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Obama’s Bright Idea: Let’s Play ‘Heads the Banksters Win, Tails the Taxpayers Lose’

(updated below)

Ian busted this nonsense on Monday:

This may sound a little hyperbolic, but my jaw did drop when I read SEIU Treasurer Anna Burger’s succinct description of Geithner’s plan for convincing private investors to buy up assets:

Secretary Geithner’s proposal for the Term Asset-Backed Securities Loan Facility (TALF) would enable private equity firms and hedge funds to buy up higher quality loan securitizations, including auto, consumer, student and small business loans. The Federal government would provide low-cost financing for up to 95% of the purchase price, with private firms putting down as little as 5% and the securitizations as collateral. The hope is then to expand this proposal to include toxic mortgage-backed securities.

Each of these programs could cost taxpayers up to $1 trillion. If the private firms make a profit from the deal, they keep all of it. If they end up losing money, they are only on the hook for the nickel or two of equity they put in. The taxpayers would then assume the rest of the losses. Even worse, subsidizing the purchase up to 19-to-1 will drive up the price of the assets…

There is no reason to do this. If the government is providing 95% of the money, the government might as well provide 100% of the money and just take the profit as well as the risk. Under Geithner’s plan, the government accepts all the risk and none of the profits and puts up almost all of the money?

This is ideology run rampant at the cost of common sense. What conceivable reason would Geithner have to pitch something like this? Could it be because he doesn’t believe government should make a profit, or that private investors should take losses? Or, worse than that. . .

Burger is right when she says that this plan will lead to yet another bubble. […]

And Krugman nailed it today:

To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad — I mean misunderstood — assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.

But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.

Or to put it another way, Treasury has decided that what we have is nothing but a confidence problem, which it proposes to cure by creating massive moral hazard.

Some may object to calling this "Obama’s plan." But Obama has explicitly claimed responsibility and has said that Geithner is doing a heckuva job. So, hopefully, it’ll sober him up, if we explicitly lay responsibility for this madness directly at his feet.

UPDATE: Per James K. Galbraith:

If I’m right and the mortgages are largely trash, then the Geithner plan is a Rube Goldberg device for shifting inevitable losses from the banks to the Treasury, preserving the big banks and their incumbent management in all their dysfunctional glory. The cost will be continued vast over-capacity in banking, and a consequent weakening of the remaining, smaller, better- managed banks who didn’t participate in the garbage-loan frenzy.

This will not achieve the stated goal, of bringing on new lending, for reasons already explained at length. It’s all about not-measuring true asset quality at the big banks, permitting them to escape a clean audit, and therefore preserving them as institutions, while forcing the inevitable shrinkage of the financial sector to occur elsewhere. In short, the plan seems to me to be a very bad idea.


If I were a member of Congress, I would offer a resolution blocking Treasury from making the low-cost loans it expects to offer the PPIPs, until GAO or the FDIC has conducted an INDEPENDENT EXAMINATION OF THE LOAN TAPES underlying each class of securitized assets, and reported on the prevalence of missing documentation, misrepresentation, and signs of fraud. In the absence of a credible rating, this is the minimum due diligence that any private investor would require.

I hope what I’m driving at, here, is clear…

The author of The Predator State is being abundantly clear.

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