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Gaming the system? That's the point.

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. 

Passport

The pirates' latest provocation

By now, I'm sure you've heard: Somali pirates captured their first U.S.-flagged ship in memory this morning, somewhere between 240 and 400 nautical miles off the coast of that country's Puntland region. Reports about the nature of the ship are clearly unclear -- with some putting the number of crew members-turned-hostages at 20, and others at 21. The cargo is either food aid, commerical goods, or something else. And the vessel was probably going to Kenya. No word on the condition of the crew, or on the ransom that will likely be demanded. The United States is urgently seeking answers about all this.

First things first: it's unlikely that there is an anti-American message here -- just profit seeking. While this hijacking, like the capture of a Saudi tanker late last year, seems more audacious than usual, it's unclear if the attackers even knew the ship carried a U.S. crew.

But yes, things are still really bad, and not just for the United States. The U.S. Fifth Fleet, which patrols the region, issued a foreboding statement last night that pretty much makes that clear: 

The notice also reiterates the fact that despite increased naval presence in the region, ships and aircraft are unlikely to be close enough to provide support to vessels under attack. The scope and magnitude of problem can not be understated."

It might be getting worse, as I noted yesterday. The first few months of this year saw rough seas, a deterrent to would-be hijackers. No longer. As these recent satellites from Ocean Weather show, the seas are now calm -- and primed for easy pirate maneuvering. 

The situation on land looks equally perilous. With a new Somali government at last in place, the governing has actually had to begin. It's been a rough ride so far. Debates over the implimentation of Sharia law and the presence of an African Union peacekeeping force have paralyzed the political system. Many in parliament see foreign troop withdrawal as a precondition for Sharia -- though President Sheikh Sharif Sheik Mohammed says the peacekeepers must stay. It's a harder call than you might think: keeping the peacekeepers alienates Sharif's main Islamist constituency, which he desperately needs to convince to lay down arms.

All this makes for a mess that no one is sure how to clean up. The Navies are trying to patrol the seas, but admit that the piracy problem beings and ends ashore. Good luck finding safe ground there.

Update: Looks like the American crew fought back. Reports are emerging that the hostages aboard the captured U.S. vessel were able to overtake at least one pirate -- maybe more. Military officials have started confirming off the record. Stay tuned for more updates.