Here's how it would work:
- Let's say a Bank seeks to sell pool of mortgages worth $100;
- A private auction decides that asset is now worth $84;
- The private investor and government put up $6 each;
- They then borrow remaining $72 from government;
- That loan is guaranteed against any losses;
- If asset is later sold at higher price, government makes profit and private investor pays back loan and pockets profit;
- If asset is sold at lower price, government and private investors could lose initial investment.
Am I missing something, or is this really saying:
- The government and the private investor share equally in all the gains on the entire $100;
- The government and the private investor share equally in losses till 14% of the market value at the auction, and
- The government foots the bill for any loss in excess of 14% of the value.
If this is right, it seems like a pretty good deal for investors if the market valuations now are relatively fair.
Krugman, meanwhile, is railing against the plan. I didn't quite follow his logic. His main argument seems to be that the banks will still have lost the money they have, and no amount of taking stuff off the books will help. True. But wouldn't the lack of exposure to further downside risk reduce the inter bank solvency issue somewhat? If Krugman has a reason to believe it won't, he didn't explain it in the article.
Krugman has pointed out that history has shown that some amount of nationalization is necessary.
Couple of points.
- Firstly, Krugman is right. Some form of nationalization is probably the most effective answer. Government guarantees / nationalization gives people confidence about the solvency of their counterparties. Geithner's plan does that too. However, the degree of confidence inspired by the former is far more and so, I would argue, it is a much quicker fix. Obama, however, needs to weigh the political expediency of nationalization and what it might do to his ability to get other policies passed. So, the fact that we haven't gone there may be just as much a political calculation as an economic one.
- Secondly, at one point in the article, Krugman writes: "And now Mr. Obama has apparently settled on a financial plan that, in essence, assumes that banks are fundamentally sound and that bankers know what they’re doing." [emphasis added] In so saying, Krugman betrays his political biases and, dare I say it, his naivete. Firstly, how can pouring $500 BN to $1 trillion into the banks in addition to billions already spent suggest that anyone in government think there is anything, fundamentally or otherwise, sound with the banks? But, maybe Krugman is reflecting on the competence of bankers, particularly senior management. In this context, I too have concerns, but is Krugman's idea any better? If we nationalize, who can we replace everyone in these organizations with? Would the bank actually operate better? Yes, they made bad bets, as did everyone else. Does that mean the government will do better? The same government who regulated these industries so 'brilliantly'?
I too am concerned that those who caused the mess are not paying a high enough cost. Having said that, there seems to be a tendency on the left to assume that just because one option is bad, the others are necessarily better. That's a logical fallacy. Krugman and others need to explain why they believe so. Also, nationalization may indeed solve the immediate crisis faster. However, would it really be the long term interest of the nation? Are nationalized banks really better banks?
My guess is that before this is over, a number of these banks and financial institutions are going to be nationalized. AIG and Citi effectively are already. Political expediency aside, more probably would have been already. However, I am not as convinced as Krugman that Obama's reticence to nationalize is necessarily a bad thing.