“what is going to be required is a judgment we don’t need to make at this time..”

In somewhat related news, the US Treasury department plans to buy up to $1 trillion worth of toxic assets – with a little help from private investors..

The Treasury does not know whether it will need more federal funds to stabilise the US financial system, but it still has “substantial resources” from the $700 billion bailout to launch its asset purchase plan, Treasury Secretary Timothy Geithner said today.

“We will work with the Congress to try to make sure there are enough resources over time to do this right, but the judgment about what is going to be required is a judgment we don’t need to make at this time and are not prepared to make at this time,” Mr Geithner told reporters during a briefing.

He also said the administration will work with Congress to make sure executive compensation restrictions do not hinder the government’s economic recovery efforts.

The BBC’s economics editor, Stephanie Flanders, identifies the problem

There’s no getting around the basic fact that 93% of the risk is being borne by the US government – 7% in the form of straight equity and the rest in the form of lending guaranteed by the government which is only secured by the asset being bought. If those loans turn out to be worth nothing, it’s the taxpayer that’s going to pay most of the price.

If you start from the position that banks cannot be allowed to go bankrupt, and they cannot be nationalised, this may be as good a scheme as you are likely to get. The problem, as I said at the start, is not the detail but the basic idea.

Geithner has to offer such attractive terms to private investors because he knows that without such enticement, the gap between them and the banks will be too large.

After all, why would the banks want to accept a low price, when the administration has shown it will do almost anything to avoid taking the banks into public hands?

Clever though it is, that is the basic incentive problem which this scheme cannot design away.

Whilst everyone’s hero, Robert Peston, spots the difference between there and here.

Even allowing for important differences between the two schemes, such as how the assets are valued and what share of loss goes automatically to the private sector, there’s little doubt that in this instance, US taxpayers are less at risk of loss than British taxpayers – which is another way of saying that it represents a more modest “bailout” (to use the emotive phrase).

Geithner seems to be hoping that the mere existence of buyers for these hard-to-sell assets will lead to a rise in their market price, thus strengthening US banks’ balance sheets even if the banks retain the relevant assets.

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  • Scaramoosh

    Well there we have it – Obama style liberalism in motion.

    The people who created the toxic assets are now being offered the chance to buy them up on the cheap – with no downside risk.

    It is no wonder that Wall Street rallied 700 points – the markets always do like a good deal when they see one.

    The tax payer will pay the price if this deal goes wrong …democracy in action you might say.

  • “US taxpayers are less at risk of loss than British taxpayers”

    That’s hardly comforting, being the difference between being very screwed and completely screwed.

  • NCM

    So it turns out that Obama wasn’t exactly a left-winger….

  • Dave

    “So it turns out that Obama wasn’t exactly a left-winger…”

    On the contrary, a right-winger would have avoided the moral hazard by leaving the banks to fail rather than transfer the burden of the losses and the risk of future losses from the private to the public sector.

    If banks are too big to fail (and they never are, despite vested interest declaring them to be), then it follows that all banking activity over an unspecified size is underwritten by the State, so the profits are privatised but the risks are not. That isn’t free market capitalism, and it isn’t even state-capitalism: it wealthy elites conspiring with their puppets in politics to screw the taxpayer.

    As Greenspan said, the market failed because the state offered an implicit guarantee that losses would be underwritten, thereby undermining the self-interest principle that acts as a vital check to reckless risk. Now that the guarantee is explicit, the markets will fail with greater frequency in future, not less.

  • NCM

    Dave, agreed with the moral hazard analysis, but how does that make Obama anything other than a champion of the very elite banking interests that oppose socialism and enslave ordinary people?

  • Wilde Rover

    NCM,

    “Dave, agreed with the moral hazard analysis, but how does that make Obama anything other than a champion of the very elite banking interests that oppose socialism and enslave ordinary people?”

    Socialism when it comes to the losses, something everyone can share in harmony.

    Profits are a private matter and you would do well not to think about trying to put your grubby little peasant mitts on any of that because that would be stealing, and that is the type of attitude that the banking classes cannot abide in others.