exchange for US Treasury Debt (i.e., "inflating").

I thought maybe the Treasury could simply issue the Fed US Treasuries for free and the Fed could return or pass on the interest payments.

Then, when it chose to do so, the Fed could sop up Federal Reserve Notes with these new treasuries.

I don't know if this is legal but, putting that aside, it can't be that easy right? I'm thinking that the problem, here, from the Treasury's point view is that this would result in a significant expansion of its debt level when the Fed engaged in sterilization activities and that it could drive interest rates through the roof, in accelerated fashion.

Applesaucer

p.s., is it just me, or have the "WORD VERIFICATION[S]" taken on some personality lately?

7:54 AM  
Blogger Mike said...

this would result in a significant expansion of its debt level when the Fed engaged in sterilization activities and that it could drive interest rates through the roof, in accelerated fashion.

I'm not sure I follow. I don't mean I disagree, I mean I'm sure I follow exactly how this works.

8:26 AM  
Anonymous Applesaucer said...

"I'm not sure I follow."

What I mean is that the basic operation is that when the Fed wants to inflate, it buys US Treasuries from banks in return for Federal Reserve Notes; when it wants to tighten it sells US Treasuries for Federal Reserve Notes.

But what happens if it runs out of US Treasuries? How will it deflate?

I was wondering if the US Treasury could simply give the Fed a huge slug of Treasuries to rebuild the Fed's balance sheet.

This seems so easy, that there has to be a catch. The catch is probably extremely obvious. But what is it, exactly?

Applesaucer

8:31 AM  
Blogger Mike said...

Thanks. But was the interest rate part that I wasn't following.

8:40 AM  
Anonymous wfta said...

Okay. I also am hating TARP and I have a legal question: Can Congress today pass a law that says
It is illegal to buy, sell or continue to hold a credit default swap (or similar financial derivative) for which there is no underlying bond or security, that all such contracts are void and all fees will be refunded to buyer prorated for the period remaining in the contract term? And further can Congress stipulate that this type of derivative, whether for hedging or for speculative purpose be traded only in a common clearing house with the margin call requirements like those in the futures contracts market?

It seems to me this could de-lever the credit system. Then we could investigate the bond sellers and ratings agencies to see if some fraud might be prosecuted.

9:18 AM  
Anonymous Applesaucer said...

I just posted a detailed explanation that disappeared into the ethernet for some reason.

My simple explanation is that because of the Fed's Alphabet Soup Lending programs, there's an extra $trillion of US debt out there, give or take, without a commensurate reduction in the Adjusted Monetary Base.

More treasury supply = higher interest rates, except if the Fed monetizes the debt, of course. But that means even more AMB.

In other words, the interest rates vs. increased money supply dilemna is ratcheted that much higher, even if the Treasury injects the Fed with a $trillion in treasuries.

Applesaucer

9:49 AM  
Blogger Weaseldog said...

Yeah, I heard the point about Geitner having a plan, and threw up in my mouth a little.

If a plan, any plan is all they want, I have a plan that will make money. Timmy can take a pair of dull pruning shears and cut off his own toes on live pay per view.

This is a great idea, because it's a plan. And any plan is way better than no plan. Obama says so! already I feel I have Obama's endorsement!

Did you hear the part where Obama's budget requires a real GDP growth of 2.6%?

Considering that the US Gov is now 50% of the GDP, this means a private sector growth rate this year of 5.2%. Right?

9:53 AM  
Blogger Weaseldog said...

WFTA, Bernanke can simply hand down an edict that prevents banks from buying credit default swaps that have no underlying bond or security.

He has the power to hold the banks to this line.

Obama wants complete regulatory control over the banks, to prevent these meltdowns.

But he already had total regulatory control.

He asking for what he already has, to fool us into thinking that this crisis was inevitable and nobody's fault.

10:03 AM  
Anonymous wfta said...

I am asking the lawyer. I'd as soon get beyond venting.

6:32 PM  
Blogger Mike said...

Can Congress today pass a law that says It is illegal to buy, sell or continue to hold a credit default swap (or similar financial derivative) for which there is no underlying bond or security, that all such contracts are void and all fees will be refunded to buyer prorated for the period remaining in the contract term?

As to the question of whether they can do so going forward, of course. The only challenge to such a legislation, on Constitutional grounds, would take years to reach the Supreme Court (if it ever got that far) and would be addressed under what's known as "minimal scrutiny" since it doesn't invoke any arguable discrimination on account of race, religion, ethnicity, etc.

As to whether Congress could legislate against current holders of CDSs, there two answers: it shouldn't, yet it could. It's strikes me as a clear violation of the ex post facto clause, but when populism roams the streets . . .

And further can Congress stipulate that this type of derivative, whether for hedging or for speculative purpose be traded only in a common clearing house with the margin call requirements like those in the futures contracts market?

I don't see why not. Either Congress or one of the regulatory agencies. They outlawed short selling of financials without debate.

Not to mention shunted our tax dollars to their financially-connected friends without debate as well.

At some level, WTFA, Weas is not just venting. He's right. The government has, can, and will do whatever it wants. The question is whether it will what you're suggesting. Politically, there isn't much to gain from this sort of measure: it potentially hurts the Insiders they really represent, but is too abstract to appease the potentially pitchfork-wielding masses they claim to represent.

All-in-all, I'd say it's possible (if still of "legally" questionable validity), but highly unlikely.

Since I've known you, WFTA, you've always had a refreshing mix of optimism and practicality. I admire that (I really do). But I just don't see Washington operating under similar ideology. I know it sounds cynical (and maybe it is), but I firmly believe the game is rigged.

And what you suggest -- whether I agree or not, or think it'll work or not -- is aimed at solving the problem for the benefit of all. I don't think that has a goddamn thing to do with what anyone in DC wants.

6:44 AM  
Blogger Weaseldog said...

I wasn't venting. I enjoy venting, but I wasn't doing it that time.

I've found over the last nine years that if I imagine the most cynical of outcomes, I can predict the future 99% of the time.

I predicted these bailouts well over a year before TARP was proposed.

Mark Denninger has been making the case that Bernanke and Greenspan had the regulatory powers to prevent this fiasco. But they chose not to.

Mark thinks they should be in prison. I feel they should be involved in one of those shovel ready projects, using actual shovels, shackles...

9:33 AM  
Anonymous wfta said...

When I say venting, I’m talking about me so no offense intended.

I am as cynical as anyone I know but I don’t necessarily see a conspiracy here. Certainly the financial lobbyists have greased the track, but I think Obama, et. al., really don’t know what will happen if they just let nature take its course or if it is realistic to perform FDIC style surgery on a number of giant bank holding companies and come out of the O. R. with a credit market capable of supporting a modern economy. The S&L thing was regional—Texas, Oklahoma and Arizona—and therefore do-able. This is global.

I agree that there is no incentive for those who now expect to come out winners in the CDS to abandon those contracts, but if the trigger event has not yet occurred, and the ante is refunded (forget the prorating,) are they truly deprived of property? Plus if they will just be another unsecured creditor in line for three cents on the dollar, is it worth getting on the new regulator’s bad side.

Trust me, I’m pissed. And I want to the management out, the shareholders dusted and the bond / credit ratings criminals in a cell with Big Leroy, but I don’t want to see four or five or ten years of 20-25% unemployment. I am hopeful that the actual collateralized debt obligations might be manageable, particularly if they receive an honest credible rating. The CDS’s should not be honored with taxpayer dollars and am hopeful that a new sheriff can shut down the gambling wheel.

11:06 AM  
Blogger Mike said...

I don’t necessarily see a conspiracy here.

It's only a "conspiracy" if it's secret. Everything that's been going on is "open and notorious," as we lawyers say.

8:12 PM  

Post a Comment

Links to this post:

Create a Link

<< Home