If I Were Grading Papers...

Krugman's "analysis" of the Treasury bail-out proposal, "No Deal", is so weak it is embarrassing:

I hate to say this, but looking at the plan as leaked, I have to say no deal. Not unless Treasury explains, very clearly, why this is supposed to work, other than through having taxpayers pay premium prices for lousy assets.

...

The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system — that is, convince creditors of troubled institutions that everything’s OK — simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem — which seems doubtful — or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.

No.  If the problem is liquidity rather than solvency (a big if, and Krugman guesses it is solvency) then removing the troubled assets at fair value will reduce the variance of the firms balance sheet without changing its expected value.  This reduction in value may be enough to reassure lenders thatt the firm in question is safe.

Developing... I have more in the UPDATE here but I am still working on my scintillating killer example of the impact of mean and variance on lenders (but not equity holders).

KILLER EXAMPLE:  *IF* this is a liquidity problem (and Krugman acknowledges it might be) then it will not be necessary to pay a premium for troubled assets.  Paying a "fair" price (whatever that is in this uncertain world) will preserve the current expected net worth of the firm but greatly reduce the variance of future net worth.  That will be very appealing to prospective lenders.

For example - suppose a firm holds a large pot of troubled assets that will, over the next ten years, produce uncertain cash flows.  The assets are currently valued at 50 cents on the dollar.  After careful analysis, prophets and seers conclude the following:

There is a 20% chance the assets will return 25 cents on the dollar; resulting losses will bankrupt the firm.

There is a 60% chance the assets will return 50 cents on the dollar, allowing the firm to survive.

There is a 20% chance the assets will return 75 cents on the dollar, allowing the firm to live long and prosper.

The "fair" price for these assets is 50 cents / dollar.  However, if the firm continues to hold them there is a 20% chance of bankruptcy.  This grim prospect will scare away all but the hardiest of junk lenders, thereby creating a liquidity crisis for the firm.

If the firm can sell the assets at a fair price of 50 cents the expected value of its net worth is unchanged but the probability of bankruptcy drops to some very low and acceptable level.  Liquidity crisis solved, even though the assets were not sold at a premium.

Obviously this doesn't work if the firm has a solvency problem, i.e., at fair value the net worth of the firm is negative.

However, Krugman's general statement that absent premium prices this plan cannot succeed is false.

Comments

[bgates]

TM, since I have a chance to get in here early - is it possible under typepad to add an ip address or cookie or some kind of unique id to the signature line? Ace of Spades does the kind of thing I have in mind. One of the trolls in the last thread noticed the troll blocker script I've been advertising, and is now writing each comment under a different name. I have no interest in the attention-starved idiot, and I think several other regulars feel the same.

[kim]

That's just Leo playing childish games. He'll get tired of it because it makes him seem more incoherent than usual.
====================================

[kim]

Nice to snap to the distinction between solvent and liquid. Solvency was indeterminate because liquidity froze up from lack of information, no? And now, still with no information but artificial liquidity, solvency can manifest itself. Close enough for a tyro?
================================

[Charlie (Colorado)]

Nice to snap to the distinction between solvent and liquid. Solvency was indeterminate because liquidity froze up from lack of information, no? And now, still with no information but artificial liquidity, solvency can manifest itself. Close enough for a tyro?

Pretty close, except it's not artificial liquidity. Once people can trust their valuations --- which, as Tom alludes, are actually a statistical distribution --- then the market will become liquid again automatically: people will be able to estimate risk and value credit. That's real liquidity by the usual mechanism.

The point about the variance is this: statistically, uncertainty about the value becomes variance in the distribution --- you know the odds are at least, say, 95 percent that the value lies between a low and a high bound.

If I sell you an apple for a dime, the value of that apple is 10 cents, with very little variance. If I want to give you my dime to hold and ask for 9 cents back (a loan with collateral) you and I both know the collateral asset is worth a dime.

But say instead I gave you the *apple*. If you're pretty sure it's worth a dime, we have the same deal. On the other hand, you don't know whether the apple would sell for a dime, or two for a penny, you won't be likely to loan me 9 cents against it.

If you're sure it's a dime, the variance is low; if you don't know whether it's a mil or a dollar, the variance is high.

(Is that the example you wanted, Tom?)

[bgates]

Kim - I stopped going to movie theaters because I don't want to listen to other people's shrieking children. Hate to see the same thing happen here.

[Emile Zola]

Solvency, then, is your basic balance sheet: Do you have more assets than debts? In a strictly budgeted scenario, if you have more debts than assets, you are not (very) solvent; all your income goes to servicing those debts.

Thats' the algebraic equation 'a negative plus a negative equals a positve' I used to distinguish this Financial debacle from algebra that was so childishly dismissed by the mass of miscreants here.

It's pretty simple really. Most of a mortgage pmt goes to interest, not principle. If the debt service of the lending institution eclipses the income from payments, they're in the RED. Get it?

[Mr Rogers Neighborhood]

"I stopped going to movie theaters because I don't want to listen to other people's shrieking children."

How childish..........

[Mr Rogers Neighborhood]

Ian Welsh on 'Paulson's Blank Check'

"I've pasted the text of the bill below the jump. Everyone should read it. But here are the key points:

* No one who foresaw the crisis, such as Krugman or Stiglitz, is involved in making the plan to fix it.
* The man overseeing the bailout is the ex-CEO of Goldman Sachs, a Wall Street Company. He helped cause the crisis.
* Paulson helped obtain the SEC exemption which allowed brokerages to increase leverage to 60:1 from 12:1.
* The money is Paulson's to use for buying commercial and residential mortgages and mortgaged backed securities as he chooses. No one has any oversight over him, and he can pay any price he wants to, including face amount of the debt.
* Courts cannot review his decisions, not can any regulators. He has to report to Congress once every six months.
* He gets 700 Billion dollars to use as he sees fit, looking after the taxpayer is a "consideration" not a requirement.
* Bet on that 700 Billion dollars being gone before January 20, 2009. Bet on Treasury asking for more.
* That is $2,324 dollars per man, woman and child in America
* There is no bailout for mortgage holders. Banks get bailed out, but not ordinary people.
* Banks and brokerages made record profits these last eight years. Ordinary Americans barely broke even.
* In 2007 Wall Street paid itself bonuses equal to the raises of 80 million Americans.
* Banks bailed out by this plan need make no changes in how they do business.
* Banks bailed out need not replace the management which drove them into insolvency.
* Shareholders and bondholders of such banks do not lose a cent.
* The securities which caused this crisis are still allowed.
* Expect the 700 billion dollars to increase inflation, especially in oil.
* Bush is asking you to trust his administration with 700 billion after spending 580 billion on the Iraq war. Do you trust him?"

[Semanticleo]

"Shareholders and bondholders of such banks do not lose a cent."

That includes me, and I don't think that is right.

[kim]

Leo, watch the Democrats in Congress go right along with it. They know something you don't.

Yes, bgates, but Leo's diluting his brand, such as it is. He'll tire of it. Just like the screaming kid. Be glad the whole theatre isn't full of 'em.
==========================================

[kim]

Read above, Leo, you'll see they weren't necessarily insolvent; crooks, read Democrats, had provoked the liquidity crisis.
=========================================

[Semanticleo]

From Yglesias:

" Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don’t do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don’t want to signal weakness and they don’t want to dilute existing shareholders. A government order could cut through these obstacles.

Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks’ bad loans but by buying equity stakes in the banks themselves. Whereas it’s horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under."

[Verner]

So Krugman's panties are in a wad because he doesn't get to write the plan. Booo Hoo.

* Bush is asking you to trust his administration with 700 billion after spending 580 billion on the Iraq war. Do you trust him?"

Well, let me see, the alternative is the Obama team! Robert Rubin, Franklin Raines, that horrid Prinsky woman and a bunch of other Clinton retreads who started all this mess in the first place! Not to mention, Chris Dodd and Barney Frank would be in positions of power in the congress.

In that case, Hell yes I trust Bush! At least he was trying to reform this mess in 2005.

[kim]

Adding capital to incalculable solvency still sums to incalculable solvency. Even I know that. So should you. Read up on the thread.
======================================

[kim]

Only 580 billion? You know, Leo, the Twin Towers catastrophe caused a trillion dollar hit to the economy. Bush seems quite prudent with his Iraqi adventure. Probably so with Paulsen and Bernanke's plan, too. Like Verner says, better he or McCain than to let the foxes into the henhouse.

You haven't figured out how stupid, corrupt and dangerous these Democrats have been have you? They sold out for fractions of a penny on dollars lost by taxpayers.

If the Democrats are so happy to bend to Paulsen's will, watch them telegraph to Obama not to make a big deal of this. They are on thin ice, I'll bet.
=====================================

[PeterUK]

"Thats' the algebraic equation 'a negative plus a negative equals a positve' I used to distinguish this Financial debacle from algebra that was so childishly dismissed by the mass of miscreants here."

-1 + -1 = 2 ?
You lose on of your balls in a tragic zip accident the other your irate partner tears of with his bare hands, that is -1ball add to other sad accident -iball that = -2 balls.You are bollockless,

[bad]

Peter, you have such a knack for putting things into perspective. Even Barbie would find that to be easy math.

[Verner]

Since the Bots are flinging neo-marxist claptrap throughout the comments, I hope TO won't mind me copying the full test of this WaPo piece--just a gentle reminder of who did what:

Where Was Sen. Dodd?
Playing the Blame Game On Fannie and Freddie

By Al Hubbard and Noam Neusner
Friday, September 12, 2008; A15

Taxpayers face a tab of as much as $200 billion for a government takeover of Fannie Mae and Freddie Mac, the formerly semi-autonomous mortgage finance clearinghouses. And Sen. Christopher Dodd, the Democratic chairman of the Senate Banking Committee, has the gall to ask in a Bloomberg Television interview: "I have a lot of questions about where was the administration over the last eight years."

We will save the senator some trouble. Here is what we saw firsthand at the White House from late 2002 through 2007: Starting in 2002, White House and Treasury Department economic policy staffers, with support from then-Chief of Staff Andy Card, began to press for meaningful reforms of Fannie, Freddie and other government-sponsored enterprises (GSEs).

The crux of their concern was this: Investors believed that the GSEs were government-backed, so shouldn't the GSEs also be subject to meaningful government supervision?

This was not the first time a White House had tried to confront this issue. During the Clinton years, Treasury Secretary Larry Summers and Treasury official Gary Gensler both spoke out on the issue of Fannie and Freddie's investment portfolios, which had already begun to resemble hedge funds with risky holdings. Nor were others silent: As chairman of the Federal Reserve, Alan Greenspan regularly warned about the risks posed by Fannie and Freddie's holdings.

President Bush was receptive to reform. He withheld nominees for Fannie and Freddie's boards -- a presidential privilege. While it would have been valuable politically to use such positions to reward supporters, the president put good policy above good politics.

In subsequent years, officials at Treasury and the Council of Economic Advisers (especially Chairmen Greg Mankiw and Harvey Rosen) pressed for the following: Requiring Fannie and Freddie to submit to regulations of the Securities and Exchange Commission; to adopt financial accounting standards; to follow bank standards for capital requirements; to shrink their portfolios of assets from risky levels; and empowering regulators such as the Office of Federal Housing Oversight to monitor the firms.

The administration did not accept half-measures. In 2005, Republican Mike Oxley, then chairman of the House Financial Services Committee, brought up a reform bill (H.R. 1461), and Fannie and Freddie's lobbyists set out to weaken it. The bill was rendered so toothless that Card called Oxley the night before markup and promised to oppose it. Oxley pulled the bill instead.

During this period, Sen. Richard Shelby led a small group of legislators favoring reform, including fellow Republican Sens. John Sununu, Chuck Hagel and Elizabeth Dole. Meanwhile, Dodd -- who along with Democratic Sens. John Kerry, Barack Obama and Hillary Clinton were the top four recipients of Fannie and Freddie campaign contributions from 1988 to 2008 -- actively opposed such measures and further weakened existing regulation.

The president's budget proposals reflected the nature of the challenge. Note the following passage from the 2005 budget: Fannie, Freddie and other GSEs "are highly leveraged, holding much less capital in relation to their assets than similarly sized financial institutions. . . . A misjudgment or unexpected economic event could quickly deplete this capital, potentially making it difficult for a GSE to meet its debt obligations. Given the very large size of each enterprise, even a small mistake by a GSE could have consequences throughout the economy."

That passage was published in February 2004. Dodd can find it on Page 82 of the budget's Analytical Perspectives.

The administration not only identified the problem, it also recommended a solution. In June 2004, then-Deputy Treasury Secretary Samuel Bodman said: "We do not have a world-class system of supervision of the housing government-sponsored enterprises (GSEs), even though the importance of the housing financial system that the GSEs serve demands the best in supervision."

Bush got involved in the effort personally, speaking out for the cause of reform: "Congress needs to pass legislation strengthening the independent regulator of government-sponsored enterprises like Freddie Mac and Fannie Mae, so we can keep them focused on the mission to expand home ownership," he said in December. He even mentioned GSE reform in this year's State of the Union address.

How did Fannie and Freddie counter such efforts? They flooded Washington with lobbying dollars, doled out tens of thousands in political contributions and put offices in key congressional districts. Not surprisingly, these efforts worked. Leaders in Congress did not just balk at proposals to rein in Fannie and Freddie. They mocked the proposals as unserious and unnecessary.

Rep. Barney Frank (D-Mass.) said the following on Sept. 11, 2003: "We see entities that are fundamentally sound financially. . . . And even if there were a problem, the federal government doesn't bail them out."

Sen. Thomas Carper (D-Del.), later that year: "If it ain't broke, don't fix it."

As recently as last summer, when housing prices had clearly peaked and the mortgage market had started to seize up, Dodd called on Bush to "immediately reconsider his ill-advised" reform proposals. Frank, now chairman of the House Financial Services Committee, said that the president's suggestion for a strong, independent regulator of Fannie and Freddie was "inane."

Sen. Dodd wonders what the Bush administration did to address the risks of Fannie and Freddie. Now, he knows. The real question is: Where was he?

Al Hubbard was director of the National Economic Council and assistant to the president from 2005 to 2007. Noam Neusner was a speechwriter and communications director in the Bush administration from 2002 to 2005.

[Semanticleo]

PUKe; Champion of Idiocracy. If it wasn't tragic, it would be funny.

I thought Brits were smart?

[Rick Ballard]

bgates,

The other thing to do is to put anyone toying with trolls in the same bin with the trolls. It tightens up the thread quite a bit.

[Semanticleo]

"anyone toying with trolls in the same bin with the trolls."

That's just what Marmalard told Dean Wormer about Bluto.

[Ann]

Bad,

This room smelled funny until around 8:05. Is it safe to enter?

[Ann]

Nevermind Bad :)

[baked alaska]

Obama is No. 2 on the list, with $126,349, right after Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee, who had $165,400.

...

analysis found Fannie and Freddie-related contributors gave $116,000 to John McCain and his related committees, compared with $16,000 to Obama and his related committees.

http://www.politifact.com/truth-o-meter/statements/727/

[Semanticleo]

"Nevermind Bad :)"

Danger! Danger! Will Smith, there is information afoot!!!!!

[baked alaska]

The soft bigotry of low expectations:

At the insistence of the McCain campaign, the Oct. 2 debate between the Republican nominee for vice president, Gov. Sarah Palin, and her Democratic rival, Senator Joseph R. Biden Jr., will have shorter question-and-answer segments than those for the presidential nominees, the advisers said. There will also be much less opportunity for free-wheeling, direct exchanges between the running mates.

McCain advisers said they had been concerned that a loose format could leave Ms. Palin, a relatively inexperienced debater, at a disadvantage and largely on the defensive.

http://www.nytimes.com/2008/09/21/us/politics/21debate.html?hp

[bad]

Ann

What is the latest from your Lib SIL? Is she receiving the troll marching orders from Obama?

[ROA]

If Obama and the Democrats are so concerned about free-wheeling direct exchanges, why didn't Obama take McCain up on his offer of 10 town hall meetings?

[JM Hanes]

Ann:

Think of it as doing a public service, keeping trolls busy where they can't possibly make any difference.

[Ann]

bad,

SIL could very well be one of these remarkable intellectuals here tonight. She is also a big fan of "Chain of fools", "I'm every woman"and
paid to go see Sandra Bernhard Live. :)

[Captain Hate]

Krugman has never shown the slightest understanding of anything pertaining to economics. I don't recall him ever being right about anything; strangely it doesn't seem to embarrass him at all (not that he'd ever be so humble as to admit it). No wonder he's in the tank for Ozero along with everybody else in Pinch's crew of losers.

[DebinNC]

Someone here this morning mentioned hearing Mark Levin's excellent take on the who/what/whys of the financial situation. Ace now has the audio [9:19 min.].

[PaulL]

Obameh did agree to debate McCain anytime anywhere. But then when someone in his campaign explained to him that there would be no teleprompters, he chickened out, and his agreement became inoperative. I think Obameh explained that he was too busy.

[DebinNC]

"will have shorter question-and-answer segments than those for the presidential nominees, the advisers said."

Anyone who has ever watched Judiciary Committee confirmation hearings with Joe Biden bloviating endlessly, never getting to an actual question during his alotted time, knows why McCain would insist on short segments. They'd like Palin to have a chance to answer as many questions as possible.

[Ann]

JMH,

I see your point but like you I sometimes prefer the dead of night around here at JOM.

How's the wardrobe coming for the cruise? I haven't been very impressed with the cruise wear this year. (Let's just kill 'em with girl talk. They are bound to go away. LOL)

[Paul Zrimsek]

McCain advisers said they had been concerned that a loose format could leave Ms. Palin, a relatively inexperienced debater, at a disadvantage and largely on the defensive.

O yes, I'm sure they said exactly that. If you can't trust an anonymously sourced indirect quote in a NYT story, what can you trust?

I see Deb has already beaten me to the real explanation.

[Porchlight]

Let's just kill 'em with girl talk

Sounds good to me, Ann! FWIW I put my hair up Sarah-style this morning to see if my husband would notice. He did, and he wants me to get Sarah-style glasses to go with it. :)

This from someone who's never voted Republican in his life. (Okay, he's probably only voted about four times ever. Maybe.)

[bad]

This book came out Sept. 8th or thereabouts. It quotes Steve Diamond in several areas.

Brad O'Leary, author of "The Audacity of Deceit, Barack Obama's War on America."

LUN

[tbrosz]

What I've found amusing is all the rending of garments liberals have been doing lately because the government is coming in and grabbing hold of the tiller.

I suspect that if the President was a Democrat, these actions would be held up as a "bold and far-reaching solution" for the failures of the private sector.

During a time of financial crisis, Franklin Roosevelt brought the Federal government down on America and the private sector like a ton of bricks, and liberals have worshipped him for it ever since.

[Ann]

Porchlight,

I have always had long blonde hair (blonder some years than others :)) but my husband always liked it back in a French twist or pulled off my face. It must be the librarian thing..who knew!

You realize if we keep this up our names will be added to the "Block Troll List" software. (Or maybe NOT. LOL)

[narciso]

Right about now, taking Krugman on his suggestion to Spiegel, that he would wind up at Gitmo; seems to have been a safe bet.
Krugman would have perfection, be the enemy of the possible; more grist for his column. So we are left with Barry Soetoro Dunham, the reformer who got the lion's share of funds from Fannie,Freddie, Countrywide, probably AIG and Lehman too; who has the track record of being up front on the issues of the . . .Well his wise advisers like Johnson, Raines, Gorelick, well the last is more a Hillary place holder, Pritzker representative Valerie Jarrett,
the colleague of REzko, Auchi, and Al Samarrai. . .no wonder he was so confidant in his statements, this week, he doesn't have a clue. Yet he is given the benefit of the doubt. One investment show analyst pointed out, those in the know, don't have a clue; those clueless are more likely to have made a decision and 'jump the gun' erroneously. In these condition it's left to Paulson, given the second most thankless job in the US govt; no pressure. It is left to the old warhorse, 'TR with a tailhook', Colonel Tigh, to others, who at one time or another aggravated every financial and policy group in the GOP (pharmaceuticals, aerospace, evangelicals, immigration activists, energy exploration enthusiasts, intelligence officials) who ran aground against the Fannie Freddie juggernaut,in 2003-2005 which included some of his current staff (Davis & Culvahouse) to regretably have to say I told you so; reduced to the ultimate pass the buck suggestions. fact finding commissions which outline the facts, we already knew but didn't have the guts to implement; except with Gorelick and Kean/Hamilton, probably obscure the real nature of the problem.

Yes, the point about whether SS can survive in the stock market is to be taken into consideration; however, the realization that regardless, it is not sustainable under
the current model, should also be taken into account. The fact that T-bills and other more dependable government securities
have to make up the SS portfolio seems to escape those making this argument.

He signed Palin, because unlikely the character out of "Mad Men" Mitt Romney, who will probably end up at Treasury, Pawlenty, Lieberman, a decent fellow, who sounds like Droopy; Ridge, really has challenged the often comatose GOP establishment, and has the credential of expertise in the critical issue of energy development. Plus she shores
up almost all the other groups, he's ticked
off over the years. It was a 'hail mary pass' which I think will bear fruit. The only thing that really concerns me, is the unabashed hatred that has been let loose by all the unusually deranged suspects. To see some tell it, Palin is the creature from Species, the alien SIL whose procreation threatens humanity as a whole. That does seem to be the Dowd, Quinn, even Fey and Lohan reaction; eerily echoing the tropes of the Plastics in "Mean Girls". But all this was written about many years ago, in the world's most published tome.

[Porchlight]

Ann,

I'll play troll for a night if it keeps the real ones at bay! Bristol Bay, heh.

Librarian power is strong. ;)

[hef]

If you look at 9/11 as Bill's bill that's why they put Bush in,the food and poverty bill and the mortgage bill; the bill is easily 4 to 5 trillion.

It's okay that the the building was going bankrupt as the government bought a brand new one.

[bad]

The only thing that really concerns me, is the unabashed hatred that has been let loose by all the unusually deranged suspects.

The goal seems to be to make her more reviled than Bush, Cheney, Rove, Halliburton and oil companies, put together.

I wonder what President Bush thinks watching her get the accelerated version of his treatment.

[Sara (Pal2Pal)]

bgates: if you want the ip, click on the site meter and get it from the stats.

[Sara (Pal2Pal)]

Take a musical break and clear the mind of all this financial stuff and then come back with a clearer head.

Moose Shootin' Mama

[The Pirates of UnRepentance.]

More Ian Welsh on Paulson's raid on the Treasury:

Palin’s Long Lost Brother

Paulson after Congressional Testimony

The more I look at the Paulson "plan" the more I come to the conclusion it's just an old fashioned stickup. A scam. The Republicans know they have only a few more months, and this is their last raid on the treasury. Republicans created this crisis, and in the way of scam artists everywhere now that there's a crisis they're demanding money and power to fix their own mistakes.

What I'm hearing is that the gun being held to Congress's head is the fear of a money market meltdown. These funds are integral to the economy, yes, but 700 billion is far more than is needed to bail them out. They aren't all going to fail tomorrow, which that number assumes - that they'll zero out on Monday, and then a few banks will fail simultaneously. A few money market funds may break the buck, but you can deal with that with, oh, 25 billion, and with change to spare. Frankly the Fed's Bernanke can deal with it with the authority he already has."

[M. Simon]

Eve'nin ladies.

[The Pirates of UnRepentance.]

"when she looks you in the eye, you know that girl don’t lie...” sang Garrett.

Moose shootin' mama, eh?

Did you also fall for Bush's line that he 'looked into Putin's soul'?

[M. Simon]

Pirate,

It is a confidence builder.

We are in a market where sentiment is more important than fundamentals. Thus people want to see a 105 where a 9 mm would do. It builds confidence.

Once things get sorted out the money can sit idle in the no bank bank.

An authorization to spend is not the same as writing a check.