The Dull Compulsion of the Economic (ii)


(1) Japan and Latvia rack up whopping double-digit 4Q annualized GDP declines. That’s two trade-loving nations in one day, one of them being a major trading partner of both the US and China, and the second largest economy, after the US, on earth. And Japan’s (in an “unimaginable contraction”) 1Q ’09 could be worse. Comparable numbers from much of the rest of Asia are discussed here. All from today’s (it’s still Tuesday in Cambridge, MA) Financial Times.

(2) Mexico’s drug-related violence is horrific, and what the next story describes is the last thing they need given the fierceness of the former, but the next time anyone in the US threatens to decertify their efforts in the “war on drugs,” Mexico should imprison all Coca-Cola executives (including former exec and President Vicente Fox). The dollar amounts (never mind the human cost) lost because of the obesity epidemic in Mexico to foregone productivity and increased health care provisioning must reverse to a respectable degree the GDP gains (disappointing and ill-distributed as they have been) from NAFTA so beloved of free-traders. And remember, much of this US production is subsidized. From The Financial Times.

(3) The Treasury is issuing a record $67 billion in debt this week. This Lex column from The Financial Times gives a short summary of essential points (though one of its points became somewhat obsolete by the end of the day it was published, as will become apparent below).

Today’s comment:
Stimulus Passes Senate, Bank Bailout Plan (Partially) Unveiled, Markets Tank

Stock prices dropped sharply today, and bond prices surged, as investors expressed confusion at best, and in some cases contempt, for Secretary Geithner’s bank bailout proposal. The Dow lost 4.6% in its biggest fall since December 1st, and other indices reported similar falls. The proposal, which, according to a JP Morgan summary (hat tip to the fine site Across the Curve), features the creation of a “Public-Private Investment Fund,” or P-PIF (just what we need, after TARP, TALF, M-LEC and all the others…). Such a “bad bank” would operate much as the TALF, providing non-recourse loans (on which the lender can only collect the collateral in case of default) to purchasers of (bad) assets held by the banks. But, in this case, it would be private investors who would be the beneficiaries. And, as the JP Morgan report put it:

…this plan’s so-called private sector pricing of assets would be directly related to hoe much leverage the P-PIF extends to other investors. The greater the share of non-recourse lending extended to investors, the higher will be the new “market” prices for assets. The dilemma that first surfaced last September–the higher the price the greater the support for the banking system, but also the greater the risk for taxpayers–is not resolved by the P-PIF but is instead transformed into a decision about how much leverage the P-PIF will provide to investors.

Wonderful. This means that hedge funds and their ilk are the targets of this move. No doubt the Treasury is looking both at halting the record redemptions that have prevented this part of the financial industry from putting much needed cash on the markets. Once again, it seems the Obama administration and its acolytes consider that any recovery from the crisis will have to involve intimately the people who got us into it. Anyway, back to the report:

There was nothing in today’s announcement about providing insurance or guarantees to assets on bank balance sheets, a proposal that seemed to be the centerpiece of the reform as late as last Friday. Any announcement related to foreclosure mitigation was deferred for a few weeks. Note that it appears the majority of P-PIF and TALF would be funded by the Fed balance sheet, thus not requiring Treasury issuance and possibly not even requiring Congressional action.

That’s change we can believe in, all right: we just endured several months of it before the new administration took office….

Of all I’ve seen written on the subject, Brad Setser has the most intriguing notions on why the administration is looking to the leveraged players in this desperate attempt to get bad assets sold off once and for all:

The Treasury seems to have concluded that it was impossible for the government to figure out what price it should pay the banks–really the banks existing owners–for their toxic assets. There is a reason why bad bank–like the RTC [Resolution Trust Corporation]–generally were created after a bank had already failed and their equity investors have been wiped out. If the government already owns the banks assets (as a result of its guarantee of the banks’ liabilities) it doesn’t really matter what price it pays the “good” bank for the assets of the “bad” bank.

But providing other parts of the financial system–including parts of the shadow financial system–with credit to help it buy the banks bad assets isn’t a perfect solution either.

Implicitly, Geithner and his colleagues seem to have concluded that the “great unwind” has limited the private sector’s ability to absorb the banks troubled assets. Key players no longer can borrow the funds needed to make large bets on troubled mortgage-backed securities. By providing credit to those willing to buy bad assets, the US government hopes to push up their market price up, and in the process induce the banks now holding these assets to sell. The US government in effect is providing the financial system with leverage to facilitate–one hopes–a transition to a less leveraged financial system. The amount that private investors have to put down–relative to the amount they are spending–is a key detail


This is simply unbelievable: assets worth virtually nothing because they consisted of much less than their hyper-excessive leverage multiples are to be peddled to the very same sort of investors who have just been burned by these things, simply because the leverage is now to be put up by uncomplaining (not to mention increasingly skint) taxpayers and foreign investors, and not the banks. And this in an attempt to make a transition to a less-leveraged system! It’s no surprise that nobody seems to be buying it.

All together, the proposals put forward today could amount to nearly $3 trillion. And everyone except the administration seems to believe that won’t be nearly enough. Be prepared for new, and even clunkier acronyms….

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