Economist Paul Samuelson says that financial markets are “micro-efficient” but “macro-inefficient.” That is, the great mass of investors and speculators is very good at winnowing out differences in value between similar securities, but not so good at establishing rational values for the market as a whole.
This is, to a large extent, the logic behind the Public-Private Investment Program that Treasury Secretary Tim Geithner outlined this morning: Private credit markets are so consumed by fear and distrust that they’re underpricing real estate loans and securities—which explains the need for government backing to get the plan off the ground. But private investors are better than government bureaucrats at figuring out if one real estate security is worth more than another—which is why they’re being included in the plan.
So the fact that a government subsidy is being provided to private investors to buy up debt—and that this subsidy will cause those investors to pay more for this debt than they would otherwise—is not a design flaw, as it has been painted in some corners. It’s the entire point of the plan. And if you buy into Samuelson’s micro-efficient/macro-inefficient split, this approach makes a lot of sense. Of course, the government could be wrong in its assessment that these toxic real estate securities are now a pretty good deal, and lose money on its bet. But it’s not a crazy bet.
So why is there so much Sturm und Drang in the blogosphere about it? Well, partly just because these are Sturmy and Drangy days. That, and I can come up with three legitimate concerns:
1) It’s too complicated and might not work. Felix Salmon does a good job of stating this case (under the encouraging headline, “Geithner’s Doomed Bailout Plan“): In an effort to minimize the amount of taxpayer dollars invested up-front, the plan ends up massively complicating things with a bunch of loans to the private investors, raising the likely cost of the plan and reducing the potential return to taxpayers. I agree, but I don’t see what choice Geithner had. It wasn’t as if Congress was going to give him $1 trillion outright so he could go about his work less messily.
2) It’s insufficient to resolve the credit crisis, but it’s being sold as a solution to the credit crisis. And when it fails to perform miracles as advertised, the Obama Administration will be in big trouble. This is the core of the Krugman argument:
I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second.
I’ve always seen this asset-purchase plan as just part of a several-pronged process that includes a serious attempt to sort out the most troubled banks from the rest. And I figured Geithner wanted to wait and see what sort of prices mortgage securities fetched under his asset-buying program before he got truly tough with any of the big banks. Because then banks would have no excuse for keeping toxic mortgage junk on their books at prices higher than those prevailing on new, government-subsidized markets.
It appears that the media and Congress are an awful lot less patient than I am, so Krugman may be right on this count. But I still hope he won’t be.
3) It does amount to a subsidy to the handful of money management firms that get picked to participate in the plan, and a lot of people will understandably hate this idea. In the “Legacy Securities Program,” the subsidy works like this: A private investor puts up $100, and Treasury matches that with a $100 equity investment. So far, so unsubsidized. But then Treasury would lend up to $200 to this newly created investment fund. This means that if the $100 investment goes to zero, the private investor only loses $100 while the taxpayer loses $300. Meanwhile, if I’ve read the Treasury white paper (available along with other relevant documents here) correctly, any investment gains will be shared 50-50 (minus interest payments to the government) by the private investor and taxpayers. So it’s an asymmetric set-up, although not as asymmetric as some in the money-management business might like. Again, offering a government subsidy is the whole idea, but as this special deal is to be just for “approximately five” money-management firms, there’s going to a lot of legitimate griping about the gains going to those who get picked. Which is why I really like this idea.
Update: I’ve been wondering if I should mention that the stock market—in marked contrast to the econoblogosphere—seems thrilled with the plan. But you can’t really make the case for the market being both macro-inefficient and a legitimate measure of whether this plan is any good. At least not in the same blog post.