The horizon is not so far as we can see, but as far as we can imagine

Market Rallies On News of Trillion Dollar Giveaway

Image by TW Collins

Image by TW Collins

Is anyone really surprised the DOW is up almost 500 points, after Geithner promised to give private investors almost $1 trillion to gamble with?

The details of the giveaway are fascinating.  I sure wish that I could get financing like this to play the market:

Under one part of the plan focused on bad loans, the Treasury will provide up to 80 percent of initial capital alongside investment by private funds. The FDIC would then offer debt financing for up to six times the pooled amount.

Now, unless I’m messing up my math, that’s 24/1 leverage.  If older details hold, and the 80% is a non-recourse loan, meaning that it’s secured only by the value of securities bought, then it’s even sweeter.

PIMCO has announced it’s interested in participating, which means that the plan has succeeded in one sense—it has the buy-in of some very smart money.  That doesn’t mean that it’s necessarily good for taxpayers, or that it will be good in the long term for the economy, necessarily, but at least it isn’t being laughed out of Dodge.  On the other hand, would you refuse 24/1 to one financing?  Or even matching funds, as contained in part two of the plan?

I sure wouldn’t.  And PIMCO have been scavengers before.  They bet heavily in Fannie and Freddie bonds after it was clear Fannie and Freddie were insolvent, which was a bet that the government wouldn’t shear bondholders when it bailed out Freddie and Fannie.  Smart bet, but not a good return for taxpayers, who would have been better served by letting Freddie and Fannie’s debtholders lose money.

I am becoming increasingly convinced that my original call was the right one: that the various bailouts would lead to Japanification.  For 20 years now, since its own bubble burst, Japan has had an economy which slips in and out of recessions like clockwork and which never ever really got good again.  In Japan’s case, the lousy economy was in large part because they left a lot of debt debt on the books of private corporations.  In America’s case, the debt may be transfered to taxpayers, but the end result is likely to be the same, only compounded by attempts to create secondary bubbles so that the toxic waste regains enough value to claim a win.

Given that Geithner’s trillion dollar giveaway has been greated ecstatically by the financial sector, I expect we’ll see more money used in this fashion.  This plan appears to be good for about $2 trillion of lousy debt ($1 trillion from the matching 1/1 program, $1 trillion from the high leveraged portion).  Total current toxic waste on the banks books is probably about $4 trillion, which will still have to be dealt with.

That money will have to be paid off, eventually.  Doing so will cost the US  and the world a great deal of future growth, and individuals a great deal of future income and employment.  As things stand right now, I don’t think employment levels as measured by employment/population ratios will recover in the forseeable future—post recession “full” employment will just be lower than pre-recession “full” employment.  There are still some ways this could be made to work for everyone, and I’ll discuss those at a later date.


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  1. Is there a clause in the Geithner plan that blocks “mark to market?” As soon as anyone starts buying these toxic I mean legacy assets don’t these banks have to re-value their own similar assets — mark them to the market values? This could show some or all of them to be insolvent. And since they declared themselves to be banks (to get TARP funds) isn’t the FDIC mandated to close them if they are insolvent?

    So if I have it right, there must be some kind of plan that lets them get around this.

  2. Ian Welsh

    No clause that I know of. But the FDIC has a ton of discretion, and there’s a reasonable amount of freedom not to mark to market anwyay, iirc, if you just declare that you’re going to hold to maturity.

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