Tuesday, April 7, 2009

Increasing Criticism of Public Private Partnership Investment Program

There has been recently fairly strident criticism of the Public Private Partnership Investment Program announce by Treasury. One of the sharpest is that made by Professor Jeffrey Sachs, who posted his critique on the Huffington Post website -- "The Geithner-Summers Plan is Even Worse Than We Thought." Mr. Sachs' main point is that there is the possibility of gaming the system by a bank essentially selling worthless assets to a partnership the bank or a confederate has entered into with the government. When the assets prove worthless, the government takes most of the loss, but the bank is ahead by the upfront money it received in the sale minus its small loss in the partnership.

Business Week also criticizes the plan in an article entitled "Geithner's Plan: Loopholes Galore." The article outlines five possible ways, depending on the final rules, to game the new program.

Joe Stiglitz weighs in with an op-ed in the New York Times -- "Obama’s Ersatz Capitalism." A key sentence in the piece: "Even in an imperfect market, one shouldn’t confuse the value of an asset with the value of the upside option on that asset." Stiglitz also states: "Paying fair market values for the assets will not work. Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time."

Peyton Young also piles on in the pages of the Financial Times. The article, "Why Geithner’s plan is the taxpayers’ curse," analogizes the "winner's curse" in the economic literature on auctions to the position of taxpayers under the current Treasury plan -- "This is the singularly perverse feature of the Treasury proposal: the greater the competition among the bidders, the worse off the taxpayers and the more distorted the so-called “market” prices that result." The article further states: "It is truly dismaying that the Obama administration, which publicly champions greater transparency, should put forward a proposal whose main object is to subsidise the banks without appearing to do so."

Paul Krugman, of course, can be counted on to criticize the plan. In his March 23 op-ed article in the New York Times, "Financial Policy Despair," he writes that "the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets." While conceding that "troubled assets may be somewhat undervalued," Krugman argues that the "Geithner plan" is "financial hocus-pocus" that will not work. Financial executives, he argues, lost their bet on the housing bubble and "the related belief that unprecedented levels of household debt were no problem."

Steven Pearlstein, who was an original supporter of the TARP plan to buy assets that Secretary Paulson proposed and then abandoned, strongly and sarcastically criticizes Krugman in a March 24 column in the Washington Post -- "Optimism over Despair." In the article, Pearlstein argues against "nationalization" of big banks. He also argues that, in regard to the assets it is directed at, the Administration's plan "merely restores things to a more normal situation in which the market prices reflect expected cash flow rather than reflecting the unavailability of reasonable financing."

A less pugnacious defense of the plan appeared in the same paper that Krugman writes for -- Joe Nocera's March 28 article, "This Time, Geithner's Plan for Banks Makes Sense." Mr. Nocera argues that the government is not bribing investors "to purchase the assets at inflated prices ... Instead, it appears that the government is trying to return some normalcy to the workings of the market." He concludes that the plan is not perfect or "guaranteed to do the trick," but " could, in the best case, make our banks a little healthier and a little better to extend credit."

Willaim Black, a former official with the Federal Home Loan Bank Board (now defunct) and the Office of Thrift Supervision, is extremely blunt in his criticisms of the current approach to the banking crisis in an interview on Bill Moyer's Journal last Friday. Among other charges, he argues that government officials in the Bush and Obama administrations are violating federal bankin law by not closing down insolvent banks according to the prompt corrective action provisions enacted in reaction to the S&L crisis.

Andrew Ross Sorkin of the New York Times raises another legal issue in an April 6 article, "‘No-Risk’ Insurance at F.D.I.C" (reproduced here along with excerpts from the relevant statute). He suggests that the amount of the guarantees that the FDIC is planning on extending stretches current law, and that, in order to comply with its interpretation of the law, the FDIC is projecting that the expected cost of the guarantees to the FDIC is zero.

Finally, for a depressing view of out current economic situation, there is Simon Johnson's article in the forthcoming May Atlantic, "The Quiet Coup." Among other points, the former chief economist for the IMF argues that Wall Street has way too much influence in Washington. His disturbing conclusion is: "The conventional wisdom among the elite is still that the current slump 'cannot be as bad as the Great Depression.' This view is wrong. What we face now could, in fact, be worse than the Great Depression—because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances."

The Adminstration is betting that Mr. Johnson is completely wrong, and that economic conditions will soon begin improving. In that case, the Administration plan with respect to the troubled, toxic, or legacy assets (or whatever their new name is) will look good, at least if the Administration can police it sufficiently to avoid it being gamed. Even then, if some investors are perceived as making too much money, there could be some political problems.

If, on the other hand, the economy continues in a slump, even if not as bad as Simon Johnson fears, then the Administration will be facing all sorts of charges of mismanagement. That liberals are currently attacking the program means that the Adminstration will not have a lot of political capital if things turn wrong and it has to go to another plan and ask the Congress for more money.

The lack of an effective response by the Administration to the criticisms, especially those involving gaming the new program, is surprising. They should have been able to anticipate this. When it comes to these types of programs, which can be easily painted as helping out Wall Street executives who already are too wealthy, it is not enough to have a program which you think is the correct one. You need to be able to sell it. If you cannot figure out how to do that, maybe you need to rethink the plan.

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