THE LATEST PLAN: GIVE US YET MORE OF YOUR MONEY
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.