Steaming Joe

I've always admired Joe Stiglitz, and not just because we shared the same college campus for a couple of years. He's always been able to make clear and understandable a subject about which I don't know a hell of a lot, but wish I did; namely, economics. His Nobel Prize didn't hurt, either.

So this disturbs me:

"(The) Obama administration’s $500 billion or more proposal to deal with America’s ailing banks has been described by some in the financial markets as a win-win-win proposal. Actually, it is a win-win-lose proposal: the banks win, investors win — and taxpayers lose...

...Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year’s time. The average “value” of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is “worth.” Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!

Assume that one of the public-private partnerships the Treasury has promised to create is willing to pay $150 for the asset. That’s 50 percent more than its true value, and the bank is more than happy to sell. So the private partner puts up $12, and the government supplies the rest — $12 in “equity” plus $126 in the form of a guaranteed loan.

If, in a year’s time, it turns out that the true value of the asset is zero, the private partner loses the $12, and the government loses $138. If the true value is $200, the government and the private partner split the $74 that’s left over after paying back the $126 loan. In that rosy scenario, the private partner more than triples his $12 investment. But the taxpayer, having risked $138, gains a mere $37.

Even in an imperfect market, one shouldn’t confuse the value of an asset with the value of the upside option on that asset."

From what little I understand, it's been my impression that the Geithner plan is predicated on success; i.e., he must think it's so likely to work that the downside isn't something to worry about. If it does work, everyone comes out ahead, even us taxpayers. But, as ol' Joe points out in the full article, the plan is not unlike the excesses that got us here in the first place, in its reliance on over-leveraging; in this case, risking government money.

I'd sure like to hear a specific response to this from the administration.

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