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Jeremy Fletcher

In the government's view, apparently bad underwriting can be cured by bad accounting.

Don the libertarian Democrat

"Second, if the Federal Reserve buys debt, especially long-term debt, and especially debt worth less than it is paying for the debt, it increases the risk of a future inflation"

I backed such a plan in order to combat Debt-Deflation through QE. My only objection at first was political backlash.

"The essential point is that whatever form the subsidy takes, the difference between the valuation that the market places on the asset and the price paid for the asset will be paid for, albeit indirectly, by the government, as otherwise there will be no transaction."

Once the government bailed out AIG, a subsidy to the buyer became necessary. That's because the owner's of the TAs have been betting on government intervention. As well, they've received money to avoid fire sales of assets. In other words, the government has subsidized and given an incentive to the owners, which necessitates a subsidy and incentive to the buyers to compensate or equalize the exchange. Because of this and the need to transfer some of the banks debts to the taxpayers, a subsidy is a necessary part of any hybrid plan.

"The government could of course hire a Wall Street firm to advise it on the purchase of assets from banks"

This was William Gross's plan. It suffers from inherent conflict of interest. In truth, any hybrid plan will suffer from this, as PPIP shows. Even though Geithner is not from Wall Street, he's a Wall Street tool. Conflict of interest is inherent in a hybrid plan.

The reason that hedge funds are involved is simple. They are designed to buy risky assets, and are currently buying them. Who else will? If the government were to do this, it would be portrayed as the government investing in risky assets like a hedge fund.

"(The bank might want to hold out for more, but the regulators can probably coerce it to sell for less than it wants.) And that is what the government plans to do."

This seems to be the plan.

"Although my guess is that the political factor is the major driver of Gaithner's complex plan, the plan does have other advantages, so that on balance, despite its higher transaction costs and likely longer delay in implementation, it may conceivably be the superior approach quite apart from the political imperative."

I disagree somewhat. I think that this is simply the best hybrid plan that can be fashioned in the current situation. Down the road, the FDIC might be able to seize these behemoths, but, as of now, that's hard to see working, although I believe that they are trying to put themselves in a position to do this.


Pick your poison. No subsidy and let the TAs go to the highest bidder and get a hard landing quickly---politically unacceptable for the morons who got us into this in the first place and whose primary aim is to stay in office and at the public trough. Subsidize the asset prices and get a soft landing after a long glide slope. In either case the standard of living in the United States is likely to come down. Too bad the pols aren't honest enough to say that up front and then allowing the markets to self adjust.


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I love the blog! Thank you for continuing to provide insightful commentary on recent events.

As far as your book goes, while I look forward to reading it I am saddened that your title calls out a "Failure of Capitalism". I understand the need for an attention grabbing title from a marketing standpoint, but with all the government meddling in the housing market I don't agree that Capitalism is to blame for our current crisis.

Worse, in my opinion you are contributing to the growing belief that free-markets are inherently bad or "evil" and that we must be saved from the greed that results from making our own choices by folks that know better. I am sure you discuss the proper causes at length within the narrative, but these are dangerous times to be fanning the flames.

I fully support your right to make money in whatever manner you deem appropriate. But please bear in mind that you are an authority figure, and people that have been trained not to think will take what you say without so much as a grain of salt. Just remember this while you are on television promoting your book.



Another lucid post from Judge Posner (and for that matter, Prof. Becker as well). Thanks for posting so prolifically on the important issues of our time. I cannot wait for your new book to come out.


What good ever came from a government run economy?
What good idea for the betterment of the common man ever originated in a government run economy. Anyone who thinks that the very folks who made this mess have the smarts or the balls to fix it is self delusional. We are headed for a split society regardless of economic status, a government part and a non-government part. This is not a good scenario for social order and properity.

Keith Roberts, NYC

I am not sure that the real estate debt the banks now hold is worth so much less than the current, written-down book value. 1. The bank accounting is certainly now coming under more serious audit than before, so I would not automatically assume that they can get away with dishonesty. 2. While banks do indeed have reason to inflate book value, those holding the worst assets, which are already involved with government loans, also have reason to deflate book value: first, to avoid any future censure; second, because the gov't loans are cheap money that they might rationally want to get. 3. Perhaps most importantly, the lack of a market for the loans reflects, in addition to the factors Judge Posner mentions, the fear and uncertainty of outside investors. This fear and uncertainty is surely not a permanent factor, and therefore operates as a temporary and somewhat artificial depresser to the value of those loans.

John A. Kilpatrick, Ph.D.

I'll try to be succinct -- thank you for this explanation of the Tresury's plan-du-jour. I'm torn in my support for the plan. I'm generally impressed with the ability of auction markets to correctly price these underlying assets, albeit with something of a skew resulting from the favorable financing. These assets need work-out talent, and that's something decidedly missing from bank personnel resumes. Thus, the proposed program is probably a reasonable bargain.

That having been said, this is terrifically parallel to the S&L crisis, except in that situation, the banks got shut down first, then the toxic assets (back then, construction and development loans, mainly, plus some semi-worthless notes) were sold to the highest bidder, usually for pennies on the dollar of face value. the bid-downs were huge, because there was no Federal loan program to provide 95% LTV financing (such as Geitner proposes) on the acquisitions.

Will this solution be less-costly to the taxpayer and -- most importantly -- more efficient to kick-starting the system? One can only wait and see.

Tom Rekdal

It appears that we about to exchange the hubris of financiers and bankers, who mistakenly believed they could disperse risk through complicated financial engineering, for the hubris of economists, who now believe they can calculate the multiplier effects of fiscal stimulus and bank recapitalizations with sufficient accuracy to avoid either massive deflation or massive inflation. Not a bet I am prepared to take. The Sargasso Sea that is the Japanese economy begins to look more and more like our optimal outcome. Oh, for the happy days created by Hank Paulson's frenetic lurchings! At least he spared us a serious run on bank deposits and money market funds.


Perception is everything. Why can no one or Institution establish a Value of MSB's? Simple, "Perception", that sees these Assets as "Toxic" and has destroyed the Market by which their value is established. Remember, the fundamental principle of Economics, "is that the value of anything, is the price that it brings at market".

Gaithner's complex plan of bringing a tripartite group together to create a "New Market" that will establish a true market value, hence clearing the Investment House's and Banks Books that have been frozen and locked up by these Assets. By clearing these books, it will allow Banks and Investment Houses to begin to loan out credit again and thus stimulate the Economy out of it's Doldrums.

If it doesn't work, we're all in for one Heck of a Depression.


My understanding is that by taking the assets off of the bank balance sheets, the Fed (or anyone else who is so kind) actually is freeing up the banks' capital, for the simple reason that the banks have to hold capital against their assets, especially assets considered risky by the regulatory guidelines. So by buying the "toxic" assets and replacing them with cash, you actually would have banks more "able" to lend, though it seems an inopportune time to be lending to anyone, frankly.


Posner assumes that the assets can't be truly toxic, but is that true? A mortgage pretty much only has some value between it's face value and 0, but it seems to me like a bundle of securities could include derivative positions backed by mortgages, which could push the value of the bundle of assets and obligations far below zero, even if some of the assets were mortgages. Is there some reason not to be worried about this?

Michael F. Martin

So in deciding whether the bank is solvent, the prospective investor will write down the value of the overvalued assets to their market value, of which probably as I have said the best estimate is what buyers would be willing to pay for them. There is no contamination of other assets and hence of the balance sheet, any more than in any other company that has some assets that are difficult to value.

I think this misapprehends the problem. The problem is not some fear that other assets held by an individual bank will be "contaminated," but that there is no stable valuation for the toxic assets at any individual bank. Because the risk in such toxic assets is correlated with similar toxic assets in other banks and institutions all over the world, there simply isn't anyway to diversify out of the risk of owning institutions with these assets -- or so that's the perception. In principle, if there were enough non-toxic assets on a balance sheet, one could treat the toxic assets as a writeoff and have a safe valuation. But in practice, because of the leveraging into these assets and the volatility in the market prices, even a stable looking balance sheet could go up in smoke.

Uzair Kayani

This is an excellent post. I have a couple of somewhat contradictory concerns, though:

(1) The hedge funds' investment in banks' assets is not a private investment in the way that we usually understand that term. Since the investment is subsidized by the government, it is a "government-induced" investment, that is, it is a misallocation of private resources. If the government did not induce the hedge funds' purchase of banks' assets, then the hedge funds would have invested elsewhere. The problem with government-induced investment is not only that a transfer from a nonbank bank (hedge fund) to a bank leaves the banking system just as poor as before, but rather that the money is transferred from a better investor (a hedge fund) to a worse one (a troubled bank). The government subsidy misallocates hedge fund resources to banks, and the banks will misallocate these new resources to either hoarding (because they are nervous) or lending to worse debtors than the hedge funds would have found if there were no subsidy. I don't think we should attach any market-based credibility to this induced investment.

(2) On the flip side, the S&L crisis reminds us of the serious moral hazard created, not by giving banks a safety net, but by assuring them that they will not be rescued. In the S&L crisis, I think we had so-called Zombie institutions that knew the government was not going to help them, and with nothing to lose, they gambled with junk bonds. If we do allow some banks to fail because of our stress tests etc, then they might go down gambling. This could also distort the market, because the sinking banks would be making bets that they would never have considered had they expected to survive. They will make a last ditch effort to stave off a government takeover or dissolution; it is like putting your last ten dollars in the state lottery.


"Especially in this depression, because the mismanagement of the economy by the Bush Administration and the Federal Reserve in the first half of the decade produced a dramatic fall in the personal savings rate and a movement of savings from safe forms to investments in houses and common stocks, so that when housing and stock prices fell, people's savings plummeted and they are trying to rebuild them--the personal savings rate has soared since the financial crisis of last September."

And you wonder why the situation is political...?

When will one of the socialist out there condemn government for setting up the ponzi scheme...? The finger pointing at free markets is really tacky.

Coldest winter since the 1970's and Obama is proposing a tax on carbon in the middle of a "RECESSION"....! This is the dumbest idea proposed by a politician since sub-prime lending.


I don't see what a carbon tax has to do with the recession, good tax policy is good tax policy, I'd rather see a carbon tax than a tax on dividends to raise the same revenue. At least there are positive externalities to people altering their behavior to pay less carbon tax. That overall tax burdens are likely to become a problem (I count inflation and fines as tax, also social security and such)is at this point fairly inevitable at this point I'm afraid. If Obama pulls this one off painlessly we should king him lol. He walked into a big mess.

Chase Mechanick

Private investors, when choosing precisely which "toxic assets" to buy, will have a heightened risk tolerance. Under normal circumstances, private investors would have to weigh the assets' payoff against the likelihood that they will perform below their (inflated) value and the losses that such a situation would incur. Since the FDIC promises to guarantee any losses on these assets (an utter betrayal of that institution's original purpose), this effectively neutralizes the cost of taking on heightened risk. This means that investors will forego the "safest" toxic assets (relatively speaking, of course) for riskier ones that promise higher payouts. Their portfolio would be skewed towards risk. So a disproportionally large fraction of the assets that these investors purchase will underperform - at the government's expense.

Rob Swanson

The answer is here:


Not sure why it is so difficult.

Michael F. Martin

Don't miss the new proposal by Zingales and Hart.


The issue or concern I have with the two Becker and one Posner posts and the comments on them, is that they seem to miss one very important point.

The banks (as often noted or hinted at) are carrying many of these assets at much closer to book values than is warranted by any "honest" method of valuation. That's why they won't tell anybody what they are or reveal their valuations. They are doing this to avoid being forced to write them down further than they already have been, because if they do that they will be obviously insolvent and forced into receivership since none of them in the presnt market can raise any new private capital.

Thus they cannot sell those assets off their books at any price a willing buyer (subsidized or not (one doubts the valuations are within 7% of the realistic values) would pay for them given the high degree of risk (and therefore discount) they would need to apply. If they did, it would be a price below what's currently on their books as that's asset's value, thus forcing the very thing they don't want...further big writedowns making their complete insolvency patently obvious.

The upshot of that scenario (if accurate) is that this Geithner plan is no more believable as a solution to the current banking crisis than was his explaination of his failure to properly pay his income taxes. The banks will continue to hold and over value these assets hoping that the economy rallies sufficiently to rescue them before they go completely bust.


Anonymous? "When will one of the socialist out there condemn government for setting up the ponzi scheme...? The finger pointing at free markets is really tacky."

Hmmmmm........ do you think those "free market" non-banks were told by government that leveraging their flaky "assets" 30:1 was a grand idea? Or? is it that you think someone in the government "leaked" that they go the bail of those whose crafty Ponzi's blew up in their grossly overcompensated faces?


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So many things seem to going wrong in so many different markets. The housing is flooded with people who should never have received the loan the did in the first place. So many companies have had to start massively laying-off individuals. I think many companies should have used a PEO to help limit the lay-offs.

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nice blog!

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