Speaking candidly, I dig Jeffrey Sachs. It’s a bit of a man-crush really. Strictly platonic though; not a situation that would give rise to any moments for awkwardboners.com. Anyway, when he’s not off gallivanting around the developing world with Bono and Angelina Jolie, Sachs spews out some brilliant insight. Such is the case in his latest economic dress down: The Geithner-Summers Plan Is Even Worse Than We Thought.I was going to summarize Sachs’ take on one of the many gaping loopholes in the “plan,” but I figured you’d probably rather hear directly from a man named among the 100 Most Influential leaders in the world, as opposed to a dude referred to by a close friend as a “more pervy Larry David” (thanks, Sloane).
Insiders can easily game the system created by Geithner and Summers to cost up to a trillion dollars or more to the taxpayers.
Here's how. Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset.
Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.
Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.
More significantly, Sachs raises the issue of transparency, or lack thereof –
Let them explain the hidden and not-so-hidden risks to the American taxpayer of the plan that they have put forward. Let them explain why they are so intent on saving the banks' bondholders, even the long-term unsecured creditors who clearly knew they were taking market risks in buying Citibank bonds. Let them work with their critics to fashion a less risky and less costly plan. So far Geithner and Summers tell us that their plan is the only option, but without a word of further explanation as to why.
Geithner and Summers don’t deserve to shoulder all the blame for their plan’s opaqueness. On his first day in office, President Obama promised “a new era of openness is this country.” And yet now he seems either unwilling or unable to force his fiscal minions to honor that sentiment. Perhaps Obama should take a cue from Harry S. Truman, who frequently referenced the sign on his Oval Office desk that read: “The buck stops here.” Except that nowadays it would need to read: Trillions of bucks stop here.
1 comment:
While it is true that there are a number of unanswered questions regarding how the geithner plan will work out, Sachs' "game the system" scenario is has a few flaws of its own.
Most importantly, the primary goal of the government in this role is to restore the shaken confidence of the investment community. In order to do this they cannot present a plan that allows them to be fleeced by that same community.
Sachs omits a few details of the plan in his scenario. First, govt leverage is not guaranteed to participants. The FDIC and 3rd party contractors (this is from the whitepaper, I'm not sure who this will refer to exactly) will assess the value of all assets going into sponsored auction. Second, the assets involved here are probably not "worthless." many are certainly severely impaired and a minority of the junior tranched securities may indeed be zeros, but there is more value here than characterized by Sachs. Third, launching a PPIF will be done under direct supervision of the FDIC/Treasury, i.e. theyre basically sitting on the board. And lastly, the plan is litered with fairly vague and ominous statements such as "vigorous oversight" and "subject to notice and comment rulemaking."
The bottom line is that the govt has left certain details of this plan open ended on purpose. they have done so in order to close loopholes as this situation progresses.
I dont think the programs as laid out are a panacea by any means. But it does address one very important issue. the private sector needs an incentive to get involved in capital markets again and this plan may make some progress there. Addressing system solvency is another thing entirely and good luck to Geithner et al on that, they'll need it.
For anyone feeling particulary wonkish the docs for the PPIP, TALF, TARP, etc are available on financialstability.gov, a treasury dept website
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