Arnold Kling  

The Toxic NCAA Bracket

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Suppose that a week ago I had entered a March Madness pool, paid $10, and filled out a bracket.

Suppose that right now my bracket is looking weak, with only about half the teams I picked to make the sweet 16 still in the tournament. I have not been mathematically eliminated from winning the pool, but I need extremely good luck the rest of the way. (Incidentally, this example is hypothetical. I don't follow college basketball, and I don't enter any pools.)

At this point, my entry is no longer worth $10. If I were to sell it, I might get fifteen cents for it. If I were a bank, my bracket would be a toxic asset.

Now, along comes Tim Geithner with a fistful of taxpayer dollars. The way his plan works, you can put up a nickel to get a share of my bracket, and Tim will lend you forty-five cents, which you do not have to pay back if you lose. If you win, you and Tim split the proceeds. You're happy, because for a nickel you're picking up half a share of a bracket worth fifteen cents. I'm happy, because I sell my toxic bracket for fifty cents instead of fifteen cents. Somebody should be unhappy. Guess who?

For less metaphorical commentary, see Steve Randy Waldman. Also, read Karl Denninger. Thanks to Tyler Cowen for the pointer.

Unfortunately, the stock market's huge cheer for the plan means that those of us who oppose it are unlikely to get any traction.

UPDATE: More from Simon Johnson and James Kwak.

UPDATE 2: An alternative approach, from Jeremy Bulow and Paul Klemperer. Thanks to Greg Mankiw for the pointer.


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The author at Three Sources in a related article titled A Public-Private Partnership writes:
    A good friend of tis blog sends a link. Arnold Kling explains the latest Treasury plan, in March terms: Suppose that a week ago I had entered a March Madness pool, paid $10, and filled out a bracket. Suppose that... [Tracked on March 24, 2009 2:28 PM]
COMMENTS (10 to date)
Willem writes:

As a professional economist, you oppose the plan. But now tell me, can ordinary people like you and me invest in this plan? I would realy like to buy me some Geithner puts.

PJens writes:

If I put up a nickle to buy your bracket with forty-five cents put up by the government, then over time the bracket becomes more valuable, and I sell it for profit, who is to say the rules will not change to allow government to grab that profit?

The scary part of this Congress is that it seems to be willing to go after whatever it wants by punitive taxation.

InstaReader writes:

Suppose you borrowed the $10 for your bracket entry fee from Bill Gross of PIMCO.

Bill Gross is eligible to borrow from Geithner/FDIC. He does so and uses that money to bid far above 15 cents to buy out your entry. He bids $10.

Your bracket still loses, but Bill doesn't care. With the Geithner subsidy, he only lost 30 cents.

But in the process you repaid Bill's $10 loan in full so PIMCO is a winner afterall.

Taimyoboi writes:

Seems like individuals might get a chance to play:

http://www.bloomberg.com/apps/news?pid=20601087&sid=aEM3sqS8r6HM

Todd Martin writes:

Philosophically I'm sympathetic to these arguments but think they (or I) am missing the crux of the valuation problem which Geithner's plan is attempting to solve.

These toxic assets are essentially portfolios of mortgages, each of which has a principal amount owed, an interest payment stream, and a property value which can be recovered to some extent in foreclosure and resale.

These portfolios have buyers at 20 cents, say, because their component principals, interest streams, and property values are all in doubt and surely worth a lot less than 100 cents -- if sold now. If held longer, or all the way to maturity, they might be worth more, if recovered cash flows hold up somewhat.

The future is highly uncertain, and nobody knows what cash will eventually be recovered. The banks have them on their books now at 80 cents, say, assuming a relatively optimistic recovery scenario.

The Geithner plan essentially finances, with taxpayer money, private-public bids for these portfolios. The key question is will any portfolios actually be sold in the gaping hole between 20 and 80 cents.

Will a bank take 60 cents, say, and write off 20 cents? Will that writeoff make them insolvent, or require them to raise more capital? Will a Gethner plan buyer project a future profit at 60 cents? Will that buyer eventually get 70 cents of cash recovery, driving a high, leveraged, return to private and public partners, and repayment of public loans?

If a market actually emerges we will know if the Geithner plan is working. I doubt any money will change hands without both sides seeing a profitable trade.

If trades are indeed made, the banks get cash for a highly uncertain asset, take writeoffs, raise capital or restructure as required (or mandated). Banks which refuse to sell have new Geithner plan market values established for these assets, which regulators will use to force subsequent restructuring.

Finally, buyers will have portfolios to manage and try to make a profit. If they do, everybody wins. If they don't, taxpayers if effect subsidize part of the original bank losses, along with their private partners (albeit to a much lesser extent).

In the end this is an attempt by Geithner to create a market where none exists given the size of the toxic assets on bank balance sheets. It takes two to tango...let's see if anybody dances!

Dan Weber writes:

But now tell me, can ordinary people like you and me invest in this plan? I would realy like to buy me some Geithner puts.

Wouldn't this be good? If people really want in on this, that will bid up the price, right? And thus reduce the costs to the government?

geevill writes:

"But in the process you repaid Bill's $10 loan in full so PIMCO is a winner afterall"

There lies the flaw in your logic. Arnold can't back Bill back. That is what started this whole thing.

The Snob writes:

So back when this all started, I recall being told we needed the bailouts in order to prevent having to pay as much as $2 trillion in FDIC-insured deposits. We now appear set to exceed that number by other, less clarifying means.

How much is out there in senior debt? I appreciate that bank secured debt is held mostly by widowed grandmothers and disabled WWII vets, so we're stuck making them whole. I just want to know how expensive this scam has to get before it becomes worse than just taking our medicine straight at the beginning.

As a business owner and entrepreneur, this whole thing makes me violently ill. The thought that these too-big-to-fail institutions will emerge from this in one piece makes me contemplate rooting for Barney Frank, as thoughts of him being on the compensation committee seems to be the only thing that gives these rent-seekers a moment of pause.

Mark writes:

The stock market would also go up if they showed up at everyone's door with a suitcase full of cash. I fail to see why that is the appropriate metric. More importantly, the USD went down and oil went up. Following the stock market is yet another false metric that will lead us to ruin.

ajb writes:

It seems like the stock move due to the plan was only a percent or two that morning. The big move came later when the data about housing sales came out. Perhaps that's the news that drove the market and people are reading too much approval of the toxic asset plan into last week's run-up.

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