Arnold Kling  

Geithner Lays an Egg

Brink Lindsey Baits Paul Krugm... Are We Getting to Him?...

I outsource my comments to Tyler Cowen.

COMMENTS (6 to date)
Joe Calhoun writes:

Hey, that's my headline....

Richard writes:

Perhaps someone may wish to comment on the following scenario.
The toxic assets, at bottom, seem to consist of mortgages for owner occupied properties and investor/speculator owned properties. They are bundled in a variety of instruments such that we currently don't know their true market value.
Say the federal government simply guarantees for some modest premium a bank/financial institution's toxic portfolio. Presumably this would accelerate the liquidation of these toxic assets since no P&L/equity effects would ensue as the otherwise realized loss would be recovered from the USA.
Such a plan would identify the actual bad or toxic assets fairly quickly, would enable banks to clean-up their balance sheets and resume responsible lending, say, the Kling 20% downpayment protocol. Whoa, one may say, the taxpayers would be underwriting the entire shortfall. I say that the taxpayers, i.e., those that are actually paying meaningful amounts of tax, are the ones being adversely affected by the present financial uncertainty and, on net, would benefit by its timely resolution. To the extent some of the burden falls on the progeny of such taxpayers, the inheritance wealth transfer eases (but not eliminates) the burden.
What am I missing here?

Carl The EconGuy writes:

Toxic assets is a complete misnomer. There is underlying value, because the housing stock is still there -- the real assets are mostly untouched. The problem is to arrive at a proper current evaluation of the mortgage backed assets. If the mortgages fail, the real asset should go to the lender. We know the decline in the value of the real asset, from looking at market values of housing in various areas, and we also know, from history, that real markets tend to overreact to bad news in the short term. The problem lies in unbundling complicated assets in a too rapidly falling market for the real asset backing the mortgages. This will take time, and banks need protection in the meantime.
This is why we invented Ch. 11. Why should not banks, including the really big banks, take the Ch. 11 route? That would put them in the hands of judges who can relieve them of all kinds of regulations while they sort things out. We don't need bailouts, we need time to let the real underlying value of housing to be revealed by the market. Only then can all the mortgages and derivatives be tied to the correct real peg. Forcing overloaded banks into Ch. 11 would also open the opportunity for new banks to spring up, or for solvent banks to grow. Ch. 11 was constructed to slow things down while the market adjusts. Why should that not work here? It seems to me that Geithner yesterday was working on a Treasury driven Ch. 11 process -- which will make it political and likely misguided. We already have adequate mechanisms for this -- I say, use them.

Maniel writes:

As the new administration and legislature put forth ever more costly "stimulus" plans, it's somehow comforting to know - just before going over the cliff - that salvation does lie in the opposite direction. The underlying problem is that we are addicted to debt on many levels, from credit cards to no-money down mortgages, from city governments to state governments, and from the federal government to eternity. Even while the prevailing wisdom is leaning (or falling) for more government spending and more debt, this is not a time for a new "fix" to postpone "withdrawal" from our debt addiction. It is a time for drastic tax and spending cuts, a time for "homeowners" with negative equity to become renters, a time for businesses and government to cut salaries rather than employees, and a time to save rather than spend.

A few words about the "homeowners" (you are one, according to some, if you have a mortgage) and the banks. I understand that "derivatives" are a problem, but the bigger problems are 1) foreclosures where families are forced to move and 2) an inability to value mortgages. Both problems could be solved through a three step process: first, the mortgage holder takes possession of the home where mortgage payments have stopped; second, the mortgage holder rents the property out at market rates, in most cases to the present occupant; and third, the mortgage holder reassesses the home based its value as rental property and then writes off the balance of the mortgage. The great fear is that there will be bankruptcies - and there will be once the reassessment plays out - but [I agree with Carl the EconGuy] bankruptcies are nothing more than orderly processes to salvage value in debt crises. One advantage is that neither banks and nor "homeowners" need to be bailed out. A second advantage is that, once homes are marked to present value, the real-estate industry will be back in business.

Walt French writes:

What am I missing here?

The financial economist's favorite word: "price."

There is no "fair" price for these assets, I'll assert, because if the bank sells them at a price that profit-seeking buyers would pay, the bank becomes insolvent, losing anywhere from 15¢ to 90¢ on the dollar. (Merrill sold some stuff at 22¢ but with a put option that made it closer to 13¢; see the NYT example of non-performing second mortgages on Alt-A and sub-prime firsts being carried by a financial institution at 97¢ on the dollar when they are probably near-worthless.)

High-yield corporates have the same situation: they're selling, if at all, at incredible discounts. For the same reason: they're very likely to default and pay back little, only after bankruptcy proceedings. (Tho I have yet to hear that illiquidity is the problem with those toxic assets.)

For the Feds to determine a fair price, they have to do forensic work that the banks and other buyers of the mortgage securities couldn't be troubled to do, and assess future losses that are guessable but inherently unknowable. So the floor under these loans sort of needs to be hugely generous to clear them from the banks; we either have the Feds giving free money to the banks or giving hedge funds all the upside without much if any downside. Otherwise, the Feds pay a lower price that while maybe even "fair," bankrupts the banks, which does not achieve the nominal objective.

Or maybe, that is the objective: to clean out the mark-to-make-believe accounting under the guise of "I'm from Treasury and I'm here to help you." Dr. Kevorkian, where are you when we need you?

Who designed your web site? Contact info?

many thanks - Michael

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