Tyler Cowen is surprised by the high leverage in the details of Geithenr's toxic waste disposal plan leaked over the weekend, as am I.
Under the proposed plan, private investors will partner up with Treasury and the FDIC to form an investment vehicle dedicated to purchasing toxic assets.
The equity investors (which includes the Treasury, which may be as much as 80% of the equity participation) will put 15% down, or $15 per $100 of total investment.
The FDIC will lend 85% on a non-recourse basis, which means that they can only look to the underlying assets of the investment vehicle for repayment and can not attempt to collect any shortfall from the private investors. (This creates the "heads I win, tails they lose" problem to which people refer).
So let's dive into the numbers! Here is a simple example to illustrate how the cash flows might work. I will present pre-tax cash flows, which will be fine if the investor is, for example, a pension fund or private endowment. After-tax cash flows will depend on the ex-post tax rate set by Pelosi and Reid as investors earn obscene profits at the expense of the taxpayer (or don't.)
The underlying toxic assets pay (I assume) a mere 4% coupon but are priced at 50% of face value for an 8% current yield (I bet investors can do better, but work with me).
The equity investors put $15 dollars in the pool (OK, $15 million, billion, whatever - we will work with percentages here.)
The FDIC will lend $85 at a generous rate meant to cover their cost of funds. The three year Treasury is yielding 1.22%, so on an opportunity cost basis the FDIC will be thrilled to collect 2% interest on a loan to the investment vehicle. Does this really cover their risk? Of course not, but what is a bailout if not a bailout? Let's press on.
Our investment vehicle has a simple balance sheet: $100 market value of toxic assets with a face value of $200 and interest payments of $8 dollars per year (4% on $200); $85 of debt costing 2%, or $1.7 per year; and $15 of equity.
Now watch the power of leverage - after collecting the $8 of interest and paying the FDIC $1.7 in loan interest, investors have $6.3 left over. That is a 42% return on their initial investment.
And it gets better. Imagine that the investment vehicle is allowed to pay out that $6.3 as a dividend, so that the loan balance with the FDIC remains at $85. Further assume that after three years the vehicle is liquidated by selling off the remaining toxic assets and repaying the FDIC.
*IF* the toxic assets are sold in three years at a price of 50 (i.e., the same as the purchase price), the vehicle collects $100 on the sale. $85 goes to pay off the FDIC loan (sighs of relief from that quarter) and the equity investors have earned, or at least collected, 42% per annum. Nice if you can get it.
Now, suppose the toxic waste fades a bit in price and is sold at a final price of 40. That means the vehicle takes in $80 of asset principal on the final sale; all of that is given to the FDIC, along with a rueful smile, in satisfaction of the $85 FDIC loan. Sorry about that!
But how have our investors fared? Well, in this scenario they won't be getting back their original $15 dollar investment, so there is a bit of shared pain. However, they have collected that $6.3 of net interest for each of three years, for total net interest income of $18.9. On an IRR basis, this is an annual yield of about 12.5%. That is not as good as 42%, but it is pretty appealing as a worst case scenario. Presumably, if Pelosi and Reid have not lost their majorities they will want to investigate this and determine the ex-post tax rate.
Obviously, reality is more complicated - for example, it may be that the underlying toxic assets fell in price because of rising delinquencies and decreasing interest receipts. However, the simplified example here depicts a Treasury and FDIC that are being pretty generous. Yes, the Treasury in their role of equity participant enjoys that nice return, too, but the FDIC has a loss, so We the People don't do so well. In fact, assuming that Treasury had 80% of the equity, the "taxpayer" return, summing the Treasury and FDIC cash flows, is about 1.2%. Of course, that will turn negative if the toxic asset sale price is lower than 40.
Now, here is a suggested modification - the Treasury might restrict dividend payouts and oblige the investors to direct a portion of their net interest income towards paying down the FDIC loan and increasing their equity stake.
For example, suppose the investors are allowed to collect as dividends half the net income but must use the rest to pay down the FDIC loan (thereby reducing the interest owed to the FDIC in subsequent periods and increasing their own net income.) That means that over three years, these redirected dividends will reduce the DIC, by roughly one half of three years worth of dividends, or about $9.4. (I am making the keep-it-easy assumption that all cashflows occur at year end.)
By my Sunday morning calculation (Do not attempt this without caffeine!), the FDIC loan will be reduced from $85 to $75.46 as the third anniversary cashflows occur and interest is passed to the equity participants. At this point, the sale proceeds of $80 are enough to pay off the FDIC, which is great news for the taxpayer; equity investors pocket $4.54 dollars as principal return on their $15 equity as well as half of the last interest payment; because half the cash flow was directed to the FDIC loan rather than their pockets, the revised IRR is -2.6%. That is hardly a disaster, especially by recent standards, but at least they are now losing money with the rest of us. In the worst case the equity investors might face, with a sale price below about 37.5, their IRR can be about -20% (they collect half of three net interest dividends and nothing else).
BETTER WITH A SPREADSHEET, BUT...
Very roughly, with half the net income directed to repaying the FDIC loan, the equity investors cash flow is a $15 dollar investment outflow at period 0; net interest income dividends of approximately $3.15 in periods 1, 2, and 3; and a final return of principal of $4.54, also in period 3.
As a simple approximation that ignores the reduced interest on the reduced FDIC loan, suppose the FDIC loan is reduced by *3 x $3.15, or $9.45, to a balance of $75.55. Then the final principal payment would be the difference between $80 and $75.55, or $4.45. That makes the last period cash flow the sum of $4.45 and $3.15, or $7.60. With that approximation the IRR is -3.3%.
WHAT ABOUT THE FDIC LOAN RATE?
If the FDIC raises its lending rate from 2% to 5% in the initial example, the simple return on capital falls from 42% to 25%. That said, if the toxic asset falls in price such that the investor's return comes only in the form of net interest income, the IRR falls from +12.5% to -13.1%.
The Times said this about the likely lending rate:
Administration officials refused to comment on the details of the plan, and refused to say what kind of interest rates the government would be charging investors. But government officials have long maintained that they could charge slightly more than the Treasury’s own cost of money and still offer rates far less than the private markets would demand.
SO HOW ARE WE DOING?
Here is an interesting (or perhaps, utterly opaque) chart. The final sale price of the toxic asset is assumed to range from 20 to 80. Cash flows are calculated as in the first example where all net interest income is used to pay interest on the FDIC loan and then is paid to the equity investors; the FDIC loan is paid off by the toxic sale proceeds.
The FDIC IRR is at best 2%, when the loan is repaid in full. The Equity IRR is never less than 12.5% (as explained earlier) but can rise if the toxic asset holds its value or appreciates. Finally, We the People experience the "Taxpayer IRR" which is calculated after summing the FDIC cash flows and 80% of the equity flows.
Toxic Asset
Sale Price FDIC IRR Equity IRR Taxpayer IRR
20 -19.6% 12.5% -16.2%
30 -8.7% 12.5% -6.7%
40 0.0% 12.5% 1.2%
50 2.0% 42.0% 6.9%
60 2.0% 66.5% 11.8%
70 2.0% 84.6% 16.3%
80 2.0% 99.4% 20.5%
DEFYING KRUGMAN ET AL: Kevin Drum stands up to Krugman's complaints about Geithner's plan:
This is all true, but it's a little too glib. After all, if markets can overvalue assets on the way up — and obviously they can — then they can also undervalue them on the way down. There's a pretty good chance that the toxic waste in question really is worth more than the market is currently willing to pay for it.
NOT TO BE WHINGING, BUT... The "5" key on this keyboard is recalcitrant, or cacified, or something, so there may be a stray "5" or "%" missing or duplicated.
Geithner's scheme mentioned at politico as well. LUN
Also scroll down for Biden's remarks at the Gridiron dinner--too funny.
Posted by: verner | March 22, 2009 at 09:29 AM
A taste of Biden:
VICE PRESIDENT BIDEN KILLS AT GRIDIRON: “Axelrod really wanted me to do this on teleprompter -- but I told him I’m much better when I wing it. … I know these evenings run long, so I’m going to be brief. Talk about the audacity of hope. … President Obama does send his greetings, though. He can’t be here tonight -- because he’s busy getting ready for Easter. (Whisper) He thinks it’s about him. …
Posted by: verner | March 22, 2009 at 09:30 AM
does not matter a whit what the contract and partnership agreement says, it will all revert to zero ( or your -2) once the Congress has a post look at the results and decides what the compensation should be.
And make sure you employ enough MWOB and follow federal pay guidelines and never foreclose on anyone who might vote for the democrat party and ( well the list is too long for this space ).
Posted by: Gmax | March 22, 2009 at 09:33 AM
Tom, don't forget that the FMV of the toxic asset purchased ($100 against face value of $200) was already reduced to present value so that it could be called fair market value. So the $100 results from someone's expectation that an orderly liquidation of the underlying assets will net >$100. Crank a liquidation higher than purchase price into your math and watch what leverage does to that 42%.
Posted by: Old Lurker | March 22, 2009 at 09:36 AM
I think this is in direct competition with the Fed's TALF program, interesting. I'm off to do more homework on it.
A side note, Tyler's reference to that NYT story as his source, should come with a warning, "no training in economic thought was used in writing this article, by any of the THREE authors." If it's not Gretchen, then don't write about complicated economic programs.
Posted by: mel | March 22, 2009 at 09:44 AM
$85 goes to pay off the Fed loan (sighs of relief from that quarter) and the equity investors have earned, or at least collected, 42% per annum. Nice if you can get it.
Now, suppose the toxic waste fades a bit in price and is sold at a final price of 40. That means the vehicle takes in $80 on the final sale; all of that is given to the Fed, along with a rueful smile, in satisfaction of the $85 Fed loan. Sorry about that!
That's a feature not a bug!
This is what public-private partnerships are all about. This is how Barry will buy back the votes (and the campaign controbutions) of the Wall Street bankers, promise them lots of free money at the taxpayers exspense.
Posted by: Ranger | March 22, 2009 at 09:56 AM
That's a feature not a bug!
This is what public-private partnerships are all about. This is how Barry will buy back the votes (and the campaign controbutions) of the Wall Street bankers, promise them lots of free money at the taxpayers exspense.
That's the thought that I was formulating as I read through it too, Ranger. This is designed to be a gift program for specific groups.
Posted by: Pofarmer | March 22, 2009 at 10:15 AM
Ranger, I think you've found the true purpose behind this program. To bribe the investors with money from the taxpayer.
Posted by: pagar | March 22, 2009 at 10:15 AM
Isn't the idea price of the assets (50 in the example) will get bid up by the private investors to the point that they won't make excessive returns? It's still true of course, that the reason they bid up the price is that the Treasury (i.e. the taxpayers) is effectively covering the downside.
In other words, as best as I can tell, the idea seems to be that because now potential buyers are only bidding 30 cents on the dollar, and banks will only sell for 60, the Treasury steps in and provides generous terms so that buyers raise their bids up to 60. Of course that doesn't make the assets worth more, it's just a tricky way to more tax dollars into the deal without actually accruing them on the government budget right now. It's like an off-balance sheet vehicle for the treasury. Geithner doesn't seem to think that we can see through this chicanery.
Posted by: jimmyk | March 22, 2009 at 10:35 AM
I'm not sure this is sounding like a bad deal for the Fed. In your example, in the original scheme -- and mind you, my acting workshop was last night, I was out late, and I'm precaffeinated -- the equity investors made about $21 on their $15 investment. At 2%, the Fed made about $5.10 in interest. So they have probably made a little money on it, at least, in this scenario.
There's another point that I'm definitely going to need coffee to think about quantitatively. The money the Fed is lending out is primarily, I expect, new money. So its actual cost of the funds is effectively zero -- after all, Bernanke just signs the papers and the Fed makes an entry on the books. As we've talked about before, the deep problem overall is to avoid a deflationary spiral and the Fed is trying that by various versions of quantitative easing. As things start to improve, though, especially as money speeds up, they don't want to have too much of it lying around.
So they take their interest payments, their return on their equity, and the eventual payment of the debt, and just burn it. Poof, money comes out of the system, and the inflationary pressure is eased.
It actually is like a balloon -- that metaphor is really better than I'd thought. The economy got cold AND we lost air from the balloon; the balloon deflated. Even if we warmed it up, there still isn't as much air, so it can't inflate as much. So we add cold gas to inflate it. As it warms up again, if we don't want it to inflate too fast, we let some gas back out.
Cool.
Posted by: Charlie (Colorado) | March 22, 2009 at 10:38 AM
Let me try again:
Isn't the idea that the price of the assets (50 in the example) will get bid up by the private investors to the point that they won't make excessive returns? It's still true of course, that the reason they bid up the price is that the Treasury (i.e. the taxpayers) is effectively covering the downside.
In other words, as best as I can tell, the idea seems to be that because now potential buyers are only bidding 30 cents on the dollar, and banks will only sell for 60, the Treasury steps in and provides generous terms so that buyers raise their bids up to 60. Of course that doesn't make the assets worth more, it's just a tricky way to get more tax dollars into the deal without actually accruing them on the government budget right now. It's like an off-balance sheet vehicle for the treasury. Geithner doesn't seem to think that we can see through this chicanery.
Posted by: jimmyk | March 22, 2009 at 10:38 AM
it's just a tricky way to [move] tax dollars into the deal without actually accruing them on the government budget right now.
Except they're not tax dollars. They're new dollars. The Fed doesn't need to tax anyone (and it's a good thing, since it can't) to get the money, it just creates it. In this scheme, when it comes back, they just destroy it. Poof.
Posted by: Charlie (Colorado) | March 22, 2009 at 10:41 AM
Charlie, there is no free lunch. It doesn't matter whether it's the Fed or the Treasury, it's the taxpayer that is behind this. If the Fed puts $85 into this scheme, they've either borrowed the money, so it's debt that will have to be repaid, or they've printed it, in which case it will either create inflation or they will have to pull the cash back out of the system down the road, which means they will have to use debt at that point. Of course the Fed may profit on the deal, but to the extent they are subsidizing it they should be expected to lose, and the cost will be borne by taxpayers, either through higher debt service or inflation.
Posted by: jimmyk | March 22, 2009 at 10:52 AM
"Crank a liquidation higher than purchase price into your math and watch what leverage does to that 42%."
OL,
No problem. A simple ex post facto Bill of Attainder setting a tax rate of 180% on any dirty profit taken above the 2.5% 10 year bill rate will guarantee a "fair" return to the Treasury and sufficient punishment for the capitalist pigs who were allowed a moment at the trough.
I'm still looking at the balance sheet of Zombiegroup. The nasty ToxAss line now has a nice clean $0 on it rather than that horrid $50 and the Cash line has increased by a simply beautiful $50 but down there at the Total Assets line at the bottom - that bottom line hasn't changed by a penny. So, Zombiegroup is now declared to be "recovering" (having received a high colonic which cleansed all the toxins from its system) but with velocity still at 1 due to the death of ABS....
Maybe Zombiegroup can get in on that sweet deal that the Hedge Hogs are cutting with Turbo and buy some of that ToxAss stuff?
Posted by: Rick Ballard | March 22, 2009 at 10:52 AM
Except they're not tax dollars. They're new dollars.
Yes, but isn't the purpose of buying these "toxic assets" to get them off banks balance sheets so they can/will lend more money?
Posted by: Pofarmer | March 22, 2009 at 11:09 AM
"Charlie, there is no free lunch."
exactly jimmyk. There is no way to sugarcoat this as some type of novel scheme. In addition to no free lunch, there is no such thing as new money. All roads lead back to the same source: the taxpayer.
Posted by: ben | March 22, 2009 at 11:10 AM
Jimmy, the problem is that most all of that's not true. You're making the mistake of thinking that money is a thing in itself and it's not: it's just counters for things. Make more of them, and each one is worth less: inflation. Destroy some, and the remaining ones are worth more: deflation. But there's still no free lunch, because you can't eat money: you have to trade it for that hamburger. If you try to print money indefinitely to buy things, eventually it takes more and more money to buy the same thing; as you say, lunch isn't free.
The interesting thing about this scheme is that, if I'm not mistaken, it actually eventually destroys more than $100 out of the system for every $100 created.
Posted by: Charlie (Colorado) | March 22, 2009 at 11:15 AM
Rick, we can write the stories today that will fire the critters up to Bill of Attainder II. Except that it's so serious, it's actually going to be fun to watch the formerly well paid WS guys eying that pie, seeing the Pelosi Tax Ax with the other eye, and wondering if maybe there is one more bite they can get. Sort like the dog who knows the master has that rolled up paper in his hand, but damn, that steak looks really really good and maybe the master will look away for just one second...
Posted by: Old Lurker | March 22, 2009 at 11:17 AM
Me: Except they're not tax dollars. They're new dollars.
Po: Yes, but isn't the purpose of buying these "toxic assets" to get them off banks balance sheets so they can/will lend more money?
Was that supposed top make sense? It seems non sequitur to me.
Posted by: Charlie (Colorado) | March 22, 2009 at 11:19 AM
there is no such thing as new money.
Aha, there's your problem: this isn't true.
Posted by: Charlie (Colorado) | March 22, 2009 at 11:20 AM
They finally discovered a perpetual money machine!
We're saved. Contact the patent office.
Posted by: boris | March 22, 2009 at 11:36 AM
Me: Except they're not tax dollars. They're new dollars.
Po: Yes, but isn't the purpose of buying these "toxic assets" to get them off banks balance sheets so they can/will lend more money?
Was that supposed top make sense? It seems non sequitur to me.
How so?
Let's look at the thesis.
Investors are willing to pay $30 for these toxic assets. With govt intervention maybe they will bring $60. This changes the leverage of the institutions. If they can get $60 there's more money to lend than if they get $30. So, I take that to mean that there will be more money to lend in the system, which would seem to be inflationary. Whether the govt can scoop up their excess money at the end of the process or not, the only way that it's not inflationary in the short term is if lending or money supply doesn't increase because of it. Or am I misunderstanding what buying these assets will do?
Posted by: Pofarmer | March 22, 2009 at 11:37 AM
Yes, the Treasury in their role of equity participant enjoys that nice return, too, but the Fed has a nasty loss, so We the People don't do so well).
Tom--
I don't understand something. I thought the Treasury loaned the $85. If so, they don't share in the upside at all, except in a larger sense. If they are equity participants, then your return calculations are wrong; the investors only get 15 percent of the total and the government gets 85 percent. No?
Posted by: Fresh Air | March 22, 2009 at 11:40 AM
"The interesting thing about this scheme is that, if I'm not mistaken, it actually eventually destroys more than $100 out of the system for every $100 created."
So far Newton's theory that no matter is lost everything is transformed has not been disproved. And the perpetual motion machine and "the net creation of energy" also have not yet been invented. Interestingly enough this applies to money also.
We really have to break away from this theory that if we don't keep throwing away taxpayer dollars the economy is going to get worse. Charlie is in favor of every bailout, give-away and smoke and mirrors scheme that has been proposed on the grounds that we are worse off if we don't do it. Yet the evidence is that we ARE worse off anyway and will continue to descend into bottomless pit of debt. The time to pull the plug is now.
Posted by: ben | March 22, 2009 at 11:46 AM
Question for the financial/wall street/investment types.
What would it take to start up alternate exchanges for stocks?
I have been reading Mark Twains "Life on the Mississippi" and he in places about citizens directly investing in Cotton Mills and the like. We now do that with "New-Gen" coops. Lot's of your Ethanol plants are done this way with direct investment by producers(and speculators) in the plants. What would it take to set up alternate exchanges to get away from all the goings on on wall street. I mean, my understanding is there used to be numerous smaller exchanges. Even today we still have the CBOT, the KCBOT, and the MinnBOT, although the last two are definately subordinate in scope. Would there be a signifgant upside to decentralizing our investment infrastructure?
Posted by: Pofarmer | March 22, 2009 at 11:54 AM
Tom,
Sounds good...
All in!
Posted by: patch | March 22, 2009 at 12:00 PM
Pardon Bernie Madoff!
Let him run this scheme.
Posted by: patch | March 22, 2009 at 12:02 PM
Either Bernie or the ghost of FDR!
Posted by: verner | March 22, 2009 at 12:07 PM
Just what every young MBA dreams of having the opportunity one day: "partnering" with the Feds in a toxic debt scheme. It's been 25 years and my ship finally came in.
Posted by: ben | March 22, 2009 at 12:10 PM
Ya know, this banking disaster ought to have everyone pining for the days when the local bank held the note, and you could go in and have a chat if you got in a tough spot.
Instead, what we have is an awful lot of folks, who ought to know better, pining for the govt to bail the system out so the credit binge can continue.
Posted by: Pofarmer | March 22, 2009 at 12:16 PM
FA,
Brad DeLong says equity participant as well. The balance of his analysis is trite (if not tripe) in that business loans are still running at 97.5% of the peak hit in October and are +7% YoY in what is supposed to be the 14th month of a recession". Consumer loans were up 1% from January to February and 10.8% YoY so I don't really believe that the "banks aren't making loans" thesis is sustainable using those pesky fact thingies.
I can't quite see the utility of the plan at this point. I can follow the dirty socialist desire to select winners and create losers but I see nothing that will hasten the restoration of confidence.
I believe that capital will remain on strike for as long as the dirty socialist wing of the Dems is running the clown show in DC.
Posted by: Rick Ballard | March 22, 2009 at 12:40 PM
Did anyone else notice the Mad Mullahs of Iran response to the Obama olive branch? Hint: the crowd was chanting "Death to America" and it gave the Ayatollah a chance to use Obama as a punching bag. So much for the "coke and a smile Kumbaya" tour.
The guy is emulating Jimmy Carter more and more by the day.
Posted by: Gmax | March 22, 2009 at 12:48 PM
I hear you Po and often feel the same way. In commercial real estate, the term used is "conduit loan", that being the name for loans underwritten and usually closed by our banks, but which are quickly sold into the secondary financing market as MBS and whatnot. On some deals, we really do want the bank (real people who we know well) to hold the notes just in case we "need to talk". The rub is that the bank always needs to charge us a pretty significantly higher rate for loans they hold vs loans they sell. When we look at it from the bank's point of view, we do understand their math, and we do see that loans sold free up lending capacity that otherwise would get locked up pretty quickly otherwise. All of this is equally true for the residential lending.
So the point I'm making is that, before the abuses got out of control, all these convoluted arrangements were designed because they provided the borrowers with more capital at a lower cost (or at all) than the traditional method. Even Michael Milken and the junk bond boys in the last wave could make a similar argument in their own defense.
Posted by: Old Lurker | March 22, 2009 at 12:48 PM
So, I take that to mean that there will be more money to lend in the system, which would seem to be inflationary.
Yep. I just don't get the if-then part of what you were saying. The other stuff is right; it is inflationary in the short term, which is what we're after -- more gas in the balloon.
Posted by: Charlie (Colorado) | March 22, 2009 at 12:51 PM
Prof DeLong says the real purpose of this hairbrained scheme is to :
Reduce unemployment!
Are Leno's writers moonlighting again?
Posted by: Gmax | March 22, 2009 at 12:51 PM
"I believe that capital will remain on strike for as long as the dirty socialist wing of the Dems is running the clown show in DC."
Have you SEEN the price of Swiss Francs lately???
:-)
Posted by: Old Lurker | March 22, 2009 at 12:55 PM
My mom-in-law's stock broker thought Milken was terrific.
One of my major concerns with the Fed inflating is whether Bernanke can pivot swiftly enough. The timing will have to be incredibly precise.
Posted by: glasater | March 22, 2009 at 12:59 PM
To clarify:
DeLong says:
Treasury Equity $150B
Hedge Hog Equity $30B
FDIC loan $820B
Total $1T against a total outstanding non-agency MBS book of $5-6T containing around $1.2T of ARM or ALT-A mortgages (which have a count of roughly 5 million units out of a total housing stock of 128 million units).
Posted by: Rick Ballard | March 22, 2009 at 12:59 PM
So far Newton's theory that no matter is lost everything is transformed has not been disproved.
And if money were matter then you'd have it right. But money isn't matter. Money is more like, poker chips in Vegas. The dealer has a big pile of chips; as long as the dealer holds the chips, they're not worth anything. Hell, they're worth less than nothing: they have to be manufactured and counted and stored and guarded. They become worth something when you have them because you can trade them for something else.
Now, what if we think of poker chips as like little ceramic stock certificates? Each chip is worth a share of the casino. If you issue more of them, each chip is worth less; take some back, and each chip is worth more. So if the casino is "worth" $1 billion, and we issue 1 billion chips, each chip is worth $1.
If something comes along and destroys half the chips, the rest of the chips are now worth $2 each. That's deflation. If you want to make chips worth $1 each again, you have to manufacture and distribute 500 million new chips. Now the chips are back to being worth $1 each.
If the casino is making a profit, then next year it might be worth $1.1 billion. Now each chip is worth $1.10. If you want the chips to be worth $1 each, you have to issue some more chips.
Perfection would be if you could issue one new chip every time the casino is worth an additional $1, but if the casino is big enough you can't do that. Because deflation is a bad thing -- people won't play roulette if they can win by just waiting -- you don't want to risk it, and since you can't be perfect, a little inflation is all right.
On the other hand, a lot of inflation is a bad thing, because then to get people to play, you have to offer bigger and bigger odds; otherwise people don't want to play because they get a smaller and smaller share of the casino even if they're winning.
Posted by: Charlie (Colorado) | March 22, 2009 at 01:08 PM
What would it take to start up alternate exchanges for stocks?
Incorporation and some SEC filings. Legal fees. A stock exchange is just a corporation.
Posted by: Charlie (Colorado) | March 22, 2009 at 01:09 PM
So riddle me this batman. You are hedgie extraordinare and dont have investors beating down your door to give back the money ( ok ok a subset of the total universe of hedgies ). The smartest man formerly at the NY FED dangles a chance to put in 30 of 180 B equity and leverage all of that 4 to 1 or 5 to 1.
How many votes do you have versus the sovereign's votes in the partnership. Looks like a minority interest to me way less than 1/3 so without some delegated authority by contract, you cant even block the majority partner from doing something incredibly stupid, like turning your largest asset in the pool into a perennial green space without compensation.
So are we back to the sanctity of a contract again? How is that working out so far?
Posted by: Gmax | March 22, 2009 at 01:10 PM
"I believe that capital will remain on strike for as long as the dirty socialist wing of the Dems is running the clown show in DC."
Unfortunately there is a large portion of our capital that we don't control, and the dirty socialist wing of the Dems will continue to spend (i.e., waste) it for us.
Posted by: ben | March 22, 2009 at 01:13 PM
So are we back to the sanctity of a contract again? How is that working out so far?
Aye, there's the rub. Note that Joe Biden's economics advisor came out today and said the confiscatory tax was a dumb idea.
Posted by: Charlie (Colorado) | March 22, 2009 at 01:15 PM
And an advisor to Joe Biden would be well acquainted with dumb...
Posted by: Gmax | March 22, 2009 at 01:17 PM
"How many votes do you have versus the sovereign's votes in the partnership."
Mr. Hedge Hog will handle this by graciously allowing Turbo to assume limited partner status (with a slight modification having to do with responsibility for losses). IOW - Turbo is allowed to write checks but is relieved of the terrible burden of cashing them. That awesome responsibility remains with Mr. Hog himself, as General Partner. For a fee, of course.
Is that George Soros over in the corner, chuckling to himself? Why, from the stench in the room, I'd say it is - with Jim Rodgers standing next to him. What are they doing here?
Posted by: Rick Ballard | March 22, 2009 at 01:19 PM
"They become worth something when you have them because you can trade them for something else."
The problem with your analogy is that the whole premise from which you start with is wrong, so what follows is wrong too. Garbage in garbage out. The casino "does not start with a big pile of chips worth nothing". Quite to the contrary. Just like the government those chips, or the governments chips, ARE REAL MONEY, and that means it's OUR money, it's taxpayer's money. The casino's money (and the government's) is backed up by cold hard cash. If it's not, then it's borrowed and there is a liability. That's the whole problem with your support for Geithner's scheme, you somehow think that there are two types of currency, the government's currency and the private sector's currency. They are one and the same.
Posted by: ben | March 22, 2009 at 01:21 PM
Even Michael Milken and the junk bond boys in the last wave could make a similar argument in their own defense.
Interesting that you bring up Milken. Wasn't one of his higher ups supposedly the one who started the CDS mess, IIRC, at AIG in London?
Posted by: Pofarmer | March 22, 2009 at 01:41 PM
Sigh.
Ben, what's "money"? When you can define that successfully, you'll understand your mistake.
Hint: you say "cold hard cash", which is a metaphor that comes from the days of gold and silver as "money". Now, if I give you a million 1 ounce gold coins -- around a billion dollars at today's prices -- and put you out in the middle of the Pacific Ocean, tied to that million ounces of gold,what is that "money" worth to you?
Let's say, being the soft-hearted sort that I am, I tie you to the money but give you a boat as well. (That's about 69,000 lbs of gold, so it should make an excellent anchor.) No one else around. Will that $1 billion buy you a hamburger? Or even a fish hook?
Posted by: Charlie (Colorado) | March 22, 2009 at 01:46 PM
Po, that would not surprise me in the least. Milken's shop was the center of such alchemy for a long time.
Posted by: Old Lurker | March 22, 2009 at 01:46 PM
But Charlie, your mistake seems to be in presuming that the Fed/Treasury/FDIC make a profit in this whole deal. That's the only way your scenario of
So they take their interest payments, their return on their equity, and the eventual payment of the debt, and just burn it. Poof, money comes out of the system, and the inflationary pressure is eased.
make sense. But if they lose, then their (meaning our) balance sheet deteriorates just as surely as the banks' balance sheets have done. And if the government's participation is pushing up the value of those toxic assets, it's only because there's a subsidy, meaning that we can expect them (meaning us, the taxpayers) to lose.
Posted by: jimmyk | March 22, 2009 at 02:01 PM
Here is one writer over at Asia Times who has some interesting but gloomy thoughts on our financial future:
I'm still reading all the articles in the set and will take a look at this Council of Foreign Relations blog next.
Posted by: glasater | March 22, 2009 at 02:01 PM
Part of the problem with being the general partner is of course that the general is never limited. That means that the general can be expected to be required to hit the table with more cash in the instance where the limited exercize their right to decline to do so.
Usually the GP is a corporation with few assets to deal with this nasty set of circumstances. Will Geithner let that happen in this structure given he is already ponying up 97% of the funds and calling on an outside partner to put in a mere 3%?
If yes, maybe someone will take him up. But if not, I doubt there are many takers for the hotseat across from Barney Frank only a year or so from now, when the structure fails to miralculous cure all ails including pleurisy.
Posted by: Gmax | March 22, 2009 at 02:02 PM
Hmmm. Here's a second puzzle for you. Let's say we have a gold standard, and one day Swift and Corbett Enterprises LLC announces they've found a solid gold asteroid, one cubic mile of solid 24 karat gold, and they'll be bringing it to Earth. That's about 2.6 quadrillion troy ounces of gold, or about $2.6 quintillion dollars at today's prices.
Now, will that "cold hard cash" but you 2.6 quintillion McDonald's cheeseburgers?
Posted by: Charlie (Colorado) | March 22, 2009 at 02:05 PM
Charlie, it's not a question of semantics. It does not depend on the definition of money. We are not talking about gold coins in the middle of the Pacific, we are talking about taxpayer's money (there is no other kind) here in the U.S. You are trying a convoluted justification to come up with a new type of "money" that has not been invented yet. I just saw an interview with a French "expert" stating that French universities are better than American universities because there is more government money and less "student" money. I think you are falling into the same trap.
Posted by: ben | March 22, 2009 at 02:06 PM
Himself picks only 11 of the first 16 games.
Obama's Bracket Goes Bust
Relevance to this thread? From the comments: "He's just doing to his brackets what he is doing to the economy."
Posted by: PD | March 22, 2009 at 02:13 PM
Jimmy, that's what's wild about this. You're right that my example assumes it makes a profit -- and this seems like a pretty decent bet, honestly, because after all the analysis we've done over the last six months, it still seems to come out that the toxics are undervalued, there's more stuff under them than the money people are willing to pay for them right now.
So if that bet pays off, then more money comes out of the system than the Fed is creating. That inherently is deflationary, and so reduces any inflation that would have come from the additional money.
But say it goes the other way, and the Fed loses money on the deal. Then some fraction of the money they created is still in the system; this is, in fact, inflationary. But it's also stimulative, a lot more stimulative than anything Congrefs in its infinite foolishness has done. And stimulation causes growth in the economy, which would be inherently deflationary.
I'm not certain about this, so don't hesitate to ty to shoot holes in it, but damned if this doesn't end up looking like a stimulus with an inherent control feedback; economy good, money is inflating, Fed automatically destroys money; economy bad, Fed automatically leaves more money in the system. A flywheel.
Posted by: Charlie (Colorado) | March 22, 2009 at 02:17 PM
Ben, if you can't define "money" how can you talk about it? If you don't know what it is, how do you know I'm wrong?
If you do know what it is, explain it to me.
Posted by: Charlie (Colorado) | March 22, 2009 at 02:20 PM
"Now, will that "cold hard cash" buy you 2.6 quintillion McDonald's cheeseburgers?"
I don't see the relevancy to the discussion at hand, frankly, but the answer is actually yes. McDonalds might charge more or give you fewer hamburgers in exchange, but yes if the gold in the asteroids is registered as an asset it will have a certain value, either what the market establishes or what the government bases the taxes you will pay on it. The idea that the government has a huge supply of poker chips (to use your analogy) ready to distribute so people can make something of it is ridiculous. Yes it can print money and it can loan that money. But the consequences of such actions are the same as if you lent me money, kind hearted as you are.
Posted by: ben | March 22, 2009 at 02:21 PM
PD: Obama probably did some private polling and determined that Carolina is more popular in NC than Duke. He really wants to keep us blue state newbies in the Democratic fold, it doesn't matter much if his teams actually lose.
Posted by: JM Hanes | March 22, 2009 at 02:25 PM
"If you do know what it is, explain it to me."
US$ dollars.
"Then some fraction of the money they created..."
Therein lies the problem.
Posted by: ben | March 22, 2009 at 02:25 PM
Himself picks only 11 of the first 16 games.
Hey, he beat random chance.
Posted by: Charlie (Colorado) | March 22, 2009 at 02:27 PM
So your definition is that "money" is "money."
So, tell me, Ben, when the local Federal Reserve Bank gets a bundle of worn-out dollars and shreds them. where did the "money" go?
Posted by: Charlie (Colorado) | March 22, 2009 at 02:29 PM
"Himself picks only 11 of the first 16 games."
How did the teleprompter do?
Posted by: ben | March 22, 2009 at 02:29 PM
How did the teleprompter do?
There's a difference?
Posted by: Charlie (Colorado) | March 22, 2009 at 02:29 PM
Ok remember the forecast in the good book about the lion lying down with the lamb? I have found something Paul Krugman wrote that I agree with. Miracles never cease.
For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn't, that's someone else's problem. Or to put it another way, Treasury has decided that what we have is nothing but a confidence problem, which it proposes to cure by creating massive moral hazard.
Posted by: Gmax | March 22, 2009 at 02:30 PM
"So, tell me, Ben, when the local Federal Reserve Bank gets a bundle of worn-out dollars and shreds them. where did the "money" go?"
It's replaced with new bills. But I think we beat this dead horse enough. I don't believe Geithner has managed to defeat the laws of economics or physics. But you can have the last word.
Posted by: ben | March 22, 2009 at 02:31 PM
"How did the teleprompter do?
There's a difference?"
Sure there is. Obama does not even have his own blog.
Posted by: ben | March 22, 2009 at 02:34 PM
For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose.
That depends on whether the taxpayers have an equity stake or not, about which there is some disagreement. There seem to be multiple programs involved, some of which involve debt, others equity. But if it's debt, Krugman is sort of right. The private investors can still lose, but they can't lose that much because they don't have much at stake.
Posted by: jimmyk | March 22, 2009 at 02:38 PM
I don't see the relevancy to the discussion at hand, frankly,...
Keep working on it, then.
yes if the gold in the asteroids is registered as an asset it will have a certain value, either what the market establishes or what the government bases the taxes you will pay on it.
Registered with whom? If the market is going to value it, how would the market do that? If everyone has $1 billion worth of gold (more or less by accident, at $1000 a troy ounce a cubic mile of gold is enough for everyone on Earth to have a billion dollars worth), does that mean there are more cheeseburgers?
If Messieurs Swift and Corbett decide to end world hunger by distributing the gold to everyone equally, making everyone a billionaire, will it work? Or will there just be the same number of hungry people, with a storage problem.
Posted by: Charlie (Colorado) | March 22, 2009 at 02:41 PM
Himself picks only 11 of the first 16 games.
I don't know how he could tell 63 groups composed mostly of African-American young men that he wants them to fail.
Posted by: bgates | March 22, 2009 at 02:42 PM
Sure there is. Obama does not even have his own blog.
Point.
Posted by: Charlie (Colorado) | March 22, 2009 at 02:42 PM
It's replaced with new bills
What happens if, oopsie, they shred a million bills, and print a million and ten. Where'd that extra ten dollars come from?
Posted by: Charlie (Colorado) | March 22, 2009 at 02:43 PM
I don't know how he could tell 63 groups composed mostly of African-American young men that he wants them to fail.
Bgates, you've been listening to Limbaugh's CPAC speech, haven't you?
Posted by: Fresh Air | March 22, 2009 at 02:50 PM
Charlie--
I'm pretty sure gold would become the new copper in your scenario, and that demand for silver would suddenly shoot to the moon. As for the hungry, can't they eat gold? It is non-toxic, after all.
Posted by: Fresh Air | March 22, 2009 at 02:52 PM
"it still seems to come out that the toxics are undervalued, there's more stuff under them than the money people are willing to pay for them right now."
Yep. That's proving out pretty much day after day. In fact, if loan servicers were releasing cumulative monthly REO sale results with net recovery to loan ratios, this discussion would have a different flavor.
IMO - there's a fair chance that this "works" in the sense that a market which more accurately reflects underlying asset value will be created. Assuming the $5T MBS asset which has been "marked to market" of $1.5T will be reflated to $3T by the purchase of $1T of ToxAss MBS, then the balance sheet problem with the financial companies will have been "solved" (for the moment). The income statement problem ccaused by the drop in velocity (or leverage, take your pick) remains.
It's a four year problem (again, IMO) so this is still Act I, Scene II.
Posted by: Rick Ballard | March 22, 2009 at 02:56 PM
This is fun:
bankers revolt against "witch hunt": "Bankers at Deutsche Bank said it could benefit from the proposed legislation by poaching its US rivals’ most talented employees."
Congressional Democrats's Bonus Witch Hunt will Sing NYC.
There's one running issue here: people like Vik Pandit have got to stop saying "some anger over executive compensation is justified". It's not: the right price for something is what that something brings in an open market. If a trader can convince a bank to pay $30 million a year in bonuses, then they're worth $30 million.
Posted by: Charlie (Colorado) | March 22, 2009 at 03:03 PM
I'm pretty sure gold would become the new copper in your scenario, and that demand for silver would suddenly shoot to the moon.
I'm not sure demand for silver would change much, but the comparative price of gold and silver would sure change.
As for the hungry, can't they eat gold? It is non-toxic, after all.
And, in these amounts, quite filling.
Posted by: Charlie (Colorado) | March 22, 2009 at 03:06 PM
Charlie's Phun Phact for today: one side effect of all this messing about with numbers is that I've not discovered that a billion dollars at today's prices is a cube of gold 10.29 feet on a side.
Posted by: Charlie (Colorado) | March 22, 2009 at 03:07 PM
"now discovered"
Posted by: Charlie (Colorado) | March 22, 2009 at 03:07 PM
In fact, if loan servicers were releasing cumulative monthly REO sale results with net recovery to loan ratios, this discussion would have a different flavor.
I wonder why they don't? Would there be a competitive advantage?
That might be a worthwhile thing for FASB to take up.
IMO - there's a fair chance that this "works" in the sense that a market which more accurately reflects underlying asset value will be created. Assuming the $5T MBS asset which has been "marked to market" of $1.5T will be reflated to $3T by the purchase of $1T of ToxAss MBS, then the balance sheet problem with the financial companies will have been "solved" (for the moment). The income statement problem ccaused by the drop in velocity (or leverage, take your pick) remains.
That seems to corroborate my sort of monetary argument by another track. Interesting.
Posted by: Charlie (Colorado) | March 22, 2009 at 03:10 PM
The income statement problem caused by the drop in velocity (or leverage, take your pick) remains.
Well, assuming that we are still reacting to deflationary pressures, people aren't loaning money because they make more by keeping it in their poke. Adding some inflationary pressure should encourage them to invest again.
The hard part is that adding velocity (heating the balloon in my balloon analogy) is itself inflationary. If I'm right that the structure of this thing automagically destroys money when interest is paid, that would be a Good Thing, because it would be a structural, inherent, negative feedback.
Posted by: Charlie (Colorado) | March 22, 2009 at 03:15 PM
I'm not certain about this, so don't hesitate to ty to shoot holes in it, but damned if this doesn't end up looking like a stimulus with an inherent control feedback; economy good, money is inflating, Fed automatically destroys money; economy bad, Fed automatically leaves more money in the system. A flywheel.
The hole in this argument is the idea that a deterioration of the government's balance sheet is stimulative. If the government loses money, there's that much less to pay off the gigantic debt we're accumulating, so it will have to come from taxpayers. Sure, the Fed can paper over this loss (literally) by printing more money, but then you're back to inflation, and if all the increase in the money supply that we've seen over the last six months hasn't stimulated the economy, how will more do it? Only in some Christina Romer-fantasy land. There are plenty of unreformed Keynesians who will agree with you, but scant evidence.
Posted by: jimmyk | March 22, 2009 at 03:20 PM
As soon as these bozos pump enough money into the economy to make my houses worth a billion kajillion bucks I'm selling and moving into a houseboat moored in Florida. And I advise you all to do the same. Of course, in the meantime take advantage of the fact that it's a damned good time to get everything in your house fixed up--you can actually find craftsmen free and the raw materials are priced well.
That's my economic tip of the day.
Oh, yes, and bake your own bread.
Posted by: clarice | March 22, 2009 at 03:25 PM
If the government loses money, there's that much less to pay off the gigantic debt we're accumulating, so it will have to come from taxpayers.
Okay, Jimmy, we can play a round of this too. Define "money".
Posted by: Charlie (Colorado) | March 22, 2009 at 03:29 PM
If Krugman is against the bank rescue plan, doesn't that mean it has a better chance of working?
Posted by: bad | March 22, 2009 at 03:32 PM
There are plenty of unreformed Keynesians who will agree with you, but scant evidence.
Well, no, this is actually a Milton Friedman sort of monetarist argument.
Oh, and the answer to your other question "if all the increase in the money supply that we've seen over the last six months hasn't stimulated the economy, how will more do it?" would be that as long as enough money-markers have been destroyed that investors think there is still deflation -- read "investors think money in a mattress is a good investment" -- then they won't take it out of a mattress. So the increase will start stimulating when it's enough that deflation stops.
It's interesting that this kind of reconciles Keynes and Friedman, in the sense that it explains how a Keynes-ian stimulus could actually work, even though the underlying theory is wrong or mistaken.
Posted by: Charlie (Colorado) | March 22, 2009 at 03:34 PM
If Krugman is against the bank rescue plan, doesn't that mean it has a better chance of working?
She's got a point.
Posted by: Charlie (Colorado) | March 22, 2009 at 03:34 PM
So the increase will start stimulating when it's enough that deflation stops.
Come to think of it, there was some inflation this month. no? And some positive economic data. And some good market news.
Hmmm.
Posted by: Charlie (Colorado) | March 22, 2009 at 03:36 PM
Okay, Jimmy, we can play a round of this too. Define "money".
I'm not playing that game. "Loses money" is a fiscal concept: They send out more than they get back. The balance sheet deteriorates. The same process that has happened to Citi and BofA. Nothing to do with the definition of money.
Posted by: jimmyk | March 22, 2009 at 03:47 PM
And I'll just add, Charlie, that you are conflating fiscal and monetary policy. This toxic waste disposal plan that we're discussing is really fiscal. The Fed can finance the fiscal operations by adding to the money supply or not, but that's something the Fed can do regardless of whether this plan is implemented. Just like the porkulus plan is fiscal: though the Fed could decide to help finance it by juicing up the money supply, that's a separate decision. So all this stuff about money and gold etc. is a a red herring.
Posted by: jimmyk | March 22, 2009 at 03:55 PM
"Well, no, this is actually a Milton Friedman sort of monetarist argument."
Ohh puhhhlease, I can't let that one go. Milton Friedman would pull his hair out and scream at your premise that government creates money. He is turning in his grave right now just at the thought of having his name associated with such heresy.
Posted by: ben | March 22, 2009 at 04:03 PM
Ohh puhhhlease, I can't let that one go. Milton Friedman would pull his hair out and scream at your premise that government creates money. He is turning in his grave right now just at the thought of having his name associated with such heresy.
No, he'd scream at the idea that government creates wealth. If you weren't confusing wealth with money we wouldn't be having this argument.
Posted by: Charlie (Colorado) | March 22, 2009 at 04:12 PM
Am I the only one old enough to remember when "toxic waste" referred to the unfortunate by-products of energy production, useful chemicals production and so forth?
Where "useful" and "production" (and "progress" and "making things better") the order of the day, not "bailout" and "bankruptcy" and "socialism"
Posted by: Larry Sheldon | March 22, 2009 at 04:19 PM
I am not confusing it, you are. You don't fund bailouts with wealth, you fund it with money. You don't loan wealth, you loan money. The government's deficit is measured in dollars, not wealth.
Posted by: ben | March 22, 2009 at 04:19 PM
Ben, the Wikipedia article on Friedman is pretty good:
Posted by: Charlie (Colorado) | March 22, 2009 at 04:19 PM
I am not confusing it, you are. You don't fund bailouts with wealth, you fund it with money. You don't loan wealth, you loan money. The government's deficit is measured in dollars, not wealth.
When you can define the difference, let me know.
Posted by: Charlie (Colorado) | March 22, 2009 at 04:20 PM
Digging around a bit on the quantity theory of money, the most amusing thing is that, if I'm reading this stuff right, I'm pushing the theory of Hume, John Stuart Mill, von Hayek and Friedman; Jimmy and Ben seem to be buying into something very much like the "anti-quantity theory of money" of Marx.
Posted by: Charlie (Colorado) | March 22, 2009 at 04:41 PM
Charlie you need to brush up on some fundamental economics. You are now talking about money supply? Is that what you think is created money?
All money (dollars)is BACKED BY DEBT. When the Feds manufacture money as in printing presses that money is IMMEDIATELY exchanged for government debt that pays interest. Once again there is no free lunch. Any money "created" by the Feds is immediately offset by an equal amount of offsetting debt.
Posted by: ben | March 22, 2009 at 04:44 PM
"The balance sheet deteriorates. The same process that has happened to Citi and BofA."
Since Turbo's plan does not require legislation (I don't think it does - it's covered in TARP I) then in five days, at the end of the first quarter, using some FASB 157-Section 3 'magic', the blossom of health will reappear on those balance sheets. By June they will be fit for the decathlon (barring the appearance of another Black Swan.)
Nothing will actually have 'changed', of course, and the 'new reality' will be no closer to truth than today's 'reality' but something will have been done. Not necessarily the right thing but a mark to market which does not reflect underlying asset value is not a "right thing" either.
I've reached the point where I'm OK with burying the Zombies. The chance of catastrophic systemic failure is now, after four months, minimal. Any counterparties which have not insured against the possibility are too dumb to live.
It's going to interesting to watch the political reaction to this. I can't wait to see the bus tours of the Homes of the Hedge Hogs.
Posted by: Rick Ballard | March 22, 2009 at 04:47 PM
"When you can define the difference, let me know."
Piece of cake. Money is a unit. Wealth is an asset. If you have a million units of money, and owe a million units of money, your wealth is zero. Sandbox economics 101.
Posted by: ben | March 22, 2009 at 04:52 PM