The Plan for Dealing With Toxic Assets

James Kwak talks about the expected treasury plan to buy 'toxic assets', This Time I’m Not the One Calling It a Subsidy.

"In the best-case scenario: (a) the government’s willingness to bear most of the risk encourages private investors to bid enough to get the banks to sell; (b) the economy recovers and the assets increase in price from the prices paid; (c) the investment funds pay back the Fed (which makes a small spread between the interest rate and the Fed’s low cost of money); and (d) the government gets some of the upside through its capital investments. (I think the main purpose of that government capital is to deflect the criticism that all of the upside belongs to the private sector.) In the worst-case scenario, the market stays stuck because the banks have unrealistic reserve prices. Perhaps the idea is that, in that case, the TALF will allow the government to (over)pay whatever it takes to bail out the banks."

Krugman writes Despair over financial policy.

"The Geithner plan has now been leaked in detail. It’s exactly the plan that was widely analyzed — and found wanting — a couple of weeks ago. The zombie ideas have won. The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved."

Jeremy Bulow and Paul Klemperer say Reorganising the banks: Focus on the liabilities, not the assets and offer details on a plan that splits the bank into two, one solvent the other not. Their conclusion:

"A plan that isolates the bad liabilities rather than the bad assets of the banks, and pays the owners of those claims everything they legally deserve in liquidation but does not fully immunise them from losses, will achieve three major objectives.
* It will help unfreeze the credit markets by creating healthy banks able to lend.
* It will assure that depositors are paid in full, and all creditors are paid at least their entitlement.
* It will make the bailout cheaper for the government, increasing its flexibility.
Finally, as an additional benefit, paying creditors based on market values rather than government guarantees reduces moral hazard in bank finance, and increases the prospect of better monitoring by sophisticated private creditors in determining the future allocation of capital across financial institutions."