Tuesday, March 24, 2009

The Morning After

Paul Krugman and James Galbraith are among the economists that have criticised the PPPIP. In addition, Moody's (yeah, I know, why pay attention to those guys) and CreditSights are of the opinion that the scale of the plan is too small to fix the problem.

I take issue with:

- The taxpayer is saddled with virtually all of the risk for a fraction of the reward

- The plan assumes that the assets will recover in price. This is a terrible assumption. The prices of the loans and securities are not depressed only because of liquidity issues. The loans and securities are suffering huge amounts of defaults. There is NO recovery from this. If a plain, vanilla bond drops in price to 80 cents on the dollar, the issuer is still contractually obligated to pay 100 cents on the dollar at maturity. If they don't, the bond holder gets to exercise their rights in the contract. This is not the case with securitized assets. Even without defaults, there is no guarantee that the holder will receive par value.

- As pointed out by a reader, a bank owning these junk assets could bid against a private market bidder. This would drive up the price of the asset and increase the burden on the taxpayer.

- I agree with the rating agency analysts, it is not enough money. Remember, the money is coming from the TARP, Congress has to get involved if they want to use more money since the TARP is nearing its limit.

- Eligible banks are at risk of insolvency if they participate. If the the difference between the actual bids and the current price on the books of the firm is sufficient, the bank could deplete all of its capital. This would motivate banks to put only the not so junky assets up for sale and leave the really bad stuff mis-marked on their books.

- There is still no guarantee that this plan will free up capital to lend. Banks won't lend if they believe that there is a lack of credible borrowers, regardless of there balance sheet position (at least in today's world).

- We are experiencing a debt deflation. The market is clearly telling us that the appetite for debt has diminished substantially, epic proportions in fact. A plan that increases the amount of debt via the FDIC leveraging will only delay the inevitable dismantling of the debt market. See Irving Fisher's piece.

If you agree with he points I have highlighted here, please, please, please contact your Congressional representatives. Tell them, in no uncertain terms, that they will no longer receive your electoral support if they allow this plan to proceed. I have not given up on this country, let's exercise our rights and usher in a new era of true patriotism.

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