At the Boston Globe, economist Laurence Kotlikoff joins Jeffrey Sachs in indicting the Geithner bank bail-out plan on the grounds that investment banks and the like will simply game the system -- allowing a government-sanctioned and epically unfair socialization of losses and privatization of gains. Kotlikoff writes:
It's one thing for the U.S. Treasury Department to overpay banks for their toxic assets on the prayer that bank shareholders will do something besides pocket it -- something that will help the economy. It's another thing to set up a complex leveraged auction scheme to surreptitiously make the transfer. And it's yet a third thing to set up a scheme that will lead the banks to overbid for their own toxics to garner even larger windfalls and end up with the toxics still in their hands.
He outlines one way for banks to game the Geithner plan, which lets banks auction off their bad (but not totally toxic) assets to investors who earn most of the possible upside if the asset makes money, while the Treasury accepts the loss if it doesn't.
Kotlikoff notes that it's a pretty easy move for banks: they set up and fund subsidiaries to buy the mortgage-backed securities -- effectively insuring against any losses that asset might accrue. The Treasury has promised that investors won't be able to buy their own assets in this way -- officials won't let them. But there still plenty of ways to get around it.
But there's a big problem -- not with the details of Sachs' and Kotlikoff's arguments, but with their very premise.
First, there's no incentive for a bank to buy its own bad debts as opposed swapping with someone else's. Say Goldman Sachs' hedge fund, GSAM, buys J.P. Morgan's assets, and a J.P. Morgan subsidiary buys Goldman's. There's nothing wrong with that, and it's effectively the same as the banks buying their own. A recent report shows that i-banks are still major global hedge fund players -- the government needs those funds to play.
Second, the gaming proposal presumes that the banks have cash to buy up the assets at auction at all. But most of the banks who will sell bad assets really don't have a lot of cash floating around -- anywhere. Many are in debt, and nobody will lend to them, so theorizing that they'll fund a bunch of subsidiaries to nick taxpayer money seems far-fetched. Even if they do it, the scale would be limited by their available capital.
Finally, in a macro sense, the Geithner plan is set up precisely to recapitalize the banks, create a market for the bad assets, and to get the assets off the banks' books. Gaming the system does recapitalize the banks. It does bolster the market for the bad assets. And it does sequester the assets in spin-off companies -- a kind of good-bank/bad-bank scenario.
In short: the Geithner plan might not be fair. It, in some sense, props up and rewards companies that took massive risks and now need taxpayers and the government to bail them out. But, taking the Geithner plan as it is, gaming doesn't seem so bad.