Tuesday, March 24, 2009

The Private-Public Investment Program

In last Sunday's Wall Street Journal, Treasury Secretary Timothy Geithner published a densely worded op-ed piece explaining the next step in the Obama Administration's solution to the economic crisis. Arguing that "...no crisis like this has a simple or single cause, but as a nation we borrowed too much and let our financial system take on irresponsible levels of risk," Geithner first reviewed the steps taken to date:
  • "...a broad program to stabilize the housing market by encouraging lower mortgage rates and making it easier for millions to refinance and avoid foreclosure;"
  • "...a new capital program to provide banks with a safeguard against a deeper recession;"
  • "...a major new lending program with the Federal Reserve targeted at the securitization markets critical for consumer and small business lending;"
  • "additional actions to support lending to small businesses by directly purchasing securities backed by Small Business Administration loans."
Geithner claimed that these programs have reduced mortgage interest rates and lead to a needed increase in refinancing. He then went on to announce the creation of a Public-Private Investment program Public-Private Investment Program "...that will set up funds to provide a market for the legacy loans and securities that currently burden the financial system." ("Legacy loans" is French for the overinvestment in the housing bubble that brought the economy to its knees.)

As Geithner explains it, "the funds established under this program will have three essential design features:"
  1. "They will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors;"
  2.  "The Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.
  3. "Private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets."
Fundamentally, Geithner assumes that the "legacy assets" are undervalued and the private sector needs only a boost from the government to get things moving in the right direction. In this scenario, the economic fundamentals are in fact sound.

Paul Krugman disagrees strenuously: "This is more than disappointing. In fact, it fills me with a sense of despair." Krugman stresses that the economy is not fundamentally sound and that the crisis does have a single cause: The working assumption by banks and lending institutions that the housing bubble had no end.  He argues that there is historically a way out:
It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books.
Moreover, Krugman does not share Geithner's view that the plan does not risk taxpayer investment: 
But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.
In other words, it's the same old song of privatize the gain and socialize the risk. And the risk is that Geithner calls "legacy assets" and Krugman calls "toxic assets" have a significantly higher value than they do now. Because so many of them are tied up in the housing bubble, Krugman does not think it possible that the value of most of them is significantly different than it is right now.

Krugman fears that, by relying on "financial hocus pocus" doomed to failure, the Obama Administration will lose its credibility with Congress and the American people, and that it will be "...unlikely that he’ll be able to persuade Congress to come up with more funds to do what he should have done in the first place."

Meanwhile, Newsweek's Michael Hirsch thinks that Geithner may be on to something:
Over the last three weeks the markets have pulled back from the precipice. As Geithner and the Obama administration have laid out most of their plans, we have gone from a desperate and pervasive fear that bank stocks might drop out of sight altogether—leading to a depression after all—to a steady rebound in financial securities. Whereas a month ago there was a real danger the major banks would all collapse at once and become government wards, today even the massively mismanaged Citigroup is no longer a pathetic penny stock (it's soared to the $3 range).
Maybe. But Hirsch's expertise is in foreign policy, not economics. Even he recognizes that "Geithner is working on the theory that the financial system is still functional and solvent," an assumption that is not readily apparent to the millions of Americans who have lost their homes and jobs (or who fear the loss of them) and who have watched helplessly as their retirement nest-eggs dwindled. These people and others may wonder why the Administration believes that it can successfully partner with bankers who have demonstrated that they cannot bank and big investors who have proven that they cannot invest. Maybe things will be different with the government watching over them, but it's hard to see why these people would enter into a public-private partnership that does not get them out from under their toxic assets by transferring the risk to the public sector (i.e., us).

Stocks have rallied before and fallen after, so I don't see the point in reading too much into the current rally. Why taxpayers should bail out this institutions without getting seats on the boards is beyond me. However, Obama looked and sounded confident and assured during his prime time press conference last night, so maybe he feels as if a corner of sorts has been turned. Krugman's point about the housing bubble nags at me, though...

For those who enjoyed Monday's Santana video, check out this show stopping 1973 rendition of "Toussaint L'Overture." (Thanks, Bob!)...

Of cardinals and crows...

The Brickyard reports that former  Alaska state senator and mid-level Obama appointee Kim Elton actually received a larger per diem than Sarah Palin:
I have a source in Alaska who did some digging through the “Alaska Legislature 2008 Salary and Business Expense Report” – put out by the state’s Legislative Affairs Agency - and it’s truly amazing what was going on. According to my source, Elton charged the state a grand total of $20,681.25 in per diem for the year 2008 – several thousand dollars more than Gov. Palin. That comes out to $122.25 per day through the normal legislative session between January 15 and April 15. Then he charged $160.50 per day for two of the year’s four special sessions (30 days each). So, just on these facts alone, the man is far more “guilty” than the Governor when it comes to per diem.
The problem with the allegation, as a number of comments point out, is that all Alaskan legislators take a per diem as part of their compensation because their salaries are so low, and that as a Juneau representative, Elton actually took less because he already resided in the state capitol. The comments applauding the "scoop" quickly turn into the usual low comedy of rationalization and defensiveness, then somehow transition into attacks on Obama. Anyway, reading through the mental contortions and gyrations makes for good clean fun...



Foxessa said...

I know now when Wall Street rejoices I'm getting screwed again, and we're on the wrong track.

All they want is things back to normal, which means substituting pixels for reality, shuffling digits not creating substance, and a huge safety net for them pillaged out of my hide.

Madoff's most wealthy clients get tax breaks. I get my subway ticket going up from $2 to $2.50 and a cut in services. That's just for starters. O, and a huge increase in the state excise tax on ... WINE! Among other things. Everything that the non-rich depend on is being cut and taxed. The rich are bailed out. Here in NYC the truth of this is rubbed in your face all the time, everywhere.

Kathy said...

Add Dr. Doom's two cents to the mix. His take is generally positive with a few caveats. (Dr. Doom was the one economist who correctly warned for years that we were in trouble.)

Sigh...I'm just confused and don't know what to think anymore.

K. said...

I'm not jumping to any conclusions, although all of my instincts say "nationalize." I do think that the guy in charge wants to do the right thing, which is encouraging in and of itself.

Incidentally re the press conference, Obama's presence is such an improvement over that preening psychotic bantam who called himself a president. Every time I see Obama in action I'm doubly grateful that that idiot is gone.

Anonymous said...

PPIP explained with poo poo: