Another rescue plan, another disappointment

Looks like I didn't post anything for a while. I suppose I'm busy...

Anyways, interesting stuff that happened:

A loop hole in the design of the bail-out to AIG, left in there because Treasury was worried about legal challenges, allowed AIG executives to take $165 million in bonuses. That has, conveniently?, given politicians in the US Congress the opportunity to jump on a "those greedy bastards" band wagon and pass a retroactive (IIRC) 90% tax rate on bonuses paid out in all institutions that received taxpayer funds. While I agree with the intention, I'm not so convinced about the means chosen to do so. I understand that this was the legally easiest way of doing it, but it does nothing for the underlying moral justification for forcing people to pay tax in the first place...

Of some personal interest to me has the decision by the Fed to finally go ahead with the direct purchase of long-term US treasuries. In order to buy the things, the Fed is printing money. So the policy has two effects: firstly, it injects more freshly printed cash into the economy (hopefully stopping the onset of deflation) and it pushes up prices of long-term US bonds and therefore pushes down real long-term interest rates (hopefully circumventing the problems in the transmission mechanism we're seeing at the moment). I think they've waited quite long to get this tool out of the box, but I agree with its deployment. The risk for the real US economy for the foreseeable future is a drawn-out deleveraging process that with it brings sustained price falls. That has to be prevented, pretty much whatever the cost.

Nevermind though, because the real news has been the final (for now) design of the banking rescue. The idea is as follows:

- Bad Assets on bank balance sheets have to be removed from there, which means someone has to buy them off the banks. But no one wants to have them, so there are no buyers and therefore no market that could tell us an appropriate price.
- A few months ago, in TARP MkI, Hank Paulson found that coming up with a price was a lot harder than he thought. While he and his team tried to figure out how to do it, the environment got a lot worse, and he switched ideas towards an equity injection strategy instead (which was subsequently bungled as well).
- So now Tim Geithner is back to the same idea, but rather than coming up with their own prices, they think they can create an "artificial" market to value the assets. Essentially, they are going to throw $100 billion into a pot and are asking private investors (such as hedge funds and distressed debt funds) to join in. They will then hold an auction, and so hopefully these private investors, subsidised with taxpayer funds, will go ahead and buy the assets.
- They then hope that everyone makes some money: the banks are relieved, and if the assets come back in value, the private investors (and their tax-paying backers) get to buy cheap and sell for much more.

That last one, in my opinion, is pure optimism. They're still treating this collapse in the value of assets (namely complex financial instruments ultimately backed by mortgages, but even physical assets, like US real estate) as something temporary. They seem to think that once confidence returns to normal, everything will be fine. And in that sense, the entire crisis right now is just a case of market failure, a temporary panic that will soon go away. Maybe someone's been spending too much time reading the final chapter of Keynes' "General Theory", I don't know. But it just screams naivety to me.

I'm going to put it out there that maybe the market isn't wrong now, but was wrong previously. Maybe these assets were so ridiculously overvalued that they will never come back to anything like the price banks paid for them. Maybe for some there just won't be anything like a liquid market ever. And if that is the case, these private investors are using the taxpayer subsidies to shift the problems from banks to their own balance sheets. That has the advantage of getting banks lending again (given some condition, see below), but means that now there are big private and institutional investors that end up with bad debts. Are we going to see the taxpayer being required to backstop those too? Indeed, will we see markets that shouldn't exist being kept alive artificially for the rest of time, by continuing use of taxpayer money?

As for that aforementioned condition, there is still the big problem Paulson faced months ago: The fair price of these assets is very low. But if the banks only receive a fair price for them, they are insolvent and by all rights bankrupt. The banks have to get a much higher price for them than their likely actual worth. So as part of the auction, things must be structured in such a way as to push up the bidding beyond a certain point - in effect either the subsidies must be so big as to shift all the upwards to some point (determined by who - by the banks?), or the auction process has to be designed to distinctly disadvantage the bidders. Hmm...I'm not sure I'd want to be in there.

And in other, rather less well-publicised news, apparently the US Treasury has taken the securities the Fed took on during its rescue of Bear Stearns by JPMorgan onto its own balance sheet. In effect, the US taxpayer has been burdened with another few billion dollars worth of potentially dodgy securities, quietly and under the cover of the bigger news. Wiki says that portfolio was down $2 billion in November '08 and I'd encourage people to find out where it's at now. Anyways, that wasn't exactly part of the plan as it had been explained to the public at the time...but I suppose the cynics out there always saw it coming, right?

Makes me kind of glad I pay my taxes here, as much as I disagree with them at times. :P