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Whoops! Back to TARP after all...
The government is looking to buy substantial amount of assets from Citi like a good bank, bad bank structure. The Government will absorb much of the losses for Citi if there are losses and Citi would issue preferred stock to the government. The government could buy more than $100 billion in the bad assets if the plans go through.
Here is more. Didn't Paulson tell us just a few days ago that TARP wasn't needed after all?
Doesn't this mean that Paulson should speak less frequently?
And yes, we do now have the Paulson plan and the Dodd plan all rolled into one. And as CalculatedRisk noted:
Hey, I thought Citi WAS the bad bank!
Addendum: Read this lovely update!
Posted by Tyler Cowen on November 23, 2008 at 05:50 PM in Current Affairs | Permalink
Comments
My prediction? -when this is all over and the final accounting of costs and benefits is made, those (including myself) who said the government should do nothing will be proven to have been right.
Posted by: at Nov 23, 2008 6:10:59 PM
To this casual observer, it would appear that the the original TARP (troubled asset purchases) was a better plan that the reformed TARP (equity injections), at least from the point of view of un-freezing the credit markets. The passage of the orignal TARP appeared to bring relief to those markets, but they re-siezed soon after Paulson announced the reformed TARP.
It's not hard to understand why this might be. If the problem is that, out of 1000s of financial firms, 100 known firms might fail because of junk assets, then the government can solve the problem by injecting enough equity into those 100 firms to cover that loss. But if the problem is that, out of 1000s of financial firms, 100 unknown firms might fail because of junk assets, and no one knows which of the 1000s those 100 firms are, then counter-parties won't want to do business with any of those 1000s, out of fear they might be one of the 100. To solve this problem, the governemnt would have to inject enough equity in all of the 1000s of firms to cover any pontential losses due to junk assets that counterparties might imagine. Obviously, the government doesn't have enough money or time to do this. To deal with this second kind of problem, a better tactic is to remove the junk assets that the market fears, i.e. the original TARP.
Posted by: David Wright at Nov 23, 2008 7:04:02 PM
If CalculatedRisk is correct, then the proposed Citi-Wachovia deal structure was as I suspected. It was a hidden bailout of Citigroup.
chsw
Posted by: chsw at Nov 23, 2008 7:39:02 PM
All I can say is, the one person who has been light-years ahead of the curve on this stuff is financial commentator Robert Wenzel. He predicted that something strange would happen with the treatment of Citi (because of the political connections of the people behind the scenes), though the last thing I read he guessed that they would structure a Citi rescue that protected shareholders. Is this equivalent?
Posted by: Bob Murphy at Nov 23, 2008 7:58:57 PM
This has to be stopped. Paulson needs to be placed under citizen's arrest.
I wish those who are so vocal about Obama's incipient evil tax plans would spend equal time and energy decrying the egregiousness of Paulson's actions, which in my opinion are far more dangerous.
Like anonymous poster #1 (please pick a name and save it, btw), I have been against bailouts of any sort since day 1 - and I work on Wall Street.
Posted by: meter at Nov 23, 2008 8:54:11 PM
Maybe we should fix the fundamentals instead of all the consequences of ignoring them. Restore an honest dollar and then the deflation will end.
Posted by: Alan Brown at Nov 23, 2008 10:53:26 PM
To this casual observer, it would appear that the the original TARP (troubled asset purchases) was a better plan that the reformed TARP (equity injections), at least from the point of view of un-freezing the credit markets. The passage of the orignal TARP appeared to bring relief to those markets, but they re-siezed soon after Paulson announced the reformed TARP.
I don't think this chronology is quite right. Markets fell when the first proposed bill died in Congress. Then the day after the modified bill passed, markets again fell. Whether this was due to the perception that buying "distressed assets" was not enough, or something else entirely, it's not clear. The "reformed TARP" that you are speaking of is something that was announced only several days after the passage of the bill, though.
But if the problem is that, out of 1000s of financial firms, 100 unknown firms might fail because of junk assets, and no one knows which of the 1000s those 100 firms are, then counter-parties won't want to do business with any of those 1000s, out of fear they might be one of the 100. To solve this problem, the governemnt would have to inject enough equity in all of the 1000s of firms to cover any pontential losses due to junk assets that counterparties might imagine. Obviously, the government doesn't have enough money or time to do this. To deal with this second kind of problem, a better tactic is to remove the junk assets that the market fears, i.e. the original TARP.
This doesn't change the scale of the problem. For government purchases of assets to have a real impact the government would have to pay more than the going market rate for these assets which, as Krugman and others have pointed out, is a backdoor way of injecting equity, although without the government getting shareholder votes. And we are past the point where arguments about banks only having liquidity problems apply. Banks are edging towards insolvency; if they sell their "toxic" assets to the government, that doesn't change their balance sheets one bit.
Posted by: Ricardo at Nov 24, 2008 12:07:44 AM
This is insane.
Citi too big to fail? Break it up then!!!
Posted by: ian at Nov 24, 2008 12:50:27 AM
This is insane.
Citi too big to fail? Break it up then!!!
Posted by: ian at Nov 24, 2008 12:51:39 AM
Ricardo:
When you write about the times "markets fell" you are talking about equity markets. I am talking about intra-bank credit and commercial paper markets. Those are the markets we are supposedly trying to "save", not the equity markets. (Although the politicians and pundits seem to only pay attention to the Dow.) And those markets underwent two clear "frozen" periods (where volumes plumeted and rates skyrocketed): one just before TARP was passed and one just in the past 1-2 weeks.
You are absolutely right that buying toxic assets at inflated prices is a back-door uncompensated equity injection, which is unfair to the taxpayers. I am not making an argument about justice here. I am making an argument about what works.
And the reason I can make an argument that buying toxic assets works better than front-door equity injections is that it does change the scale of the problem, and it does change the balance sheets. It changes the balance sheets because the government would buy the toxic assets for more than their (essentially zero) market price. It changes the scale of the problem for the reason I outlined above. I'll try to spell this argument out a bit more clearly.
The problem I'm talking about here isn't directly insolvency. It's fear of loaning to anybody, even a firm that doesn't directly hold toxic assets, because they might be vulnerable to counter-parties that do hold the toxic assets (or are themselves vulnerable to another counter-party that does, and so on ad infinitum). If you want to alleviate that fear via front-door equity injections, you have to spent a lot more money than even the face value of the toxic assets, because you have to inject enough equity into every firm that they couldn't possibly be vulnerable to the failure of any counter-party. But if you instead use the back-door technique of buying the toxic assets, you only have to pay at most the face value of those assets, and you remove the market's fear that anyone is vulnerable to them, because they are gone from the system.
Again, I am making no argument that this is particularly just. On the contrary, it gives the biggest subsidy the the worst risk-takers. But it is, I think, the cheapest way to eliminate the fear of systemic collapse.
Posted by: David Wright at Nov 24, 2008 1:03:33 AM
Ricardo: I should add that it is possible to deal with the deal with the justice issue you brought up within the asset-purchase framework. If the government pays face value for the toxic assets, it could require that the selling firm grant it an equity stake. As long as the value of that stake is (slightly) less than the difference between the face and market value of the toxic assets, the firms holding the toxic assets will still sell because they wills still come out (slightly) ahead.
I really don't care one way or the other, because, from my perspective, we aren't doing this to help the firms holding the toxic assets. We are doing this to be able to help all the other firms out there that fear contamination, without having to open up the national checkbook and pay them all as well.
Posted by: David Wright at Nov 24, 2008 1:24:28 AM
TC: "Doesn't this mean that Paulson should speak less frequently?"
Could be said of all politicians.
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