Brad DeLong (Desperately?) Tries to Rationalise the Giveaway

UPDATE: Dr. Black twists the knife.

The Geithner Plan FAQ is worth reading; it’s a classic example of treating an incomplete market as if it were the entire market. And note that “skin in the game” is limited to a part of the local pool.

Unfortunately, while Treasury plays in the wading pool, hedge funds have The Whole Wide World in which to romp. Yves (h/t Mark Thoma) has a commenter who explains:

Say I am SAC Capital. I get to be one of the bidders on bank assets covered by the program

Citi holds $100mm of face-value securities, carried at $80mm.

The market bid on these securities is $30mm. Say with perfect foresight the value of all cash flows is $50mm.

I bid Citi $75mm. I put up $2.25mm or 3%, Treasury funds the rest.

I then buy $10mm in CDS directly from Citi [or another participant (BOA, GS, etc)] on the bonds for a premium of $1mm.

In the fullness of time, we get the final outcome, the bonds are worth $50mm

SAC loses $2.25mm of principal, but gets $9mm net in CDS proceeds, so recovers $6.75mm on a $2.25mm investment. Profit is $4.5mm

Citi writes down $5mm from the initial sale of the securities, and a $9mm CDS loss. Total loss, $14mm (against a potential $30mm loss without the program)

U.S. Treasury loses $22.75mm.

I would have thought by now that economists would know what happens when you create bubbles in a market. That doesn’t change just because you use the U.S. Treasury as a Fluffer.

Tags: , , , , , , , Comments (0) | |