Krugman, who i had criticized sharply for leaping on bandwagaon and endorsing this plan, but today he has gone from original "i approve" to "Rescue Doubts" at 1:23pm to "No Deal' by 4:46pm. Max
September 20, 2008, 4:46 pm
No deal
Krugman blog
I hate to say this, but looking at the plan as leaked, I have to say no deal. Not unless Treasury explains, very clearly, why this is supposed to work, other than through having taxpayers pay premium prices for lousy assets.
As I posted earlier today, it seems all too likely that a “fair price” for mortgage-related assets will still leave much of the financial sector in trouble. And there’s nothing at all in the draft that says what happens next; although I do notice that there’s nothing in the plan requiring Treasury to pay a fair market price. So is the plan to pay premium prices to the most troubled institutions? Or is the hope that restoring liquidity will magically make the problem go away?
Here’s the thing: historically, financial system rescues have involved seizing the troubled institutions and guaranteeing their debts; only after that did the government try to repackage and sell their assets. The feds took over S&Ls first, protecting their depositors, then transferred their bad assets to the RTC. The Swedes took over troubled banks, again protecting their depositors, before transferring their assets to their equivalent institutions.
The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system — that is, convince creditors of troubled institutions that everything’s OK — simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem — which seems doubtful — or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.
And there’s no quid pro quo here — nothing that gives taxpayers a stake in the upside, nothing that ensures that the money is used to stabilize the system rather than reward the undeserving.
I hope I’m wrong about this. But let me say it again: Treasury needs to explain why this is supposed to work — not try to panic Congress into giving it a blank check. Otherwise, no deal.
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Krugman's 3 hours earlier, so he has been running through this today---we see him thinking:) Max
September 20, 2008, 1:23 pm
Doubts about the rescue
There’s something I don’t quite understand about how the big rescue plan is supposed to work. Maybe this is naive; but let me put it out there.
So, here’s my problem: what we have now are a bunch of financial institutions in trouble, because they’re highly leveraged, and have mortgage-related assets on their books. And they can’t raise cash because nobody wants to buy those assets. The Paulson plan will in effect create a market for toxic paper, thereby supposedly unfreezing the markets.
But what if the institutions are fundamentally broke, even if the liquidity squeeze is relieved?
I think of a hypothetical institution, which tradition says we should call Capital Decimation Partners. CDP’s balance sheet looks like this:
Decimation doubtsNow, obviously CDP is in trouble if it can’t sell the toxic waste at all. But suppose that Hank Paulson does his reverse auction, and it turns out that the Treasury’s price for toxic waste is 40 cents on the dollar. Even so, CDP is still underwater. So what does Treasury do then?
One answer, I suppose, is that we think that there aren’t too many firms in that position — and that those that will still fail, even with the Paulson Plan, aren’t going to disrupt the markets too much when they go down. But do we know that?
What I haven’t heard anything about is how Treasury might recapitalize firms that will be bankrupt even with the purchase facility, yet need to be kept in being.
So I’m starting to worry. Is this the son of MLEC, another attempt to create something out of nothing through fancy financial footwork?
krugman.blogs.nytimes.com |
