Timmy Talks To The World

Timmy takes to the WSJ today to explain his plan for saving banks. I'm actually glad to see this, Timmy The Invisible Boy seems to be trying to be visible. In his own words:

The Public-Private Investment Program will purchase real-estate related loans from banks and securities from the broader markets. Banks will have the ability to sell pools of loans to dedicated funds, and investors will compete to have the ability to participate in those funds and take advantage of the financing provided by the government.

The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors. Second, the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.

Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.

The new Public-Private Investment Program will initially provide financing for $500 billion with the potential to expand up to $1 trillion over time, which is a substantial share of real-estate related assets originated before the recession that are now clogging our financial system. Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets. The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.

This program to address legacy loans and securities is part of an overall strategy to resolve the crisis as quickly and effectively as possible at least cost to the taxpayer. The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses. Our approach shares risk with the private sector, efficiently leverages taxpayer dollars, and deploys private-sector competition to determine market prices for currently illiquid assets. Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.

Keep in mind when Timmy says that the government is "sharing risk with the private sector" he means "assuming 85 to 97% of the risk". Also keep in mind when Timmy says "private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets" then the Government has put the No Right Price problem squarely on the heads of the market.

What I mean by the "No Right Price" problem is this: There's no right price that can satisfy the two goals of the program: a price that is both high enough to make sure the banks get paid enough for their toxic assets so that they don't suffer a massive loss, and a price low enough to make sure the US taxpayer assuming the vast majority of the risk here doesn't lose money.

If the price is too low, then banks won't sell their assets because they will be sold at a confirmed loss. If the price is too high, then the taxpayer is on the hook for billions in losses...and the private partners running the funds won't buy either knowing some of their skin in the game will be lost as well.

SOMEBODY has to lose on this deal, either the banks (and they collapse), or the public-private partnership (and the taxpayer loses hundreds of billions). That is a hard and fast rule. If there was a right price, the market would have determined it by now. In fact it has, but Timmy on one hand says that the current market price for these toxic assets is too low (the market is broken) and on the other, he's depending on the private partners in this plan to determine a market price for these assets by throwing government money at it (the market works perfectly fine).

Timmy's plan is based off a paradox. Practically, he's decided that the taxpayer losing several hundred billion is better than the banks collapsing. It's a moral hazard brand bailout of the banks using these funds as the middleman, but he has plausible deniability because he's not the one setting the price.

The practical upshot is that most likely the plan will fail miserably because the private fund managers aren't going to pay the banks' crazy prices for this toxic crap. The fund managers can honestly say "If I pay what the banks want, I will lose money and the taxpayer will lose money. I refuse to do that." The fund managers will not buy unless they can make a profit. The banks can honestly say "If I sell at the price the fund mangers want, I will have to close my doors and the country will lose thousands more jobs. I refuse to do that." The banks will not sell unless they can make a profit.

Standoff. Nothing happens...other than more time is wasted. That's the part where we all lose.