Legacy assets

To be honest, I’m still trying to understand the Treasury’s new “legacy assets” proposal: Krishna Guha’s account; Treasury fact sheet. Of course it might fail but my instant reaction was not to think that it is “almost certain to”, as Paul Krugman writes with characteristic clarity (and a corresponding refusal to see any merit whatever in the other side’s position).

There are (at least) two programs here, not one. Many critics are failing to distinguish between the loans program and the securities program, though these are intended to work in very different ways. And although the great complication of the overall plan seems to have satisfied most commentators’ appetite for details, at least for now, crucial aspects of how it will work are in fact still unknown. For instance, as Krisha notes:

Pricing will still be difficult. Many toxic securities are complex and backed by fraudulent mortgage loans. Some are highly idiosyncratic, so discovering a price for one may not convey much about others. Banks may not be willing to part with loans that have not been heavily written down at auction prices, though Ms Bair hinted that regulators may force them to do so.

That banks will simply refuse to play at the prices offered by the PPIFs is probably the main risk for the loans part of the plan–though one that goes away if they are forced to sell. Will they be? Krishna continues:

Moreover, unless credit conditions ease considerably, the price levels established under these schemes will be sustained only by continuing access to lower-cost government finance.

Again, details to follow. The full terms of the FDIC’s guarantees under the loans program, and how it proposes to recoup any losses incurred on these guarantees, are not spelt out. The much-expanded TALF will carry the burden of dealing with legacy securities (hitherto regarded by the Treasury as the larger part of the problem) as opposed to legacy loans, but exactly which assets it will cover and the interest rate to be charged by the Fed are also not stated. And so on.

Standing back from the trees, Steve Pearlstein has a good piece making the case for guarded optimism. It would be educational to see Paul respond to some of his points.

Paul is certainly right that this is really just a new improved TARP. But an improvement is an improvement, not to be dismissed out of hand. Especially if it moves the scheme in the direction of an RTC-type resolution, which is something many critics singing from Paul’s hymn-sheet have been calling for. Gillian Tett writes:

Mr Geithner’s plan essentially tries to fix this problem [the breakdown in the market for securities] by handing government money to private investors so they can purchase the toxic debt. The basic idea is a rehash of the formula successfully adopted 15 years ago by the Resolution Trust Corporation, the body that resolved the Savings and Loans crisis.

Back then, the RTC extended up to 85 per cent non-recourse loans to private investors to kickstart a market for trading S&L assets. This time, the Geithner plan will also offer large dollops of government debt to investors wanting to buy toxic assets (and kick in some equity capital too.)

Moreover, just as the RTC tried to depoliticise the pricing of these assets by conducting open firesales and competitive bids, Mr Geithner’s plan aims to use free competition to establish a price for these planned sales. That way nobody can claim that the price has been “fixed” to the benefit of either banks or investors, or so it is hoped.

“This is RTC II,” enthuses Tim Ryan, the former head of RTC. “I have been crying out for something like this for seven months – now we have it at last.”

Paul is also right that everything depends, as it has from the beginning,  on the degree to which this is a liquidity problem (implying that the toxic assets are fundamentally underpriced in the current market) and a solvency problem (implying that they are are worth no more than the existing market, such as it is, says). The plan is as awful as Paul says only if lack of liquidity has nothing to do with it. To defend Geithner’s plan, you don’t have to argue that the banks would be fine if only the market for these securities could be made to work–this is expressly not the government’s position–only that the market is impaired and that this is adding a lot to the problem. Paul’s view seems to be that the toxic assets are more or less worthless under any plausible scenario. That seems to be putting a lot of faith in the efficiency of the market for toxic assets.

Clive Crook’s blog

This blog is no longer updated but it remains open as an archive.

I have been the FT's Washington columnist since April 2007. I moved from Britain to the US in 2005 to write for the Atlantic Monthly and the National Journal after 20 years working at the Economist, most recently as deputy editor. I write mainly about the intersection of politics and economics.

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