Kevin Drum

Price Discovery

| Mon Mar. 23, 2009 1:31 PM EDT
Felix Salmon writes:

How Treasury's Bank Bailout Could Make Things Worse

....The minute the Treasury plan is put into action, we'll have a lot of public price discovery for the banks' bad assets. And if the prices don't clear — if the minimum price the banks will accept is higher than the maximum price that the public-private partnerships are willing to pay — then no one will any longer be able to perpetuate the fiction that America's banks are solvent.

....The big hope of the Treasury plan is that the private sector will be willing to pay a higher price for leveraged assets than it would for unleveraged assets....During boom years, that was a wager that many investors were willing to take. But now? I'm not sure. Chalk it up as yet another thing-which-has-to-go-right in order for this scheme to work. There are far too many of those for comfort.

Um, how is this a bad thing?  Isn't a whole bunch of very public price discovery exactly what we want?  Then we get to find out for sure whether banks are solvent, as they claim, or irredeemably underwater, as a lot of us suspect.  Right now they can lie about their books and no one can really prove them right or wrong.  After these auctions, though, smoke and mirrors will be a lot harder.

I don't have any more insight than anyone else about whether this is a deliberate part of Geithner's plan.  Oddly enough, though, his tongue-tied interviews about it make me suspect that it might be.  Geithner might not be the most silver-tongued spokesman in the Obama orbit, but he's not a doofus.  If he's having trouble explaining the plan in public, one reason might be that he's unable to fess up to the central pillar of the whole thing: forcing banks to put up or shut up.

Somebody is wrong about all this stuff, after all.  Either the critics are wrong, and banks are actually perfectly solvent, or else the banks are wrong, and all their memos about how they're practically sagging under the weight of all their Tier 1 capital are just a bunch of hooey.  Geithner's plan goes at least part of the way to figuring this out.

Advertise on

The Byrd Rule

| Mon Mar. 23, 2009 12:46 PM EDT
Perhaps unsurprisingly, I have never roused myself to understand the intricacies of the budget reconciliation process and the Byrd rule. The reconciliation process is basically designed to eliminate Senate filibusters on budget resolutions, but it's the Byrd rule that specifies what counts as a budget issue and what doesn't. But who decides what the Byrd rule itself says?  Ezra Klein:

The Byrd rule allows senators to challenge the acceptability of any provision (undefined) of a reconciliation bill based on whether or not its effect on government revenues is "merely incidental" (undefined). Thus, if you enter reconciliation with a health-reform bill, it's not clear what's left after each and every provision — however that is defined — is challenged and a certain number of them are deleted altogether: the tax portions, certainly. And the government subsidies. But is regulating insurers "merely incidental" to government revenues? How about reforming hospital delivery systems? How about incentives for preventive treatment? Or the construction of a public plan? An individual mandate?

It's hard to say. The ultimate decision is left up to the Senate parliamentarian, whose rulings are unpredictable. Under George W. Bush, Republicans managed to ram tax cuts, oil drilling, trade authority, and much else through reconciliation. But they were as often disappointed: The GOP leaders fired two successive Senate parliamentarians whose Byrd rule rulings angered them.

Ah, I see. The Senate parliamentarian will decide whether we get healthcare reform this year. That's comforting to know. Perhaps Ezra's next task should be an in-depth profile of Alan Frumin, apparently the people's representative for all things healthcare related.

Housing News

| Mon Mar. 23, 2009 11:56 AM EDT
Looking for some good news?  Well, there isn't much, so this will have to do:

The National Association of Realtors said Monday that sales of existing homes increased 5.1 percent to an annual rate of 4.72 million last month, from 4.49 million units in January. It was the largest sales jump since July 2003.

Sales had been expected to fall to an annual pace of 4.45 million units, according to Thomson Reuters.

....February’s median sales price was up slightly from January, which recorded the lowest median price since September 2002. Prices are down about 28 percent from their peak in July 2006.

It's not clear what caused this, since home prices are almost certainly going to keep falling another 20% or so.  In fact, this might even be bad news in a way, since the faster we hit bottom and get back to trend growth, the faster we're likely to see the end of the recession.  But really, these days, who knows?

Exposing Torture

| Mon Mar. 23, 2009 11:32 AM EDT
This is good news:

Over objections from the U.S. intelligence community, the White House is moving to declassify — and publicly release — three internal memos that will lay out, for the first time, details of the "enhanced" interrogation techniques approved by the Bush administration for use against "high value" Qaeda detainees....According to the administration official, ex-CIA director Michael Hayden was "furious" about the prospect of disclosure and tried to intervene directly with Obama officials. But the White House has sided with Holder.

Obama's record so far on the related issues of torture, civil liberties, detention, and surveillance has been mixed.  I hope that part of this is simply the caution of a new administration that doesn't want to make irreversible decisions before it's given them enough thought.  Releasing these memos is a small sign that perhaps once they've settled in they'll start unraveling the abuses of the Bush-era more thoroughly.

(Via Andrew Sullivan.)


| Mon Mar. 23, 2009 10:58 AM EDT
In Tim Geithner's Public-Private Investment Program for buying up toxic waste, just how much is public and how much is private?  The Washington Post seems to have the right answer:

With the government financial support, private investors could end up putting down only about 7 percent of the price of an asset, with the rest contributed by the government and by private lenders who receive government guarantees.

This appears to be based on TARP funds providing half the equity stake and the FDIC loaning money for the rest at leverage not to exceed 6:1.  But is this enough?

We'll see.  One of the key sources of tension in this plan is getting this number right.  If private investors have too low a stake, the opportunity for gaming the system is high.  They might overbid on assets, for example, because their stake is small enough that they can make more money on side bets than they can on the main investment.  Conversely, if the private investors are required to put up too much money, they won't participate.  Without some leverage, the projected returns just aren't good enough.

Overall, Geithner's plan provides leverage of about 12:1.  That strikes me as too high.  I'd rather see private investors having at least a 10-15% stake.  But I guess time will tell if Geithner got this component of the plan right.

You Say You Want a Revolution?

| Mon Mar. 23, 2009 12:35 AM EDT
Is class warfare — the real kind, not the phony conservative talking point kind — close to becoming reality? Felix Salmon has a short post on the subject that's worth reading.

Advertise on

The Road to Nationalization?

| Mon Mar. 23, 2009 12:09 AM EDT

I've already made my semi-defense of Tim Geithner's toxic waste buyup plan, and I won't repeat myself here. But there is one point that I think deserves a post of its own.

It's this: Do supporters of bank nationalization really think it's either legally or politically feasible at this point in time? I'm skeptical on both counts. Legally, I'm not sure Obama has the statutory authority to take over a big bank. He may well need congressional authorization of some kind first. And even if he doesn't, does anyone really think it would be wise to go down this road without broad congressional support anyway? I don't.

Like it or not, there's only one way to get this support: show that (a) one or more of the big banks really is insolvent and (b) every other option for rescuing them has been exhausted. Geithner's plan does both.  If it works — well and good. But if it fails — if nobody is willing to participate, or if the auction demonstrates that the market price for toxic assets really is accurate — then banks will be forced to mark their assets to those prices. Plug in those marks to Geithner's stress tests and it's likely to prove to everyone's satisfaction that some of our big banks really are insolvent. At that point, even skeptics will be forced to accept nationalization as the only remaining alternative.

Politically, I don't see any other way forward. Bank nationalization will be complex, costly, and contentious. To work, it will almost certainly have to include a broad guarantee of all bank system obligations, something the public won't be happy about.  Congressional support won't be easy to come by. Geithner's plan will either work or else it will pave the road for that support. It might not be pretty, but that makes it a plan worth trying.

Eating It

| Sun Mar. 22, 2009 2:35 PM EDT
Atrios pungently describes the main objection to the Geithner plan:

Aside from setting up an overly complicated plan to try to disguise what they're really doing, the utility of the Geithner plan rests (or pretends to rest, not sure) on one fundamental premise: that Big Shitpile is greatly undervalued by "the market" and that these mortgage securities really have expected revenues which justify higher prices. One could have reasonably believed this months ago, I have no idea why anyone would believe this now. The housing bubble burst, and now recession is here. There's a lot of shit to be eaten, the question is who will eat it? Timmeh wants to make sure it's not the banksters.

Although I'm less sure than Atrios that we should accept the market's verdict on this stuff unquestioningly, he certainly might turn out to be right. But it's worth noting that taxpayers are going to eat almost all of this shit no matter what happens. If Geithner's plan fails, we eat it. If we nationalize the banks and become owners of all the toxic waste, we eat it. This financial crisis is going to cost the government a ton of money no matter what we do at this point.

Now, it's true that if we nationalize we'd wipe out the shareholders of the bad banks. But although that's the right thing to do, it's also pretty small potatoes since stock prices have dropped so far that shareholders in bad banks have virtually no equity left at this point. (Sweden didn't even bother trying to wipe out shareholders when they nationalized Nordbanken in 1992, for example. They just bought out the minority shareholders at the highly depressed market price.) What's more, a lot of those shareholders are mutual funds and pension funds anyway. The amount of bankster wealth that would be wiped out in a nationalization is probably pretty small.

It's not so much that I disagree with Atrios about this, just that I think he overstates the issue here. Nationalization would hurt bankers a little bit, and it would give taxpayers a bigger upside than the current plan. That's good. But it would also be ungodly complex and create plenty of problems of its own. It's worth avoiding if there's another solution.

If Geithner's plan fails because it turns out that the market price for all this toxic waste is really correct, then his stress tests will almost certainly show that Citigroup and Bank of America are insolvent. At that point, he's out of options and it's time to nationalize. Paul Krugman's fear about Geithner's plan is that "this will be the administration’s only shot," but I think that's wrong. In fact, far from making nationalization more difficult, its failure would make it both inevitable and broadly acceptable. All by itself, that's probably a good reason to let Geithner give this his best shot.

Valuing the Toxic Waste

| Sun Mar. 22, 2009 1:45 PM EDT
The details of Tim Geithner's plan to buy up banks' toxic waste are still a little vague, but liberal reaction (Krugman, Baker, Smith) has mostly been pretty harsh regardless. Their primary criticism is simple: banks aren't willing to sell their mortgage-backed assets at market prices because they think the market is panicked and only willing to buy at fire sale prices. And fire sale prices will ruin them. But if the government buys at the price banks value this stuff at, they're almost certainly paying too much. It might rescue the banks, but only by essentially giving away lots of free money.

This is all true, but it's a little too glib. After all, if markets can overvalue assets on the way up — and obviously they can — then they can also undervalue them on the way down. There's a pretty good chance that the toxic waste in question really is worth more than the market is currently willing to pay for it.

I think this sometimes get obscured because of a lazy shorthand that a lot of us have fallen into: namely the notion that the value of mortgage-backed securities is certain to keep plummeting because home prices themselves still have another 20-30% to fall. But these securities aren't backed by the value of the homes they represent. They're backed by mortgage payments. Home prices could fall by half, but the value of the securities wouldn't drop by a dime if homeowners kept making their monthly payments. Their value only drops if default rates go up.

So what causes default rates to rise? Falling home prices are certainly a factor, since it's more tempting to mail in the keys when your loan is way underwater. Rising unemployment is an even bigger factor: if you lose your job, you're more likely to stop paying the mortgage. And the crappy lending practices at the height of the bubble produced a surplus of buyers who have always been more likely to default than average.

But there are also forces that can reduce default rates. Fannie Mae and Freddie Mac are buying up billions of dollars worth of mortgages and renegotiating their terms. Barack Obama has committed $75 billion in direct aid for distressed homeowners. Congress is likely to allow bankruptcy judges to rewrite the terms of mortgage loans. And the Fed is trying to reduce long-term interest rates, which will allow homeowners to refinance their loans at lower rates.

Obviously, then, there's tremendous uncertainty about future default rates. But the market appears to be valuing most mortgage-backed securities these days at something like 30 cents on the dollar. That's crazy. When you factor in recovery rates, it assumes that over three-quarters of all homeowners will default on their loans. That might be true of the absolute worst of the toxic waste, and it's certainly true of the equity tranches of even the better stuff, but on average? No way. 30 cents on the dollar simply doesn't represent a reasonable long-term value for most of this stuff.

But everyone is scared, and when there are no buyers prices get unreasonable. So maybe with some nudging (along with plenty of leverage from Uncle Sam), Geithner's plan will motivate private investors to spend more time really trying to figure out what this stuff is worth and making fair bids for it. It's true that there are tricky aspects to running the auctions that Geithner may or may not be able to solve, but if his plan works it will help clean up bank balance sheets and keep taxpayers from getting fleeced. And if it doesn't work? There's always nationalization.

So it's probably worth a try. In the meantime, I'll recommend again Brad DeLong's FAQ, which explains the mechanics of the plan pretty well (though it might be wrong on some of the details since it's based on conflicting press reports). And I'll also re-recommend James Galbraith's post suggesting that we might not have to guess so much about the value of all this toxic waste if banks were forced to allow independent examiners to look at the loan tapes and find out just how vulnerable all these mortgage are.

UPDATE: Robert Waldmann makes the case that the market is actually valuing this stuff pretty accurately. That certainly might be true.  But if it is, then Geithner's plan will fail, the value of the toxic waste will be settled beyond question, and insolvent banks will be exposed for what they are.  That's a good thing, no?

Predator Update

| Sun Mar. 22, 2009 12:06 PM EDT
Greg Miller of the the LA Times reports that the CIA says its stepped up Predator attacks in Pakistan have been enormously successful:

An intense, six-month campaign of Predator strikes in Pakistan has taken such a toll on Al Qaeda that militants have begun turning violently on one another out of confusion and distrust, U.S. intelligence and counter-terrorism officials say.

....The stepped-up Predator campaign has killed at least nine senior Al Qaeda leaders and dozens of lower-ranking operatives, in what U.S. officials described as the most serious disruption of the terrorist network since 2001.

....Officials said that the surge in strikes has less to do with expanded capabilities than with the decision to skip Pakistani approval. "We had the data all along," said a former CIA official who oversaw Predator operations in Pakistan. "Finally we took off the gloves."Officials said that the surge in strikes has less to do with expanded capabilities than with the decision to skip Pakistani approval. 

....The effect was immediate....CIA officials had suspected that their targets were being tipped by Pakistani intelligence to pending U.S. strikes; bypassing the government ended that concern.  It also eliminated delays. Former CIA officials said getting permission from Pakistani authorities could take a day or more, sometimes causing the agency to lose track of the target.

I find this pretty believable.  There's really not much question that there are plenty of high-level ISI operatives who are sympathetic to al-Qaeda and likely to tip them off to upcoming attacks.  And as the article mentions, the Pakistani government knows this perfectly well.  Its objections to the drone attacks have been decidedly pro forma.

But even if this is all true, it's still not clear that the short-term success of the Predator program outweighs its long-term potential for blowback.  For now, though, I'll let smarter people than me try to figure that out.