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Sentences to ponder
I think it's very telling that in two days of hearings and two weeks of discussion we have yet to see *any* detailed mechanism for how Paulson's plan will increase the supply of, say, inventory loans.
Here is more, mostly on the commercial paper market, interesting throughout.
Posted by Tyler Cowen on October 2, 2008 at 03:17 PM in Current Affairs | Permalink
Comments
Very interesting, as usual, Tyler. In order for a legislative fix to work, it has to meet two tests. First, the diagnosis of the problem has to be correct and second, the cure has to be targeted correctly. Even allowing that near misses may have some benefit, what are the chances that the Congress and President will be 2 for 2?
Of course, if a lot of the problem is a matter of confidence and trust, a placebo may work. But $700 billion for a placebo?
Posted by: Rich Berger at Oct 2, 2008 3:33:50 PM
From what I understand of it, which admittedly might not be much, the author is attempting to argue that commercial paper is in direct competition with TBills, and that the increase in treasury debt will lead to a spike in the interest rate in TBills, making the situation even WORSE for commercial paper.
Couldn't this problem mostly be avoided by issuing long-term debt? 10 Year bonds?
I also can't say how the bailout plan would directly affect those short-term loans. But if the banks are a necessary intermediary between banks and money-market funds, and banks are in distress, which is causing the run away from money-market funds...then wouldn't relieving the stress on banks be a good idea, if the FDIC extension to MM doesn't seem to work?
Posted by: Robert Olson at Oct 2, 2008 3:38:54 PM
One issue that hasn't (as far as I know) been mentioned is the fact that non-recourse loans are peculiar to the US. Amending US mortgages so that lenders had recourse to the borrower if the mortgage failed at a loss would surely be an effective market mechanism to *help* reduce the moral hazard in the current/previous situation..?
Posted by: nick at Oct 2, 2008 5:39:21 PM
sorry, I meant to add that recourse would help to increase the supply of inventory loans.
Posted by: nick at Oct 2, 2008 5:42:23 PM
The other thing we have yet to see is banks, despite their alleged hunger for deposits, offering to pay more than desultory interest on them. If the TED spread is so wide, why are retail interest rates so low?
Posted by: Zorkmid at Oct 2, 2008 5:50:33 PM
I've been asking Zorkmid's question on various forums for weeks [Why are CD rates so terrible?] and have yet to get an answer I believe.
Maybe part of it is that the Fed's discount window is so generous [cheaper to borrow from the government], but if that's true there'd be less liquidity problem.
Surely not ALL banks are awash in bad mortgages. Even if all bankers were stupid, wouldn't some be stupid in a different way? How can ALL banks be awash in bad mortgage debt?
Shouldn't those banks now be able to act as intermediaries between those with money to invest in CD's and those needing, say, inventory loans?
Posted by: ZBicyclist at Oct 2, 2008 6:33:25 PM
ZBicyclist, the problem is that it's not clear who is vulnerable to the bad mortgage debt. Even an institution that doesn't hold any mortgage debt itself might hold paper from some other institution that does, and thus be vulnerable to the failure of that institution. So out of fear, no one lends to anyone.
That said, beyond preventing a panicked freeze of essentially all credit, I don't want a government plan to get inventory loans pack to their previous levels. Because they assumed unrealisticly low default rates, lending institutions have been lending too much. Credit markets should contract. We should have a recession. What some people seem to want is to try to keep the party going longer; effectively, they want the government to borrow for them so that everyone can access capitol at the same, low rate the government can. That is not what we need.
Posted by: David Wright at Oct 2, 2008 6:52:30 PM
sorry, I meant to add that recourse would help to increase the supply of inventory loans.
I think it's more that after you foreclose on somebody, it's not all that likely they can pay for any recourse. In California, recourse loans have to go through a judicial foreclosure which can take months and a lot of money, instead of a fairly simple trustee sale. Even with recourse loans in California, banks rarely go through the process that allow recourse.
Posted by: JordanT at Oct 2, 2008 7:12:48 PM
Clowns.
Pennywise goes to Washington.
Posted by: Andrew at Oct 2, 2008 7:40:25 PM
It's not only that we haven't seen the mechanism by which the plan will achieve this or that. We haven't seen what the plan really is.
I still don't understand what price Paulson is claiming he will pay for banks' MBS (and this detail is like 95% of the plan if you ask me). Reverse auctions and paying hold-to-maturity value are mentioned simultaneously as if they are perfectly compatible instead of almost mutually-exclusive. To hear the cheerleaders talk, he's going to both make the taxpayers money with a carry trade by picking off securities at depressed prices and holding them, and rescue banks' balance sheets by letting them unload depressed securities at their 'intrinsic', 'true', and/or HTM value (which is supposedly a well-defined thing that the government, or someone, can figure out).
It's insanity. One can't even address whether the plan will help without knowing how it is going to function and what its goals are. The best argument in favor of the plan remains: "We have to do something." Because after all, this is certainly something.
It's just that nobody knows what.
Posted by: Sonic Charmer at Oct 2, 2008 8:19:43 PM
Am I imagining things, or is the Treasury's plan to guarantee money market funds likely to have a much bigger effect on credit markets than the rescue bill that the Senate passed? And of course, the MMF plan is much more likely to make money than the Senate bill...
Why do we need a gargantuan rescue plan instead of trying a few smaller ideas to see if they work?
Posted by: Chuck E at Oct 2, 2008 9:24:03 PM
David Write - "What some people seem to want is to try to keep the party going longer"
Here's the discourse I'm hearing:
Mr. Market-"Well that was a nice party, we should go home now. Maybe we could get back together next week?"
Senior Paulson-"No way dude, your not leaving now are you."
Mr. Market-"I'm really tired, it's like, 4 in the morning."
Senior Paulson-"Let's get some coke!"
Posted by: Nate at Oct 2, 2008 10:19:56 PM
David Write - "What some people seem to want is to try to keep the party going longer"
Here's the discourse I'm hearing:
Mr. Market-"Well that was a nice party, we should go home now. Maybe we could get back together next week?"
Senior Paulson-"No way dude, your not leaving now are you."
Mr. Market-"I'm really tired, it's like, 4 in the morning."
Senior Paulson-"Let's get some coke!"
Posted by: Nate at Oct 2, 2008 10:20:40 PM
Yeah, don't hold me to this, but I think most mortgages are recourse. It just rarely happens that the bank will go after the ex-homeowner. Maybe because most people who have been foreclosed on have little assets other than their home?
Posted by: Cliff at Oct 2, 2008 10:27:55 PM
Sonic Charmer,
I completely agree with you. As economists we have to use data to solve a problem, I have seen no data to support this 700 billion dollar amount because there isn't any data. We also have no idea what the value of these bank assets are, which means we don't know if this plan has even a 10% chance to work. But sadly, economists do not make public policy. However, our government will do what they always do when a problem arises, "throw money at it and hope it goes away, if that doesn't work blame it on your predecessor".
Posted by: Torris187 at Oct 3, 2008 12:31:37 AM
I think the whole idea of the superfund is a lot simpler and a lot more sinister than all these scenarios currently being considered by all these "overly educated beyond their capacity" folks.
I just think that Paulson has fancied himself as a hedge fund manager for some time now, even before H.W called upon him into the civil service as a favour. Now, knowing that his time is up, and that there is no way back in into GS, and not willing to disappear into the unknown, he has simply come up with a clever career progression move using what amounts to nothing more than a "mis-"use of all these mighty powers assigned to him, in a classic Wall-Streeter fashion.
Who said that the fund must make any sense to the public good? Let the next one in charge worry about that.
Put simply, an individualist at his best.
Enjoy.
Posted by: Jose at Oct 3, 2008 6:38:42 AM
Torris187:
We also have no idea what the value of these bank assets are, which means we don't know if this plan has even a 10% chance to work.
Yet merely knowing what the assets are worth is only one side of the equation. I actually don't agree with most peoples' assumption that there's some sort of huge mystery over how much this or that bond is worth; a bond's paydown structure, credit level, and basic collateral details are usually open knowledge, after all. What's a mystery is what the collateral will do in the future; it's something you have to project, and you can be wrong, and depending on the bond, being wrong by a small amount could make your valuation off by a large amount. (I hasten to add that this uncertainty over a bond's future cashflow is an intrinsic property of said bond; it's not going to be made to somehow go away by Paulson throwing money at the bond.)
But even if we knew all that - even if we somehow knew with certainty what future cashflow each bond would bring - we still have no real idea what Treasury plans to pay for that bond! Or how they plan to choose prices. They've talked about holding a reverse auction, yes, but they've also talked about paying the HTM value (which, by their own assumption - an assumption I don't necessarily agree with, but Paulson claims to - is significantly higher than the 'fire-sale' price). So which is it? Without knowing that, we basically don't know anything about the plan.
It's as if you run a business and one of the people under you says he's going to buy some sprockets, do you approve? "How much do they cost - how much are you going to pay per sprocket?" you say. "Haven't figured that out yet", he says. "Just please approve me now. Give me X dollars. To buy sprockets." You try another tack: "Okay, let's say I give you X dollars, how many sprockets will you come back with?" Him: "That's to be determined. That's a detail I can work out later. I just need X dollars right now."
The price is virtually the entirety of the plan. Or, to borrow bond lingo, 'There are no bad plans, only bad prices'. But we don't know the first thing about what Treasury will pay, not really. This is worrisome, and should be embarrassing to anyone who has been defending the plan without knowing what prices Treasury will pay (equivalently, how they will choose prices) for the bonds they want authority to buy.
Posted by: Sonic Charmer at Oct 3, 2008 6:55:51 AM
Couldn't this problem mostly be avoided by issuing long-term debt? 10 Year bonds?
Yes, the liquidity problem would be fixed and that would avoid strangling the economy. It would of course drive up long-term interest rates substantially since the long bond market is much thinner than the short bond market. I think increased interest rates are an inevitable result of any real fix to the problem. We need capital in our financial system; it's been lost; so the price of capital has to go up to draw more it.
A more generic issue is the risk of putting 700 billion in the control of a man who is obviously not thinking carefully about what he's doing. You can do a lot of damage with 700 billion dollars. Everybody makes mistakes. I'd be very reluctant to put that kind of money at the unlimited discretion of somebody experienced in previous major financial crises with a track record of successful resolutions. To put it in the hands of Paulson, who has been pretty much out to lunch since he got the job (remember "the problem is contained'? Hope Now?) is insanity.
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