(P) Exciting news on the bailout front, we have some more details to chew on regarding the Public-Private Investment Program (ie, the Geithner plan). Essentially, the plan is for government to subsidize the purchase of assets owned by banks.
The plan is neither new nor much of a program. In fact, what was revealed is more like a slow leak of what's been leaking for weeks now about what exactly Geithner, Summers, and other economic voices in the Obama Administration have in mind. What's notable, to be blunt, is the continued lack of transparency about what exactly the ultimate goal is and how exactly the program will get there. It is also hard not to look at the evolution of this idea as being to become purposefully more convoluted and opaque as to make it increasingly difficult for citizens to understand what's going on; the program seems unnecessarily complex precisely for the purpose of masking what it does, and masking what could be done instead.
Before going on, let me add one caveat, and that is that this is easily remedied. Lack of transparency can be very easily addressed by being transparent. This has the additional benefit of being politically sensible as well as letting us analyze the policy outcomes.
But to understand the concept, we don't need to know exactly who will be allowed to buy assets or exactly how the subsidy will work or exactly what the strategic plan is two or three or five steps down the road. And to be honest, that's not where my interest or expertise lies. There are detailed explorations of this that are floating around places like naked capitalism and calculated risk from people who actually are experts about various economic topics.
What I think is helpful is a comparison to an activity that most people can understand. Essentially, the Geithner plan works like a roulette table. There are an equal number of red and black numbers, plus two green ones. [Interesting side note, the American table has two green numbers. The European roulette tables only have one, so the house odds in American casinos are basically twice those of similar European operations. That's a pretty good indicator of how Americans and Europeans differ on a whole range of issues related to risk and corporate control.]
One way to bet is to bet on a color. So say you put $1 down on black. If it comes up black, the house pays you a dollar. If it comes up red, you pay the house a dollar. This is roughly a coin toss, but the 'roughly' is how the casino makes money. Every once in a while, a little over 5% of the time, neither red nor black come up, because two of the numbers are green.
So if you think of this simple bet in expected-value terms, you would expect to earn a dollar about half the time on black, lose a dollar about half the time on red, and lose a dollar every once in awhile on green. In other words, your roulette bet is worth less than a dollar because you expect to lose a dollar more frequently than you expect to gain a dollar. The way that casinos get you to pay a price of one dollar for something that is worth less than one dollar is simple: they appeal to something other than rational, expected-value calculations. They make it fun to gamble. They promise the potential of a big gain. They convince your friends to bring you along on their excursions. Etc.
How does this relate? The core element of plan Geithner is the pricing mechanism. Geithner and Summers are making a very important bet, and like any bet, it's risky. The risk itself is what is costly. The bet is that the various asset-backed securities are priced incorrectly. PPIP is founded on the belief that these assets are priced artificially low; that their 'real' value is higher than current markets are pricing them. The plan is to have government pay private actors to bid on these assets. When the government subsidy is added to the market price, the purchase price will increase.
Here's the problem. On the roulette table, everybody agrees how many black, red, and green numbers exist. Markets, however, do not agree with Treasury and Fed officials about the ratio of black to red to green. Markets are currently pricing assets much lower than banks hold them on their balance sheets. Market prices suggest there are a lot of red numbers and not very many black ones; in other words, the odds of losing money on your black bet aren't close to a coin toss any more. Instead of an expected value of close to one dollar, your expected value has now dropped substantially, perhaps to 40 or even 30 cents on the dollar.
The logical question of a plan designed to leverage private investment is what the Treasury and Fed officials think they know that the very private actors they are relying upon don't know. Hence the need for transparency, for without it, this plan looks like a pretty straightforward transfer of taxpayer money to the banks, just as if the casino decided to remove half the black numbers from the wheel after you had already placed your bet.
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