The Economist on the Financial Rescue
Someone at the Economist writes:
Weekend link exchange: Financial rescue edition: SO, THE latest details on the Obama administration's plan to shore up the banking system have been leaked.... One prong is simply an expansion of the Term Asset-backed Securities Loan Facility (TALF!).... Another prong is a move to create public-private funds that will be capitalised by private money matched dollar-for-dollar with goverment money (and potentially leveraged by government loans). These funds will seek to buy toxic securities backed by mortgages and some other kinds of debt. Finally, there is a plan to create privately-managed funds financed overwhelmingly by the FDIC and the Treasury, but with some equity from private investors on the line. These funds would bid at auctions for pools of bad assets being sold by troubled banks.
The first place to start reading about the plans is at Brad DeLong's site, where he offers an FAQ post that probably reflects, to a certain extent, the adminstration's thinking.... As Mr DeLong explains, there is a decent chance the plan will work, so long as "work" is understood to mean "address one small aspect of the banking crisis—amounting to perhaps one quarter of the $4 trillion in bad stuff out there—and a smaller still aspect of the overall economic crisis". It's not the plan, in other words; it's part of a plan.
One needn't click too far to find critics of the plan. Start will Paul Krugman, who reacts initially with "despair", and who subsequently responds to Mr DeLong's post. Then there's Yves Smith (extremely sceptical!), Calculated Risk, and Robert Waldmann. Plenty of others, too. James Kwak offers a fairly reasonable critique of the plan, writing:
In the best-case scenario: (a) the government’s willingness to bear most of the risk encourages private investors to bid enough to get the banks to sell; (b) the economy recovers and the assets increase in price from the prices paid; (c) the investment funds pay back the Fed (which makes a small spread between the interest rate and the Fed’s low cost of money); and (d) the government gets some of the upside through its capital investments. (I think the main purpose of that government capital is to deflect the criticism that all of the upside belongs to the private sector.) In the worst-case scenario, the market stays stuck because the banks have unrealistic reserve prices. Perhaps the idea is that, in that case, the TALF will allow the government to (over)pay whatever it takes to bail out the banks.
And then, in a follow up post he engages with a questioning reader on the merits of nationalisation.
I am still digesting the plan and the responses (and I will be interested to see the full details tomorrow). My supposition is that administration officials are very reluctant to nationalise for some very good reasons. Nationalising an enormous bank like Citigroup or Bank of America, or both, might be the thing to do, but there are some pretty substantial risks—a meltdown half as bad as the one last autumn would eliminate any chance of a recession bottom this year. Moreover, nationalisation isn't reversible This plan, on the other hand, might not work. It might do some good, however. At the very least, it could help indicate which markets and institutions are afflicated by illiquidity, and which are really and truly (and hopelessly) afflicted by insolvency. And then a few months down the road, if Citi and Bank of America are still looking hopeless, well, nationalisation remains an option.
This, I think is their thinking. The problem is (and it's a really dangerous problem) that policy is beginning to bump up against some serious logistical constraints. I live in the bubbles of Washington and the economic blogosphere, but the roars from inside those bubbles are loud enough that they must be audible on the outside. And the AIG fiasco looms large in the background. Everyone is upset—the bankers, the legislators, and the voters. The uncertainty and the anger from these parties may begin to compromise the adminstration's ability to act, on the financial rescue and on other economic policies and on the presidents agenda more generally.
If Treasury officials have determined that nationalisation is too risky, given their extensive look at information to which most of us don't have access, then it's well that they have chosen not to nationalise. You don't want leaders to act simply because everyone is demanding action. At the same time, it's not enough to roll out a policy like this and hope the public receives it well. Clearly this reaction could have been foreseen, and it certainly appears as if nothing has been done to preempt and mitigate it.
This plan might be the best option, but the administration has manifestly not made the case that it is, and that's a problem. If the president feels that this policy can work, he needs to sell it hard enough to buy enough time to allow it to work, and to allow him a second shot if it doesn't. If he can't accomplish that, then it doesn't matter how much better this policy looked relative to alternatives on paper. It's worse, in that case, than nothing.
I suspect that at least one of the reasons the Obama administration is not nationalizing the banks right now is named "Voinovich": getting 60 votes in the Senate for bank nationalization is no easy task with this Senate until the administration can demonstrate that it has gone the extra mile.
I did have a comment on the Economist's description of my post as "probably" "to some extent" "reflect[ing]" administration thinking:
Mesdames and Sirs--
You write: "probably" and "to some extent." Don't you know? These are my guesses--the White House operator keeps dumping my calls to the "comment" line rather than putting me through to Larry Summers's office, and nobody is answering the main NEC number this Sunday...