Tuesday, January 27, 2009

 

The Difficulties of Price Fixing

I am getting really sick of hearing all these bank experts explain the difficulties in government "bad bank" programs to buy "toxic" assets from the frozen lending institutions. They sound so serious and aware of the problems when they explain, "If the government pays too little for these troubled assets, then the banks will still be insolvent. But if the government pays too much, then the taxpayers lose."

And then they move on to the next question, instead of saying, "...so that's why this scheme is ridiculous. It was a bad idea when Paulson first lied and said he would implement it, and it's a bad idea now."

The idea seems to be that there's a sweet spot, a zone of prices in which the banks would win and the government would make money. But if that's true, why aren't private financiers swooping in and reaping the gains from trade? You could make some convoluted argument that "partial equilibrium" analysis doesn't work here, and that the massive government buying would change the landscape and hence the marginal value of any given mortgage-backed security.

Yes, you could make such an argument, but you would be wrong, methinks. It wasn't a sudden crisis of confidence that made these MBS assets tank in value, it was the fact that people started defaulting like crazy on their mortgages. And that wasn't because a bunch of racist Americans were spooked by the prospect of a president who didn't look like them, it was because house prices crashed and they were getting laid off.

Also, it is wrong to think that the federal government is qualitatively a bigger buyer than the entire private world market. It's true, Uncle Sam is bigger than any particular hedge fund or speculator, but if these toxic assets were such a steal, a bunch of oil sheiks and software moguls could come up with hundreds of billions to invest in them.

Part of the reason that isn't happening, is that the insolvent banks are sitting on underwater balance sheets, hoping for a federal bailout. I think that is one of the main reasons for the lingering "credit crunch" and "frozen" credit markets.



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