THE STASH APRIL 6, 2009
In a piece today on The Huffington Post, Jeff Sachs conjures up another seemingly gruesome gaming scenario:
Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.
Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.
But is this really such a bad thing? It sounds a lot like a good bank/bad bank model, in which we recapitalize Citibank to the tune of $925,000 and take the toxic asset off its books and stick it in another entity--a "bad bank"--created for that purpose. As I've said before, there may be moral objections to such an arrangement. (It is offensive that taxpayers have to bail Citibank out.) And the Geithner plan may not have enough money to recapitalize all the banks this way. But that's different from arguing that it can't work.
In fact, later in Sachs's piece he argues for a pretty similar-sounding bad bank approach:
The best ideas are forms of corporate reorganization, in which a bank weighed down with toxic assets is divided into two banks -- a "good bank" and a "bad bank" -- with the bad bank left holding the toxic assets and the long-term debts, while owning the equity of the good bank. If the bad assets pay off better than is now feared, the bondholders get repaid and the current bank shares keep their value. If the bad assets in fact default heavily as is now expected, the bondholders and shareholders lose their investments.
The only real difference, so far as I can tell, is who pays. Under Sachs's preferred approach, the bondholders and stockholders take most of the hit, while under his hypothetical gaming approach, the taxpayers do. Again, that's not fair. But being unfair doesn't doom something to fail. And I'd take an unfair success over a fair failure. (Though successful and fair would be ideal, and Sachs's proposal may get us close.)
Having said that, I could see this kind of gaming being both unfair and a failure--for example, if relatively healthy banks are able to sell assets to themselves with government financing the way Sachs describes, which would entail a transfer from taxpayers to healthy banks without removing the bad assets from marginally solvent or insolvent banks. I really hope we avoid that, but that's more a question of policing who participates in the Geithner plan than outlawing gaming.
Also, I prefer this type of gaming to the type I discussed yesterday--in which Bank A agrees to buy Bank B's bad assets at inflated prices with government financing, and Bank B agrees to do the same for Bank A--because it seems more transparent. Under the Sachs gaming scenario, we're basically taking the toxic assets off the banks' balance sheets. Under the other scenario, the banks are trading toxic assets with one another, except we end up with an even worse idea of what they're worth because they're now propped up by generous government loans. (On the other hand, even this switcheroo would be a step toward recapitalization: It would give the banks more capital while limiting their losses to the equity they put up to buy the assets under the Geithner plan.)