Friday, March 27, 2009

No no a thousand times no

Here's another meme that must die, this one propagated by a full-fledged academic economist:

Since most of these troubled assets are held by banks, the FDIC has already effectively given them non-recourse loans–if the value of the troubled assets in the end doesn't cover the value of bank deposits, the bank shareholders walk away and the FDIC ponies up. I don't understand how moving these FDIC commitments out of the banks and into these Treasury-sponsored funds changes anything.

Yes, the banks deposits are already non-recourse FDIC insured. But it's common equity, preferred equity, and unsecured debt are not. So whether you let the banks first go bankrupt and then bail out (some) of the creditors or bailout the banks from the beginning makes all the difference in the world in terms of who bears the loss on these assets. This has been floating around a lot, and it is a perfectly fallacious in-the-long-run-we-are-all-dead professional economist type argument.

You can argue -- in decreasing order of probability now -- that this is really just a liquidity crisis and we should all calm down and let the bank go back to making the big bucks that their marks indicate they anticipate if they hold these assets to maturity (ie. that there is really no need for a bailout). Or, as many have, you can argue that the US banking system is too big and complex to nationalize all at once, a la Sweden. Or you can argue that there's some other good reason that the greater health of the economy requires that equity and non-deposit creditors be guaranteed up front. After all, if you were clever and sold some stocks, and put the proceeds in a money market fund, you are likely one of these unsecured non-FDIC-insured claim holders yourself, however indirectly.

But you cannot argue that that the Geithner plan and nationalization are effectively the same. That's shamefully misleading, which is actually something I believe Brad DeLong can often be accused of in pursuit of his ideological agenda.

(A more generous interpretation would not have DeLong shilling for Tommy-gun Tim, but simply suffering from an advanced case of economistitis, a near terminal condition characterized by the inability to see that an economy is not always at equilibrium and hence that there are problems that cannot be solved simply by restoring liquidity, because this would entail returning the whole system to what was already an unstable state. Side effects include not understanding that debt is a contract that perhaps should be violated on occasion for the greater good.)

3 comments:

adam said...

Its become an article of faith that the unsecured debt must be honored or the sky will fall (or something). The Johnson piece is the clearest description of the disease so far and this Buiter piece is the clearest explanation of the cure, at least for this layperson.

http://blogs.ft.com/maverecon/2009/03/dont-touch-the-unsecured-creditors-clobber-the-tax-payer-instead/#more-804

Clark said...

Yeah, Buiter has been all over this stuff like a dog on turkey. I agree that some version of his good bank proposal is obviously the best solution. Be careful what you wish for though, as I was saying, a lot of people's money market funds are unsecured creditors. Somebody has to pay for that jingle mail on your mortgage, and it might come out of your 401k.

adam said...

With haircuts and debt-to-equity ots gotta be cheaper than BARF etc. Better the creditors (whoever they are) become the proud new owners of a healthy bank and a ghoulish asset fund than this bailout crap. Not to mention the soil-turning it would do for reform.