Due to a snarky suggestion from sammy, I actually read this pdf fact sheet from the Treasury about the Geithner plan (thanks again sammy). It was much less bad than I thought.
Although he doesn’t like to disagree with Krugman, Maynard at Creative Destruction makes this argument (much more briefly and clearly than I will here).
The problem with this [Krugman’s] example is that it assumes that each loan guaranteed by the FDIC is used to buy a single asset that either defaults or pays in full. … But in fact the Treasury’s plan, as I understand it, is for PPPICs to bid for pools of loans/securities held by banks. The FDIC loan guarantee will apply to the pool rather than the original loan. The PPPIC will only default on the loan if the value of the pool turns out to be considerably less than the purchase price (specifically, less by the amount of the firm’s capital investment).
For me a chance to disagree with Krugman is a rare pleasure. I also had a blast disagreeing with Brad DeLong on the same issue. That means I am … consistency is the hobgoblin of small minds.
Now disagreeing with Ken Houghton, now that is scary (don’t let it go to your head Ken its partly that Krugman won’t bother with me). Gulp. here goes (after the jump).
update: Citizen K is on the case too.
The Geithner plan as described in the official fact sheet is much less bad than I thought. In particular there are 3 programs (including Talf II the legacy).
The program which involves the FDIC, provides a large no recourse loan to buy pools of loans. The FDIC must approve the pool. The the pool is auctioned, then the FDIC decides how big a loan to make (if any).
The FDIC can (try to) protect its trust fund by not allowing pools with (predictably) huge variance. FDIC bosses do not want to have to go to congress to beg for a top up of the fund (I think that’s putting it mildly). I now think the delay in the roll out may have occurred because the FDIC demanded better tools to protect itself (my old theory was that Warren Buffett demanded that the FDIC get worse tools to protect itself — hobgoblin etc).
Now if the pools were pools of same rated tranches of similar pools of tranches of etc, the Krugman Sachs scam would work. But the FDIC can just say no. I have the impression that the pools which come with a huge FDIC donated Geithner put are supposed to be pools of loans — first order toxic. To me the PDF isn’t clear on whether pools of higher order toxic waste are eligible, but it is clear that the FDIC must agree.
The higher order toxic waste (or junk too toxic for the FDIC) is to be bought in a separate Treasury program in which private partners have to put up at least a third of the money and the Treasury has at least half of the equity. This reduces the value of the Geithner put. In fact letting private partners cut off the losses at the investment losing 2/3 of purchase price might be a reasonable correction for the fact that private partners are risk averse and the Treasury is, or should be, risk loving (if things tank worse than we expect we *want* a larger than planned budget deficit).
So maybe maybe not so bad. I’d say that the banksters have further hard lobbying to do at the FDIC to get a huge handout, so it’s not time for dispair (yet).
Disclaimer: Brad DeLong has authorized me to post quotations from Keynes and Orwell on his site. This post is not pay back. Honest.