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toxic assets « Previous | |Next »
March 24, 2009

How do you clean up the toxic assets of the troubled banks? Just how bad are their books? No one really knows. However, everybody is insisting that the banks in Wall St and in the City are cleaned up. Though the regulators are all over the banks---given the abdication of responsibility for oversight of these markets-- there is precious little evidence of any fundamental rethinking, either in the industry or by the economics profession, much of which still seems in denial about the character and gravity of the present crisis.

Letting banks that took excessive risks fail in order to encourage more prudent behaviour is seen to be all very well in theory. However, with few exceptions, the argument from all sides—and from most in politics too—is for a return to business as usual as quickly as possible:

Rowsonbankers.jpg Martin Rowson

The current US proposal is a programme to appeal to the culture of greed ( the "animal spirits" of capitalism) by matching private sector money with treasury funds to buy up to $US1 trillion) of toxic assets from the sagging balance sheets of failing institutions.The treasury intends to use between $75bn and $100bn from its emergency bailout fund to generate co-investment from hedge funds, private equity funds and other private-sector investors willing to participate in buying derivatives, mortgage-backed securities and other troubled financial instruments.

What is a realistic value for the toxic assets?

The bank plan appears to turn on a metaphor. Credit is “blocked” or “frozen.” It must be made to “flow again.” Take a plunger to the toxic assets, a blowtorch to the pipes, it's said, and credit will flow. This will make the recession essentially normal, validating the baseline forecast. Add the stimulus to a normalization of credit, and the crisis will end. That's the thinking, so far as I can tell, of the Treasury department in this new administration.

It is a replay of the Bush administration “cash for trash” plan with variations that avoids taking temporary control of the insolvent banks, in order to clean up their books. Secretary Treasury Timothy Geithner proposes a complicated scheme in which the government lends money to private investors, who then use the money to buy the trash. The assumption is that the bad assets on banks’ books are really worth more than anyone is currently willing to pay for them. As Paul Krugman observes in the New York Times:

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.The likely cost to taxpayers aside, there’s something strange going on here. By my count, this is the third time Obama administration officials have floated a scheme that is essentially a rehash of the Paulson plan, each time adding a new set of bells and whistles and claiming that they’re doing something completely different. This is starting to look obsessive. Will it work? Krugman reckons not, but offers little by way of argument. But he's probably made the right call, as the logic is one in which a calm investor whose mood does not swing with the mood of the average investor who is also willing to buy and hold to maturity would be eager to invest in CDO's. Are such investors?

| Posted by Gary Sauer-Thompson at 12:43 AM | | Comments (7)


A lot of the debate about the Geithner plan is based on the assumption that there are three options:

1) The Geithner plan
2) Try to convince congress to nationalize banks now (real quick before they knew what hit them) and
3) Do nothing.

‘economics has become increasingly an arcane branch of mathematics rather than dealing with real economic problems. Unfortunately neither crashes, crises nor failures of prediction necessarily impel economists in the direction of realism. One likely reaction to the current downturn is that economists should try harder to develop better models, not the wholesale revitalisation of the culture within the economics profession.

There is a need for change in culture of the economics profession. The free-market fundamentalism and push for deregulation over the last thirty years, however, have rolled back many older systems of protection against catastrophe, increasing profits in good years but leaving industries and people exposed to enormous risks in bad years.

They repeated endlessly that government is the problem and the market is the solution – at least until the crash of 2008, when the roles were abruptly reversed.

Free markets are wild markets. It is foolish to believe that the market can
impose its own self-discipline.There is no framework in classical economics to understand wild markets, even though their existence is so obvious to the suffering layman.

"...and credit will flow"

Well that would be just peachy. Except I see a kink in that path. It's great for business to get some easy money, BUT they will be relying on the same reckless consumption of the past decade to get them smiling again. I don't think the public is in the mood to that roller-coaster just yet.

yep---Geithner's "bank rescue" plan enables great benefits for the richest investors, with the public protecting them from the risk of losses (privatize gains; socialize losses).

Until the punters feel COMFORTABLE about their debt level, SECURE about their jobs and CONFIDENT about their retirement prospects they are going to keeping a low profile.

The toxic bailout isn't going to do that for them.