“[T]he US government will serve as buyer of last resort for the junk debt that the private sector has not been able to price. Who, exactly, does the Treasury plan to employ to figure all this out? Why, unemployed investment bankers, of course!
Let's ponder this. Investment bankers have been losing their cushy jobs because they could not figure out any convincing way to price distressed mortgage debt. Otherwise, their firms would have been able to tap the trillions of dollars now sitting on the sidelines, held by sovereign wealth funds, private equity groups, hedge funds, and others. Now, working for the taxpayer, these same investment bankers will suddenly come up with the magic pricing formula that has eluded them until now. ....
[This policy], however grand, might end up doing more for profits and bonuses in the financial sector than for the rest of the economy.”
Kenneth Rogoff, "Spend in haste, repent at leisure: America's latest bailout plan", Project Syndicate (September 2008).
http://www.project-syndicate.org/commentary/rogoff47/English
Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.
The Treasury Department has already told us of some of the ideas it hopes to put into place to stem the decent into full financial chaos: It first announced insurance of all money-market funds, and the full insurance of bank deposits. The new law passed by Congress allows the Treasury Secretary to increase the liquidity of the banking system by purchasing as much as $700 billion in toxic bank assets.
To implement these programs Treasury Secretary Henry Paulson named Neel Kashkari, formerly a colleague of Mr. Paulson at Goldman Sachs and now assistant Treasury secretary for international affairs, as interim assistant secretary for financial stability. Sour assets now held by the banks are of uncertain worth so there is no market for them and hence no price for them. It is reported that Mr. Kashkari intends to use a reverse auction to rebuild bank assets, where banks would offer securities at particular prices and the Treasury would decide whether to buy them or not. Other provisions in the legislation allow for the government to take an equity position in the banks.
Needless to say, it will take time to put these programs into full effect, even with experienced, if unemployed, investment bankers. These assets to be brought forward for sale by the banks are complex because they include derivatives and securitization. Moreover, it is by no means what it inside some of these packages in terms of the quality of the underlying assets, and therefore it is by no means clear what their price should be. It will take time to set up the institutional mechanisms to carry out the asset purchases and even longer to figure out how they should be priced.
There is also the problem that we are in the midst of a political campaign and it will be months before whoever is elected assumes office and can set policy with regard to the bailout of the financial sector and the longer-term rebuilding of the real economy. Until the policy approach of the new President is known, actions taken by the Treasury will be limited.
Were he to be elected, John McCain would no doubt follow a policy approach that emphasizes reliance on the market mechanism to restore stability and growth. It would in the first instance deal with restoring financial stability but it is increasingly recognized that the country must also eliminate the outsized structural imbalances that now describe the budget and trade deficits. In the long-run a market-oriented approach would lead to a more efficient outcome and a more vibrant economy than alternative ways of dealing with these problems. But market-oriented approaches come with high short-term costs in terms of unemployment and loss of incomes in those areas that suffer from downsizing. Because of its costs, market-oriented adjustment is not popular, and even if elected McCain would find considerable opposition to implementing his program.
Were he to be elected, Barack Obama would likely follow a more government-oriented approach, in the hope that it can be more rapidly implemented and, with the exception of the financial services sectors, would not entail far-reaching and painful adjustments likely to increase unemployment. He would regulate financial service firms more closely than McCain but would also be more protective of those affected by change in the economy and attempt to slow down the process of structural adjustment. Obama would also be more protective of the environment and a more incline to allow government policy to intrude into the decisions of firms. In the long-run, government-oriented approaches tend to lead to a more inefficient economy and a slower pace of change but one with a lower degree of inequality and a higher degree of moral hazard. In the short-term, government-oriented approaches are more popular but the longer pursued they tend to generate resentments rooted in the inequities of unshared burdens and unfair subsidies to those who have made poor economic decisions and those that refuse to work.
At this time, it is by no means clear who will win the election and the policies they will actually put in place. Until this question is settled, the Treasury and the rest of the country cannot really a program for a recovery and restoration of its economy.
Thanks Larry for another great Tdj.
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