Wednesday
Mar252009
CrowdSourcing the Bank Recovery
Wednesday, March 25, 2009 at 8:11PM
I don't believe Tim Geitner's toxic asset auction plan will work to change the basic problem of bank insolvency, but that doesn't stop me from appreciating the sheer brilliance and post-partisan nature of the approach.
Most commentators and economists are focusing on the way the plan distributes risk, perhaps unfairly - with the government guaranteeing most losses while giving hedge funds and investors half of the gains. But that misses the point of the whole thing.
The underlying problem with the toxic assets currently on the books of most banks is that no one knows quite how to value them. (Their market value is very low right now - lower than most believe it should be. This is what is meant by "mark to market." In time, when things are better and the world is generally less risk-averse, they should be worth more. Most banks need their balance sheets to look better now, and they can't while they have these - perhaps artificially - deflated securities on their books).
Were the government to simply go in and buy them all, the Treasury Department would have to hire a huge staff of accountants to look at each and every toxic asset - every single loan package and bond and bond fund, and come up with what it is worth. If that were even possible.
While this would give government all the winnings if and when the securities become worth what they are really worth, they would be saddled with a huge actuarial task, and would surely arrive at numbers that banks feel are unfairly underestimating the securities' true worth.
Geitner's plan is less about spreading risk than it is about finding a more efficient way to evaluate all those issues. So why not crowd source?
The government assumes a hunk of the risk - the hunk that no one else wants to assume - while letting a huge army of investors bid and fight over the profit potential. His hope is that those people will do the necessary homework on all this stuff, since it is some real money they are staking.
Thus, Obama's team comes up with entrepreneurial socialism, or market-based welfare. The scores of investors bidding on all these securities become a giant unpaid (but insured) bunch of bidders.
That's the brilliant part.
The stupid part is that it's not a real marketplace, so the invisible hand of collective market genius just won't take effect. While the market may, in the best of circumstances, have some of the self-regulatory features of nature, we can't expect it to act like nature when so many of the underlying rules have been rigged. Auction-determined prices will not reflect underlying value when some large percent of risk has been removed. And the percentage of risk assumed by government remains the same, regardless of the riskiness of the toxic asset. So, playing the game properly, investors should go for the highest odds instead of the lowest. Unless they don't.
In the end, if these folks really and truly believed in the wisdom of the crowd, they would accept the fact that the market no longer values this stuff in the present.
Banks made a bad bet. Over time, it seems, banks came to believe that the terrible assets they were pawning on the rest of us actually had some value. They broke the cardinal rule of pyramid scheming and decided to maintain an account in the pyramid. They believed their own hype, or the guys who made up the hype died, leaving a generation of bankers who forgot how the scam of hand-me-down interest was supposed to work. It was actually a game hot potato: you're supposed to get rid of it as fast as possible, and make your money on the commissions.
The fact that they were left holding stuff as crappy as the rest of us is the price of doing business.
The real market has crowd-sourced this fact already.
Most commentators and economists are focusing on the way the plan distributes risk, perhaps unfairly - with the government guaranteeing most losses while giving hedge funds and investors half of the gains. But that misses the point of the whole thing.
The underlying problem with the toxic assets currently on the books of most banks is that no one knows quite how to value them. (Their market value is very low right now - lower than most believe it should be. This is what is meant by "mark to market." In time, when things are better and the world is generally less risk-averse, they should be worth more. Most banks need their balance sheets to look better now, and they can't while they have these - perhaps artificially - deflated securities on their books).
Were the government to simply go in and buy them all, the Treasury Department would have to hire a huge staff of accountants to look at each and every toxic asset - every single loan package and bond and bond fund, and come up with what it is worth. If that were even possible.
While this would give government all the winnings if and when the securities become worth what they are really worth, they would be saddled with a huge actuarial task, and would surely arrive at numbers that banks feel are unfairly underestimating the securities' true worth.
Geitner's plan is less about spreading risk than it is about finding a more efficient way to evaluate all those issues. So why not crowd source?
The government assumes a hunk of the risk - the hunk that no one else wants to assume - while letting a huge army of investors bid and fight over the profit potential. His hope is that those people will do the necessary homework on all this stuff, since it is some real money they are staking.
Thus, Obama's team comes up with entrepreneurial socialism, or market-based welfare. The scores of investors bidding on all these securities become a giant unpaid (but insured) bunch of bidders.
That's the brilliant part.
The stupid part is that it's not a real marketplace, so the invisible hand of collective market genius just won't take effect. While the market may, in the best of circumstances, have some of the self-regulatory features of nature, we can't expect it to act like nature when so many of the underlying rules have been rigged. Auction-determined prices will not reflect underlying value when some large percent of risk has been removed. And the percentage of risk assumed by government remains the same, regardless of the riskiness of the toxic asset. So, playing the game properly, investors should go for the highest odds instead of the lowest. Unless they don't.
In the end, if these folks really and truly believed in the wisdom of the crowd, they would accept the fact that the market no longer values this stuff in the present.
Banks made a bad bet. Over time, it seems, banks came to believe that the terrible assets they were pawning on the rest of us actually had some value. They broke the cardinal rule of pyramid scheming and decided to maintain an account in the pyramid. They believed their own hype, or the guys who made up the hype died, leaving a generation of bankers who forgot how the scam of hand-me-down interest was supposed to work. It was actually a game hot potato: you're supposed to get rid of it as fast as possible, and make your money on the commissions.
The fact that they were left holding stuff as crappy as the rest of us is the price of doing business.
The real market has crowd-sourced this fact already.
Reader Comments (9)
I've been seeing the situation as expressed in the first half of your analysis. I bought back in exactly a month ago because i knew the coming struggle was (in one administration option or another) going to ID the various assets.
Now, that said, we can't have our market and eat it too. The fact that our money and retirement money is the debt we've been saddled with *after* the potato burst into flames (if you will), has nothing to do with changing the market for the future.
I missed your last show and don't know what you really think about regulation and European social-program-ism coexisting with the market, a market that for the same regulatory problems suffered as much as ours.
With Geithner's plan, and i think we can assume, given the vector of his plan, we can expect the market as it is to be instrumental in it's success. I would assume, that despite investor reaction, that the public money that is used to buy various *identified* assets will (like the private investor's money) see profit or loss.
The turmoil of the past two months is not a reflection of Obama policy as it is imagined or developed and put forth. The turmoil has been the completely natural human response to combined fear and desire.
I believe plenty of folks knew what kind of a precipice we were upon and that plenty others know precisely what you believe is a forgotten game. Now they and we all will know just what these assets are and who's holding them.
If i understand this process, it is not a blanket that will address and auction all troubled assets. Moreover, the administration has made it clear that the whole process, like all of it's economic policy is built for constant tuning and retuning.
So as things are now. I am confident on all counts, save future regulation. This will have to wait until who knows how much longer.
You are correct that the potato *value* (in debt) is greater than the original potato. This is the real problem we have to address. I would like to observe a bit longer and see if (contrary to your beliefs) anything of real value remains in these so-called assets.
To my mind, letting it all collapse is not an option being entertained by governments or markets. To them it is inconceivable! I have not heard one conceivable transitional mode to any other structure. Yes, there are plenty of better future structures and foundations, but for now all we have is this interesting hybrid relationship.
Please explain the difference between these two postures: "Their market value is very low right now - lower than most believe it should be. This is what is meant by “mark to market.” In time, when things are better and the world is generally less risk-averse, they should be worth more."
and
"In the end, if these folks really and truly believed in the wisdom of the crowd, they would accept the fact that the market no longer values this stuff in the present."
My analysis is simply that "the crowd" has not yet valued some things going forward.
I suggest "the crowd" continue paying attention to the news. It is one of the things Obama has asked of them. Sure, i would like to hear and see some news about engineering a better future, but from the standpoint of all that i do have and don't have in my retirement account and chicken coop, i don't mind a little boost in the spirits of those hopeful and fearful denizens of the market.
-mason
Very astute analysis.
As for your main question, I dont think European style regulation really has a chance against monopoly currency, either.
And just for clarity, I dont think we let the whole thing fail. Just the giant former banks that made the bad bets. I dont even think they would fail or fall if we left them alone. I think they would find solvency. But even if they did go under, I think there are plenty of great banks who did not get into this betting that would remain and rise.
The whole bargain we have begun is interesting. In Europe the purely regulatory bargain is hobbled, like ours, for the reason you suggest. However, Europe has struck different bargains and contracts for healthcare, with obvious success.
I too believe stronger and wiser banks would rise ..... eventually, after much more pain and trouble. My greatest hope in *this* situation is that some of the small banks and investors profit in this venture with the government and taxpayer's money. If it can work ..... i'd like to see it work for the people it should.
-chairman ma[]o[]
Doug, Mason,
It's just a far bigger bubble than anyone cares to admit. Economics 101 is supply and demand. With capital the supply is the lender and demand is the borrower. After thirty years of supply side economics giving every break to the lenders, the borrowers are long maxed out. Their theory to get the cycle moving again is to further squeeze wealth out of the larger economy to give to the lenders to encourage more lending.
The problem is that people want money, but to invest beyond your own inventiveness, it must be loaned to someone else. When there weren't enough shaky loans to support all this wealth everyone thought they had, huge bubbles of extraneous circulation were developed to store it. Now everyone is scrambling to hold on to their particular stash, but even the real economy is shrinking. The monetary system, as we know it, is well and completely broken, but it is the house in which we live and it's easier to go into a state of denial than really accept the enormity of the situation. So we are going to go through this water torture for a few years, as each level pancakes onto the next, while those on top do their best to hold on to what they have, as those on the lower levels do their best to survive.
Money is a public utility which lubricates the economy. When we live by a philosophy of greed, where everyone is determined to siphon off as much as they can, large pools of wealth develop, but the larger economy seizes up. The reason capitalism works so well with seriously progressive taxation is because this serves as an oil pump to drain off those reserves and put them back into the larger economy. When we started with Reagan to borrow, rather than tax this wealth, it started the process toward the current economic implosion. So now we have an entire generation raised on a philosophy of speculative acquisition, rather than industriousness. Time to push the reset button.
Hi John!
Good to see you here and in Douglas' new book!
"When there weren’t enough shaky loans to support all this wealth everyone thought they had, huge bubbles of extraneous circulation were developed to store it." This is what you were saying almost from day one which was more than a year ago. And i believe you knew it was the derivatives. We just didn't know it would be the mortgage-backed ones. Well done!
What i really like now is your second thesis: "The reason capitalism works so well with seriously progressive taxation is because this serves as an oil pump to drain off those reserves and put them back into the larger economy." Despite the situation, i think we need to see a more progressive tax developed sooner and especially later when things improve.
OTOH i have been interested to read of a "Payroll-tax Holiday." Article is (first article) Talk of the town, in New Yorker March 23, 2009, by Hendrik Hertzberg. Idea was triggered (of all things) by a David Frum appearance on Chris Matthews' "Hardball."
http://www.newyorker.com/talk/comment/2009/03/23/090323taco_talk_hertzberg
Looks like he has a blog too....
The articles on this page look promising as well!
http://www.newyorker.com/talk/comment/2009/03/23/090323taco_talk_hertzberg
What do you think of the Payroll-tax Holiday or other fixes/solutions? Also what do you think about timing in implementing? Finally, transparency: It seems to be a multi-edged sword?
Regards,
mason
What the government needs to do is honor their "obligations" to depositors under FDIC, let those whose employment is displaced collect unemployment and let them and those who lose their investments apply for food stamps and SSI.
Let them mingle, and if they have talents that can be employed, I for one, would try to find them a place in the transition to a socialist economy, given the fact that they are or come clean relative to traits like greed, priggishness, carelessness, and ignorance and/or apathy with regards to exploitation of others and the planet.
Otherwise, we'll call the world Memphis, and a new one will rise from the ashes of the old.
Peace.
Mike Morin
I do not understand how you can say you don't blieve the plan will work but it is sheer brilliance.
How can the government control the value of assets?
If you can't lose when you gamble what is the fun. I believe you are advocating the end of capitalism and further government intervention.
Furthermore, my belief a that the government has no business in private business.
There is norhing free about this government oversight.
Argue all you want but the people determine market value, not uncle Sam. You are destroying our monopoly money against our will.
Douglas, please stick to marketing and stay out of government.
Surely you must be able to understand this!
One can brilliantly apply a methodology (crowdsourcing) to a task that won't work. A painter can paint a brilliant rendering of a terrible piece of architecture. A brilliant cinematography method can be employed on a film that is, nonetheless, terrible.
Geitner's impulse to crowd source a solution is clever and admirable. He is applying the crowd to the wrong task.
So I think you are having a bizarre kneejerk reaction to what you think is a call for government intervention in business. Nowhere do I even imply such a thing.
And my role in government is limited to voting, just like most citizens. I don't work in marketing, or in government.
I will go back and read the essay, and look for where my communication may have led you to believe I'm arguing for that. I fully agree, and state directly here and in other posts, that the market value of these assets is the value of these assets, and that any effort to change that is futile.
Here is my way of saying what you just said. It's in the post to which you responded:
"While the market may, in the best of circumstances, have some of the self-regulatory features of nature, we can’t expect it to act like nature when so many of the underlying rules have been rigged. Auction-determined prices will not reflect underlying value when some large percent of risk has been removed."
"We" don't call for the total abolition of the government(s). We do see very much in the way of parasitic bureaucratic redundancy, Institutionalized Capitalist Oppression, Institutionalized Capitalist Corruption which is only reaching its zenith (our nadir) with the so-called TARP program.
We need to keep the safety-net programs like un-employment insurance, FDIC, FSLIC, NCUA, SSI, SSDI, AFDC?, food stamps. We may also want to institute a small guaranteed income based on age (in some ways that is what SSI is heading towards, although the payments are paltry for middle-aged adults).
We also want to keep the Treasury to provide the currency for financing a peoples' equity union financial restructuring plan. We would want to keep the capability of printing cash, even though it would be more judicious (no speculation and trading in currencies) and more fair (as to be determined by a world committee (don't hassle me about administration and assurance of fair play, but so what, we have those issues with varying currencies anyway)) to evolve to a world currency.
O'bomber's rejection of such an idea ( a world currency) trumpeted by me and crescendo'ed by China and Russia shows the USA's determination for holding on to an economic hegemony and the continuing unjust gains of the privileged parasites of the equity trading class.