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“Toxic assets” revisited: Obama embracing discredited Paulson plan?

As the Obama administration prepares to take power this week, the latest word on what it will do with the remaining half of the $700 billion in Troubled Asset Relief Program funds authorized by Congress last fall suggests that political judgments are trumping economic ones.

This past weekend, Team Obama floated the idea of establishing a new entity, a government-run “aggregator bank,” whose purpose would be to buy up toxic assets from banks in the name of restoring confidence and getting money moving through the system again. If it sounds familiar, this was precisely the plan that outgoing Treasury Secretary Henry Paulson floated initially when the $700 billion TARP package was proposed. It was rejected, in large part because so many economists concurred that capital injections–giving financial institutions money for ownership shares in the institutions–has proven more efficient in cycling money moving through the system.

Obama’s version of Paulson II will surely be more conscientious in its window-dressing. Yesterday on Face the Nation, chief economic adviser Larry Summers proclaimed that “the focus isn’t going to be on the needs of banks; it’s going to be on the needs of the economy for credit.” The underlying theory is that the government, by setting a floor on the value of “troubled” debt instruments, can establish what their real market value is. But as Paul Krugman pointed out in a blog post yesterday, the trouble with these assets is that they have no value at all:

It looks as if we’re back to the idea that toxic waste is really, truly worth much more than anyone is willing to pay for it — and that if only we get the price “right”, the banks will turn out to be solvent after all. In other words, we’re still in Super-SIV territory, the belief that fancy financial engineering can create value out of nothing.

Oversight? You can be sure that pledges of same are forthcoming. But when it’s a question of choosing between this worthless piece of paper and that one, how much does oversight matter? The “aggregator bank” idea, writes Krugman, is based on the Resolution Trust Corporation that was created to deal with S&L crisis of nearly 20 years ago. But the comparison is flawed. The S&Ls’ bad paper was underwritten by real assets like houses, whereas the exotic financial instruments of our time are really just bets about money.

This is pure bailout stuff. Public moneys thrown in this direction will never be repaid. It’s another testament to the extreme political pressures that complicate the new administration’s efforts at stabilization and stimulus–like Obama’s apparent willingness to make tax cuts account for up to 40 percent of the new stimulus plan he’s expected to announce soon after taking office. Economists point out that tax cuts are a poor way to provide short-term stimulus because they’re more likely to be put into savings or debt reduction than cycled through the economy as consumer spending.

Comments (1)

  1. Submitted by Annalise Cudahy on 01/19/2009 - 11:28 am.

    The total amount of money to be put into this economy over the next 3 years includes this $700B, Obama’s additional $850B, and three years of trillion-plus deficits. That’s about $5T total, or around half of GDP that will be the total “stimulus” package.

    As a part of that, and a small part of that total, the Obama administration is considering a system to allow banks and other money managers to get bad assets off their books while the Feds figure out what, if anything, can be gleaned from them.

    Is this a “bailout”? Oh, yes. A small part of a massive bailout.

    I do not understand why this portion of the program is being considered in isolation, or for that matter why the gravity of the entire problem isn’t foremost in the analysis. I agree that certain people I’d like to see in jail are going to benefit from this, and I’d rather they didn’t. I hope this is all considered very well. But in a collapse of this magnitude things like this are going to happen.

    I hope you will explain your reference to SIVs because I do not think for one moment there is talk of inflating the value of assets on the books – rather, it is quite the opposite. We are removing bad assets and dealing with them in a central clearing house.

    In short, it seems to me that you don’t think it’s time to have the government supervise a massive restructuring of our financial system. Call it a “New Deal” if you are a poker player. A lot of things have to go forward for that to happen, and one of them is to get rid of bad assets.

    Do I like it? I screamed like all Hell when this mess was being created, so I can honestly say I don’t. But if you don’t have an alternative, well, I don’t see the point in arguing. Equity in these financial institutions will also be part of the deal in the next $850B, so it’s not either/or – more like “all hands on deck”.

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