“That’s why they say it’s invaluable. It’s an infinite subsidy. It’s their franchise value.”

TO BE NOTED: From the NY Times:

"U.S. Program Lends a Hand to Banks, Quietly

By LOUISE STORY

Eager to escape the long arm of government, Goldman Sachs is preparing to return $10 billion in taxpayer funds as fast as the ink can dry on the check. But the bank, and a number of others, is quietly holding on to other forms of public support that come with virtually no strings attached.

Banks have been benefiting from an indirect subsidy adopted by the federal government at the height of the financial crisis last fall that allows them to issue their debt cheaply with the backing of the Federal Deposit Insurance Corporation.

That debt — more than $300 billion for the banking industry so far — helped otherwise cash-strained banks to keep their businesses running even when it was virtually impossible for other companies to raise funds. The program will continue to bolster scores of banks through at least the middle of 2012.

The value of the assistance, economists say, is incalculable, because it helped keep participating banks alive despite the panic sown in financial markets after Lehman Brothers collapsed.

“I don’t know how you measure that subsidy,” said Mark Zandi, the chief economist at Moody’s Economy.com. “That’s why they say it’s invaluable. It’s an infinite subsidy. It’s their franchise value.”

The program has allowed Goldman to issue $28 billion in debt over the last six months. The debt totals more than $40 billion each for Bank of America and JPMorgan Chase, and $23 billion for Morgan Stanley.

The F.D.I.C. program does not come with the compensation and other regulatory conditions attached by Congress to the $700 billion bailout, but it charges the banks a small fee. Rather than relying on a direct infusion of taxpayer money, the agency is helping the banks raise debt from private investors by endowing them with the equivalent of an AAA rating. If any of the banks relying on the guarantees ran into trouble, the F.D.I.C. would make good on those bonds.

But as Goldman and other banks look to escape the restrictions attached to the bailout, it is unclear if the government might add rules to programs like the F.D.I.C.’s.

“It is definitely a risk,” said David Trone, an analyst with Fox-Pitt Kelton, who noted that lawmakers could at any time decide to change the rules, just as they retroactively added tighter rules on compensation to banks that accepted taxpayer money.

Goldman was the first bank to take advantage of the debt program when it was introduced in November, when the financial crisis made it nearly impossible for companies to raise cash. Morgan Stanley and Citigroup were quick to follow. More than 119 debt deals have been issued with the F.D.I.C.’s backing, according to Dealogic. Larger banks are using the program more than smaller ones, because they have capital markets businesses that depend on financing in the public markets.

Bank executives are quick to acknowledge that the program was critical to their survival.

“We would have had a real problem in the capital markets,” said David A. Viniar, the chief financial officer of Goldman. “The market shut down.”

Now Goldman is likely to be the first large bank to test the grip of the government. Last week, Goldman formally requested permission to exit part of the Troubled Asset Relief Program, the initiative that injected taxpayer money directly into the banks and has received far greater attention.

Goldman on Tuesday raised $5 billion in new common stock to help pay back the $10 billion it received under TARP, raising the possibility that it will become the first large institution to do so. Mr. Trone, the analyst with Fox-Pitt Kelton, said he knew of a number of investors who planned to buy Goldman’s stock, once the bank returns the TARP funds.

“We would view any institution that pays back TARP has having a material competitive advantage,” Mr. Trone said.

But some are pointing to Goldman’s F.D.I.C.-backed debt as a reason the bank should remain under government scrutiny.

“Money is fungible, and if Goldman didn’t have access to the cheap guaranteed government money through the debt program, it would have been less easy for them to come up with the funds to repay TARP,” said Jeremy Bulow, an economist at the Graduate School of Business at Stanford.

Mr. Viniar said in an interview that Goldman had no indication that lawmakers intended to add rules to banks who issued the government-backed debt. And he said that the backing was not all that different from insurance that the F.D.I.C. provides on deposits in banks.

From his perspective, the rules surrounding TARP are related to its use of taxpayer money, Mr. Viniar said. As for the debt, he noted that Goldman and the other banks borrowed from private investors, not the government.

The F.D.I.C. is charging banks for its backing, and has already pulled in nearly $7 billion in fees intended to be used to cover defaults on any of the bank debt issued in the program, should a bank collapse.

But given the huge amounts of debt issued by Goldman, JPMorgan Chase and Morgan Stanley alone, any major collapse could breach the F.D.I.C.’s reserves. The agency has asked Congress for authority to borrow more money from the Treasury in case of an emergency.

William M. Isaac, who ran the agency in the 1980s, pointed out that the F.D.I.C. had the ability to run programs like the debt program because it had charged banks fees for decades.

“The banking industry has funded the F.D.I.C. for 75 years,” said Mr. Isaac, who is now a managing director at LECG, a consulting firm. “That is why the F.D.I.C. has the ability to do this.”

come forth quickly with its subsidy, or make it clear from the beginning that no subsidy was coming

TO BE NOTED: From the NY Times:

"Waiting for the Subsidy

By Casey B. Mulligan

Casey B. Mulligan is an economics professor at the University of Chicago.

Subsidies can have a perverse effect on activity if they are debated too long. The banking sector bailout is one example; the purchase of hybrid automobiles by Chicago cab drivers is another.

Hybrid automobiles can save gas, especially in urban driving conditions when the automobile is moving slowly or idling, where alternative power sources have a bigger advantage. A problem is that the purchase price of hybrid vehicles is often higher, and many are less spacious than the more ubiquitous sport utility vehicles.

A significant fraction of the taxicab fleet may be well suited for hybrids, because many of the miles driven are in urban conditions, and often the vehicles have only one passenger. Thus I have been surprised to notice so few hybrid taxis in Chicago, where less than 1 percent of cabs are hybrids.

by Ray Tsang

[via Apture]

In an admittedly unscientific survey, I watched for Toyota taxis with about 100,000 miles. I assumed that many drivers of Toyotas would be likely to buy a Toyota for their next taxi, and that the Prius — the company’s hybrid model — would get their consideration. I asked the drivers about buying a Prius.

The drivers told me about the Chicago City Council’s debates about transforming the city’s taxi fleet.

The council has debated mandating hybrid purchases. But the rumor among taxi drivers is that in addition, or perhaps instead, the city or another government agency will eventually subsidize the purchase of a hybrid. Drivers have decided that they should not purchase a Prius or another hybrid until the subsidy arrived. Buying one now would mean overpaying.

Regardless of whether it is realistic to expect Chicago to someday subsidize purchases of hybrid taxis, the fact is that some cab drivers are considering the possibility. If taxi drivers consider future subsidies in their industry, then so must bank executives.

Last fall the public learned that banks were not selling many of their legacy mortgages and mortgage-backed securities, despite the impression that ownership of the assets was hindering the banks’ lending. A variety of theories have been put forward to explain this failure, and to suggest what the government might do to fix it.

But the lack of trade in mortgage-backed securities may have something in common with the lack of trade in hybrid Chicago taxicabs. The secondary market for legacy mortgages may have stagnated largely because of the (ultimately correct) anticipation of a huge government subsidy. As I wrote last week, banks were not “unable” to sell their legacy mortgages; they were prudently unwilling to sell because they expected the government to step in eventually and help push the prices of the assets higher.

There would have been two preferable possibilities: for the government to come forth quickly with its subsidy, or make it clear from the beginning that no subsidy was coming. With both Chicago taxis and the secondary market for mortgages, the government did neither. Instead, it only fueled rumors that subsidies were on the way, and froze the same markets it intended to stimulate."

they were prudently unwilling to sell because they expected the government to eventually step in and help push the prices of those assets higher.

TO BE NOTED: From the NY Times:

"Encouraging the Sellers, Not the Buyers, of ‘Toxic Assets’

By Casey B. Mulligan

Casey B. Mulligan is an economics professor at the University of Chicago.

Last week the Obama administration released what has become known as the “Geithner plan”: an administration policy to reorganize asset ownership in the banking sector. The plan may have its desired effect of loosening up the market for “legacy assets,” but probably not for the reasons the Obama administration has stated.

Banks own mortgages (either directly, or through ownership of mortgage-back securities) whose values plummeted in 2008, because the mortgages are collateralized with real estate whose value crashed.

Conventional wisdom about the banking crisis says that bank lending to the wider economy cannot occur because banks have been unable to sell these assets, which adds to their difficulties in making new loans.

As Treasury Secretary Timothy F. Geithner says, a secondary market for mortgages “does not now exist” because there is a “ lack of clarity about the value of these legacy assets [which makes] it difficult for some financial institutions to raise new private capital on their own.”

I agree that (to a good approximation) a secondary market for legacy mortgages does not exist. But the biggest reason is not lack of clarity, but rather the lack of a viable government policy to deal with the banking crisis. Until now, perhaps.

But let’s stick with the conventional wisdom for a moment more. According to that wisdom, it does not help for the Treasury and the F.D.I.C. to subsidize and leverage the purchase of legacy mortgages from banks as Secretary Geithner proposes, because the plan does nothing to (a) create clarity in legacy asset value or (b) ensure that banks no longer have significant direct or indirect holdings of mortgages on their balance sheets.

As Professors Paul Krugman and Joseph Stiglitz have explained, the Geithner plan does increase the value of legacy mortgages to its owners, because it subsidizes the purchase of them. But it does not increase the clarity of those values, and in fact reduces clarity.

Consider an example, again from the conventional wisdom. Market participants are not sure whether a pool of mortgages will be worth $30 million or $50 million, and are concerned that the current owner knows a bit better and thus will offer for sale only the weakest of the weak. This $20 million worth of uncertainty, according to Secretary Geithner and the conventional wisdom, stops the secondary market from operating.

Thanks to the emergence of the Geithner plan’s subsidy and its leverage, the pool of legacy mortgages last week suddenly became worth $40 to $90 million (the Geithner subsidy raises private investors’ value of all types of bad mortgages, and its leverage increases the gap between the value of the best and the value of the worst). Yes, the legacy mortgages are worth more, but the profit of owning them is now less certain.

To make matters worse, the Geithner plan has no provision to stop banks from financing some of the ventures that will purchase the banks’ own legacy assets. The result may be bank ownership of mortgages that is less direct, but is bank ownership nonetheless.

Thus, if the conventional wisdom is right, this plan will fail because it creates no clarity, and it does little to separate banking from legacy mortgage ownership.

But I believe that the conventional wisdom is highly exaggerated. Instead, the secondary market for legacy mortgages has stagnated largely because of the (ultimately correct) anticipation of a huge government subsidy. Banks were not “unable” to sell their legacy mortgages; they were prudently unwilling to sell because they expected the government to eventually step in and help push the prices of those assets higher.

We all witnessed last week the big capital gains to banks that came with the unveiling of the Geithner plan. A bank would have been foolish to sell off its legacy mortgages during the fall or winter, before such a plan was unveiled and executed, because a fall or winter non-bank buyer of legacy mortgages would likely be ineligible for the ultimate subsidy.

Thus, the secondary market for legacy mortgages has failed so far because of the lack of a plan rather than a lack of clarity. To get the market operating again, the Geithner plan does not need to alleviate the market weakness improperly identified by its authors, but needs only to stay on the path to execution."

Me:

Your comment is awaiting moderation.

“Banks were not “unable” to sell their legacy mortgages; they were prudently unwilling to sell because they expected the government to eventually step in and help push the prices of those assets higher.”

I agree. Many Toxic Assets have, in fact, been sold. However, the fact that the government has been bailing everyone out has led to the belief that it was worth holding on to many of the TAs to see if the government could induce a better price. As well, money to banks has lessened the need for a fire sale of TAs.

Thus, having given incentives and subsidies to the sellers, it must do this for the buyers as well. Also, the large banks are counting on the government not being able to seize them for some time.

One other point: although many people are complaining that the buyers are getting a very good deal, they should remember that the buyers know that the government can always get some of that money back, through taxes.

— Don the libertarian Democrat

"Export subsidies do not diminish international commerce, they, um, subsidize it. "

From Interfluidity:

"Compete to give, give to compete

'Tis better to give than to receive.

A nice sentiment, surely. But is it good economics? My takeaway from China's experience is that it is, or it can be. There are lots of ways to spin China's policy of limiting the appreciation of its currency in order to promote export-led capital formation and growth. One story is simply that the policy amounted to a export subsidy: Purchasing power was withdrawn from Chinese workers and transferred to dollar and euro spending foreign consumers.

It's unmistakable that the policy "worked", in some sense. China's growth, along with the scale and pace of change in that country, have been remarkable.( TRUE )

I've mulled over the question of subsidy before. Simple economic reasoning suggests that subsidies harm the subsidizers and help the subsidizees. Yet nations often do subsidize their exports, overtly and covertly. Instead of welcoming cheap goods with open arms, the recipients of the subsidized merchandise usually complain, and sometimes slap on "anti-dumping" tariffs to keep cheap goods from being too cheap. Economists often tsk-tsk at all this, blaming both the subsidies and the tariffs on rent-seeking politically connected manufacturers. It's all "protectionism", they say.

A fair review of the history of "protectionism" would be much more mixed than the economic mainstream would like us to believe, with their stories of comparative advantage and expanding production possibility frontiers. (Thankfully, economists like Dani Rodrik and Paul Krugman weave more nuanced tales, but still "protectionism" rates somewhere just below coprophagia on the economic profession's list of distasteful things.) In some times and places, trade barriers have served to isolate and impoverish people. In other times and places, tariffs have protected infant industries that grew into powerhouses in countries (like the United States) that otherwise might have remained agricultural backwaters( IN THOSE DAYS, TAXES WERE MUCH LOWER OVERALL. ). That said, I think we should avoid tariffs, not in deference to economic pseudoscience, but because they are stultifying. Intercourse across borders is a per se good. A mixed-up, intermingling world is better than one made up of insulated national tribes( THAT'S FOR SURE ). We should avoid tariffs not because of their adverse economic consequences, but despite their potential economic benefits.( THEY DO HAVE ADVERSE ECONOMIC CONSEQUENCES. AGAIN, HISTORICAL COMPARISONS ARE OF VERY LITTLE USE. WE USE THEM FOR THEIR NARRATIVE EFFECTS, WHICH HELP US TELL OURSELVES STORIES ABOUT HOW THINGS GOT BETTER IN THE PAST, AND WILL DO SO HERE AS WELL. THIS IS, IN FACT, AN IMPORTANT PART OF THE RECOVERY PROCESS, WHICH DEALS LARGELY WITH HUMAN SENTIMENTS. )

But subsidy is a different story. Export subsidies do not diminish international commerce, they, um, subsidize it. From a libertarian perspective, there is a strong case against tariffs. Trade restrictions prevent free people across borders from interacting as they wish. But subsidies restrict no one. Sure, libertarians might complain of the wealth expropriated to fund the subsidy, but that critique applies to nearly all functions of modern government. Until we abolish public schools and the NIH, there's no reason we shouldn't have export subsidies.( IT WOULD DEPEND UPON HOW USEFUL THEY WERE. )

The more serious case against subsidies is that they are "distortionary". But for even the most ham-handed sort of subsidies, where governments favor particular firms or industries, it is not at all clear that this is so. Investment is not a "distortion", even though it involves accepting an up-front cost. When local governments offer tax abatements, free infrastructure, and other perqs to attract economic activity, there's a clear payoff from taxpayers to particular private parties. Yet sometimes( THIS IS TRUE ) these inducements do pay for themselves, in financial terms as growth increases the long-term tax base by more than the upfront costs, and in nonfinancial terms as residents reap direct and indirect benefits from prosperity of place. Sure, governments make poor investments sometimes, whether corruptly or out of innocent miscalculation. Firm managers also make bad investments( TRUE ), and sometimes their motivations in doing so are not aligned with the welfare of shareholders. Sometimes firms are large, and capable of investing on a scale that deters potentially superior upstarts from entering a market. But we don't prohibit corporate investment as "distortionary". In both the public and private sector, restricting investment implies preventing potentially welfare-enhancing projects from taking root. Subsidies, when they are not a form of corruption, are a form of investment( TRUE ). We should be very careful in designing public subsidies to private parties, since the potential for crooked dealing is obvious. But forbidding subsidy outright is prima facie welfare destructive. Preventing governments from internalizing the external benefits their communities would receive from economic development would itself be "distortionary". (I dislike the language of optimality and distortion favored by economists. But when in Rome...)

The example of the United States is often held up as a model of a free-trade zone, as a reducto ad absurdiam. If protectionism is such a good idea, asks some supercilious hypothetical interlocutor, why shouldn't we have tariffs between Tennessee and Alabama? Of course we don't, and shouldn't. But Tennessee and Alabama can and do compete in bidding wars with firms deciding where they ought to put their factories. The "free trade" that has worked so well among the 50 United States is actually a trade regime involving ubiquitous and competitive subsidies. Maybe that's not a flaw, but a feature.( TRUE )

At this moment, there's a fear that "Smoot-Hawley", "beggar-thy-neighbor" protectionism will take hold, condemning us to a depression more harmful than the one we already face. If insufficient aggregate demand is the problem, then competitive tariffs are a negative sum game: They not only confine demand within borders, but they eliminate demand that would otherwise exist for goods and services that could be provided internationally. So, the fear of tariffs is not misplaced.( GOOD )

But competitive export subsidies are a different thing entirely. If the people from whom funds are borrowed or taxed would otherwise have saved, then export subsidies can increase effective aggregate demand. A trade war in which the nations of the world strive to outgive one another in order to help support their own industries would amount to a collaborative global stimulus. Angloamerican economists are tut-tutting over how "surplus countries"( SAVER ) aren't doing their part in stimulating domestic consumption. Instead, export-heavy nations are stimulating consumption elsewhere, by stepping up their export subsidies( TRUE ). If China wants to support American consumption, then why shouldn't America support Chinese consumption? Rather than digging holes again and filling them back in again, why not give the world's "bottom billion" perishable gift cards redeemable for US goods and services, and let the jobs follow?

I don't think this is only a matter of "depression economics". It really is better to give than to receive, even in good times. But it is impolite to give but then refuse the gifts of others. And it is best to be up front about what you are doing. Making "loans" that are unlikely to be repaid is the worst form of giving. Everyone ends up unhappy when the inevitable comes to pass.

I started with the example of China, and I'll end with it. A year or two ago, China looked unstoppable, but suddenly conventional wisdom is that chickens are coming home to roost. China has subsidized exports, but its subsidy has been synthetic, implicit and deniable, and therein lies its problem. As Brad Setser has described for years, in order to maintain a "crawling" currency peg, China's central bank has been forced to purchase US dollar assets on which it must expect an eventual loss in real terms. China's subsidy to foreign consumers has been hidden in this overpayment. China's policy of giving worked very well for it, but executing that policy by pretending to lend rather than to give has put the nation in a bind. The technocrats responsible for China's huge currency reserves must continually expand their losses by purchasing more dollars to keep the value of the dollar high and hide the costs of subsidies already granted. If they do not, the exposure of large financial losses might create a firestorm of domestic outrage. China's central bank might be able to hide reserve losses by engineering a large domestic inflation, so that its US dollar portfolio does not lose value in nominal terms. In either case, even though the development gains were almost certainly worth the financial cost of China's export support, China's leaders face a problem since they pretended there was no subsidy when in fact the subsidy was very large.( TRUE )

It would have been better for China as well as for its trade partners (who face traumatic currency devaluations) if its policies had involved explicit, sustainable, and broad-based subsidies to foreign consumers. Explicit subsidies paid over time are more politically palatable than sharp losses suddenly revealed. China's covert, financial-engineered subsidies relied upon complex chains of financial intermediation, which eventually could not withstand the stress. China is still trying to subsidize, but lending to the US Treasury no longer translates to increased consumption by American consumers( IT WILL ). China's approach to subsidy contributed to instability in the financial arrangements of its customers, which has unsurprisingly boomeranged, creating economic instability in China.

Here is my proposal for the WTO. I know it will be greeted enthusiastically. Explicit export subsidies in the form of time-limited direct-to-consumer vouchers redeemable towards substantially all of a country's domestically produced goods and services should be deemed permissible, and the inevitable bureaucracy should be created to quibble over the terms of the institutionalized subsidy. Nations may choose to opt out of the program, but if they wish to offer subsidies, they must accept all other nations' subsidies. (Nations may accept subsidies without offering them, though.) Each subsidizing nation then sets an annual lump-sum amount, which is distributed in the form of equal-valued vouchers to adults in all participating nations worldwide. (Goverments that cannot brook direct-to-consumer payments would be excluded both from offering or accepting subsidies under the program.) Vouchers would be transferrable, but redeemable only by non-residents of the issuing country, for delivery outside of the issuing country. (Yes, for electronically deliverable services that might be hard to enforce. But that's what we have bureaucracies for.) In particular, subsidy vouchers could be bought and sold on organized exchanges, so that recipients who need food more than imports could sell them, for example to entrepreneurs hoping to purchase foreign capital goods at a discount.

I know this will grate on some of my "free-trade" luvin' readers, but please compare this proposal with the actual status quo rather than hypothetical optimization problem. Governments will subsidize, sometime corruptly, sometimes mistakenly, and sometimes because it is a good idea that they do so. This scheme does not directly address narrowly tailored subsidies (e.g. US farm subsidies), but it does provide an alternative and "less distorting" means by which nations can broadly support their tradable industries while picking winners and losers as little as possible. It will also provide an alternative to the current practice of synthetic subsidy via currency and financial market intervention, which has led us to the brink of depression and dramatically increased the likelihood of serious conflict, economic or otherwise, between major powers. Since governments will always subsidize, we should try to devise and institutionalize least-harmful-means by which governments can do what they will (and sometimes should) do. This proposal avoids government picking of winners and losers, encouraging governments to subsidize tradables very broadly defined but let markets fill in the details. It prevents governments from targeting and undermining tradables production in particular countries. It avoids the obscenity of the current decade, wherein the mechanics by which export subsides were arranged meant that the wealth transfer went primarily towards the consumption of the already wealthy (owners of real estate or financial assets). The aggregate demand required to mobilize China might have been generated by entrepreneurs building factories in Africa rather than homeowners buying lawn furniture in America. Also, the structure of the proposed subsidy means that poor countries can choose to accept it as a form of foreign aid whose direct-to-consumer requirement might limit corrupt misuse, and whose breadth renders the subsidy less harmful to domestic producers than, say, dumping underpriced grains onto the market in the name of charity.

I think this is a pretty good idea. Tell me why I am wrong."

But he's answered his own question. When some things are made explicit, they won't work. That's why they were done in the dark in the first place. China is not going to admit subsidizing the American consumer, or any other foreign consumers for that matter. On the contrary, allowing the US to default makes much more sense. China can argue it is our fault, and that there was nothing else that they could do. You might as well expect magicians to show how their tricks are done while they're doing them, as to expect China to openly declare their economic strategy.