It is inadequate, but it also seems to be the most the administration can produce at this point.

From Free Exchange:

"Link exchange

Posted by:

Economist.com | WASHINGTON

Categories:

The econoblogosphere

TODAY’s recommended economics writing:

The discussion of Tim Geithner's banking plan continues. In today's Washington Post, Lucian Bebchuk, who responded to Hank Paulson's original asset purchase proposal by arguing for public-private funds bidding for assets at auction, says the Geithner plan is pretty good, but for one thing:

But while the program is intended to partner public and private capital, the partnership it sets up is quite unequal. As things stand, the private side -- the private manager and investors possibly affiliated with it -- would capture 50 percent of the upside but would bear a disproportionately small share of the downside, contributing as little as 8 percent of the fund's capital.

Treasury officials believe that because private parties have not thus far established funds dedicated to buying troubled assets, favorable terms are needed to induce their participation. This logic is reasonable, but it is important to keep the government subsidy at a minimum. Without any market check, the terms set by the government could substantially overshoot what is necessary to induce private participation and end up imposing large and unnecessary costs on taxpayers.

His solution? Have private investors bid on the share of the upside they're willing to accept in the partnership. He really likes auctions.

Meanwhile, Adam Posen has a very sobering look at the Geithner plan which, he says, duplicates many of the mistakes that Japanese leaders made before they were finally forced to get serious with the banking sector. It's not a pleasant read. But as Matt Yglesias notes, his is more an indictment of the American government as a whole—and by extension the American polity—than of the Geithner plan. It is inadequate, but it also seems to be the most the administration can produce at this point.

But some caveats are in order. The connexion between flailing banks and economic weakness isn't as clear as is often asserted. Some researchers have argued that Japanese household debt was the real source of the lost decade, which isn't encouraging for America but at least suggests a different policy tack. Mr Posen also notes that the Japanese economy began to take off in 2002, when it got serious about fixing the banks. But that also happens to be when Japan's recent export boom began. In any sample of two or three, significance will be difficult to obtain.

Deepening the sample to include two recent American experiences is James Surowiecki, in a very good column.

Elsewhere, Felix Salmon answers questions about the financial savviness of journalists.

Calculated Risk helpfully summarises March in charts.

And GM inspires confidence as only GM can."

Me:

Don the libertarian Democrat wrote:

April 1, 2009 4:46

"That is why the Geithner plan is so complex and jury-rigged, to avoid the need for public requests for more money for banks. Unfortunately, it is unlikely to succeed absent additional public money and more-intrusive government action. The plan will buy some time and certainly some appreciation in bank share prices. Current shareholders will be getting a new lease on life with subsidies from taxpayers. For that reason alone, the plan certainly will cost the taxpayer more in the end than a more direct recapitalization with public control would have."

It's complex and jury rigged because it's a Government/Private Hybrid Plan, that has to balance competing interests and incentives. TARP was bound to be that from the start. It is not simply the need to avoid asking for more funds from the Congress.

"In essence, the U.S. Treasury’s plan to subsidize private investors’ purchases of the banks’ toxic assets is a too-clever-by-half mechanism to fix the banks while avoiding going to Congress for more upfront on-budget expenditures. One can imagine the discussions at the White House: We have a budget to pass, and cannot give up those goals to give the bankers still more. Figure out some way to do this off-budget. And so the Geithner plan hugely bribes private investors with taxpayer money, as Simon Johnson, Paul Krugman, Jeffrey Sachs, and I have all described, with one-way government insured bets. Yet the bets are contingent, they only pay when the taxpayer loses—and those losses first appear on the Fed or FDIC balance sheet, not subject to congressional approval."

The government gave an incentive to hold these assets in hopes of government help when it saved AIG. In giving the banks money, it also gave them the resources to hold out for a higher price. Although the TAs have been selling, expecting government aid in this current crisis is a good bet. Because of these incentives and subsidies, buyers need to receive incentives and subsidies as well now. That's just part of the deal.

If you assume that everyone who is really involved in this knows that the government cannot really seize these large banks as of now, it becomes easier to see why this plan has worked out this way.

We are just buying time until we can actually seize these large banks, but, except for just letting the problem fester until then, we don't have much choice. I don't think that these auction ideas are of much help, because the investors who will buy these TAs know that they are going to need as CDS on future possible taxes, and so they know that there's a possible downside, even if they make money.

implementing the net-liberty-enhancing policies that a real libertarian would favor if he or she were truly a decisive agent

TO BE NOTED: From Marginal Revolution:

"Words of wisdom

From Matt Yglesias:

The question here is what would Adam Posen have done if he had Tim Geithner’s job? And based on Posen’s analysis, I think the only conclusion you can reach is that he’d have done more-or-less the same thing. Talking about a different issue last week, I heard Tyler Cowen forcefully make the point that you have to think of the political constraints as a real policy consideration. Suppose Geithner had asked Congress to appropriate $1 trillion to implement a program of bank nationalization, asset writedowns, and loan guarantees—what would that have accomplished? It certainly wouldn’t have gotten Congress to appropriate $1 trillion to implement a program of bank nationalization, asset writedowns, and loan guarantees. It might have derailed the budget and thrown the political momentum on the Hill to proponents of a neo-Hooverite spending freeze program. It might have caused panic. And it certainly would have undermined the credibility of the inevitable effort by Geithner to do the most he can with the authority he already has.

One thing I like about Bryan Caplan's book is an interpretation which he will probably hate. The truly decisive actors are people directly in the political process. Maybe the "libertarians" who are or have been in politics are not just "sell outs." Rather they are implementing the net-liberty-enhancing policies that a real libertarian would favor if he or she were truly a decisive agent.

Posted by Tyler Cowen"

only to have to take the full measures a few years down the road when in even greater debt.

From Alphaville:

"A deceitful deal for Lloyds Banking Group Posted by Paul Murphy on Mar 07 18:34.

It’s a deceit on British taxpayers, not Lloyds shareholders, who are getting a free and gloriously pimped ride.

Lloyds formally released details of the terms of its participation in the government’s Asset Protection Scheme on Saturday, along with information on a further strengthening of its capital base. The three key moves are:

- a bolstering of its core Tier 1 capital by the conversion of the government’s £5bn holding of preference shares into ordinary stock at 38.43p per shares;

- the issue, to the government, of £15.6bn worth of convertible stock called “B shares” that are offered at 42p-a-share and convert into ordinaries at 120p-a-share; and

- the purchase of $15.6bn worth of toxic asset protection.

There are claw-back arrangements for existing holders, but we won’t worry about those for now.

The converted £4bn of prefs, we are told, take the government’s shareholding from 43.5 per cent to 65 per cent. The new convertible B shares do not carry votes (although there is a 7 per cent minimum coupon) and the Lloyds statement declares the following:

In addition, in the event of full conversion of the B Shares, if HM Treasury retained all the ordinary shares resulting from such conversion and assuming it still retained all its existing shareholding in Lloyds Banking Group plc, then HM Treasury’s aggregate ordinary shareholding would be 77 per cent.

This looks like voodoo mathematics.

Lloyds has a little over 16.3bn shares in issue, which as of Friday gave the bank a market capitalisation of about £6.85bn. Since the conversion of the existing prefs does not amount to new money (just the assumption of more risk for taxpayers), it would be misleading for us to extrapolate directly from the stated fact that £4bn of equity at 38p or so is worth a further 26.5 per cent of the bank – taking the government’s holding to 65 per cent.

But £15.6bn in brand new “B share” money is another matter entirely. Pretending that the “see thru” economic interest of this convertible stock is worth just 12 per cent of the whole entity is plainly heroic. Especially when you consider this, from the appendix to Saturday’s announcement:

For these purposes, on a winding-up, each holder of a B Share will be deemed to hold one ordinary share of the Company for every B Share held at the date of the commencement of such winding-up (the “Winding Up Ratio”).

Actually, it’s anti-heroic in that it amounts to stamping all over the interests of British taxpayers – all in the name of retaining Lloyds’ status as a private entity listed on the London stock market.

Think about it - £15.6bn of new money required to pay for years of stupid lending decisions does not speak for 12 per cent of Lloyds Banking Group. It speaks pretty much for the whole stinking lot.

Why is the government doing this? Set aside for the moment all the tosh about it being important to keep banks in private hands and the danger of creating a nationalisation panic at other wobbly institutions. Think back instead to the events of last autumn, when the Tripartite Authorities, egged on by Victor Blank (cheque), convinced Eric Daniels that a speedy takeover of HBOS was both in the public interest and attractive to Lloyds, handing it a prospective monopoly position in British retail banking.

It is difficult to avoid the suspicion now that the government, to hide its own in adequacies, is conniving to keep these men in their jobs, while at the same time allowing existing shareholders to cling on to the fantastical idea that their stock is actually worth something.

For the record, when the head of media relations was contacted by telephone for comment, the reply was: “I’m sorry, but the person you wanted has a voice mail that has not been set up yet. Goodbye.”

If anyone in political opposition to the government wants to get up to speed on what is happening here we’d suggest reading this first – an account of testimony delivered to the US congress by Adam Posen of the Peterson Institute at the end of last month.

In elegant and convincing terms, Posen maps out how in a banking crisis like this one politicians, supervisors, regulators, bank management and shareholders are incentivised to hide the truth from themselves and from the public at large.

The Lloyds/HBOS debacle offers a perfect illustration of Posen’s thesis, which the Peterson man says has to be addressed by limited temporary nationalisation and wholesale replacement of both supervisors and bank executives.

Note his conclusion:

If those programs live up to their associated rhetoric, and are thus tough enough on the current shareholders and top management of our undercapitalized banks, we can in 2011 be like Japan in 2003, at the beginning of a long and much-needed economic recovery. If unneeded complexity of the bad-bank construct, excessive reliance on and generosity to private capital, and unjustified reluctance to temporarily nationalize some US banks turn the proposed bank clean-up programs into only half-measures, then we will be like Japan in 1998, squandering national wealth and leaving our economy in continuing decline, only to have to take the full measures a few years down the road when in even greater debt.

Related links:

Lloyds Banking Group APS statement

Lloyds in £260bn deal with government - FT

Adam Posen testimony

This entry was posted by Paul Murphy on Saturday, March 7th, 2009 at 18:34 and is filed under Capital markets. Tagged with Lloyds Banking Group."

Me:

Don the libertarian Democrat Mar 7 19:55

I agree with Posen, but Vikram has a point. Just as in the US, there was no real plan to seize large insolvent banks. The plan was to merge large insolvent banks with large solvent banks. That was a costly and terrible plan, since their size led to their complexity and unconcern about risk. Vikram could even argue that the government owes Lloyds because they helped them to get involved.

But one way the government got involved, at least in the US, was to subsidize the deal. So there was an assumed positive side to the investment for the acquiring bank. The real question, going forward, is who is more important? The taxpayers or the banks and shareholders?

I've an easy answer to that, being a taxpayer only. I do see the other side of the problem, but it is simply too costly both economically and socially. Any plan is risky. We cannot escape that.