Thursday, April 2, 2009

Stiglitz: Wall Street Wins, Taxpayers Lose

This is now two Nobel prize-winning liberal economists vociferously opposed to Geithner's PPIP. A week after Paul Krugman announced that the leaked reports of Geithner's plan "fills me with a sense of despair," Columbia professor Joseph Stiglitz takes to the New York Tims to voice his own displeasure over the huge taxpayer giveaway the Geithner plan represents for banks and private investors. From the New York Times:
In theory, the administration’s plan is based on letting the market determine the prices of the banks’ “toxic assets” — including outstanding house loans and securities based on those loans. The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets.

The two have little to do with each other. The government plan in effect involves insuring almost all losses. Since the private investors are spared most losses, then they primarily “value” their potential gains. This is exactly the same as being given an option.

Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year’s time. The average “value” of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is “worth.” Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!
Stiglitz goes on to attack the claim that the current crisis is simply the result of a lack of liquidity - i.e. panic is driving down asset prices beyond the fundamentals. Again from the New York Times:
The main problem is not a lack of liquidity. If it were, then a far simpler program would work: just provide the funds without loan guarantees. The real issue is that the banks made bad loans in a bubble and were highly leveraged. They have lost their capital, and this capital has to be replaced.

Paying fair market values for the assets will not work. Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time....

What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. And such partnerships — with the private sector in control — have perverse incentives, worse even than the ones that got us into the mess.
Has the Obama economic team rebutted these arguments, aside from saying calls for putting insolvent banks into receivership are "deeply impractical"? If Obama is seen as in Wall Street's pocket, there will be no political will for further bailouts, which will inevitably be necessary. Putting off the day of reckoning, and playing nice with the bakers is a very, very dangerous course.

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