The right eloquence needs no bell to call the people together and no constable to keep them. ~ Emerson

Wednesday, March 25, 2009

Fear of Commitment

Late night talk show host David Letterman married his girlfriend Regina Lasko last weekend and was back to work Monday night to announce it on the air. Nothing unusual there – people get married impromptu all the time. The two have a five-year-old son together. Nothing unusual there either – many couples establish a stable home life before making their togetherness official these days.

On his program, Letterman mentioned that Lasko and he began dating in February of 1986. Twenty-three years and one month of dating before deciding to tie the knot? Now that is a bit unusual. Letterman is surely the epitome of an old stereotype – a male with a fear of commitment.

Letterman showed plenty of staunchness after finally making up his mind. When the couple’s truck got stuck in the mud on the way to a Montana courthouse – a scenario providing an easy out for a queasy groom – Letterman walked two miles into a headwind to find a phone and call roadside assistance. If you know his bio, Letterman’s feelings for Lasko were not the source of his hesitation but rather lingering trepidation over his first go at wedlock.

In 1969, Letterman married his college sweetheart. The marriage was reportedly very unhappy and ended with a bitter divorce in 1977. An intelligent and naturally gloomy man, the episode poisoned Letterman on the idea of marriage. It took many decades for the toxic assets accumulated on his ledger to finally clear out and allow optimistic commitment to flow freely again.

U.S. Treasury Secretary Tim Geithner revealed himself as a man of economic romance this week, pitching woo to private investors to get banks and other financial institutions lending again – a key development necessary to jump-start our ailing economy. He is likely to find a fear of commitment in investors that David Letterman could readily appreciate.

After the housing bubble burst, U.S. banks found their ledgers filled with bad mortgages and other toxic assets – dubbed “legacy assets” by the Obama Administration – that dampened their willingness to write new loans. This disrupted the flow of capital necessary to finance the entire economy.

Geithner’s plan is to form a partnership between the Treasury Department, the Federal Reserve, and the Federal Deposit Insurance Corporation that will buy up $1 trillion of the estimated $2 trillion toxic assets currently held by banks. However, the plan also relies on private money from institutional investors, such as hedge funds. For every dollar of toxic assets purchased, the private sector would put up seven percent, the government would match another seven percent, and a government loan would cover the bulk.

By collaborating with private investors and loaning the money rather than just purchasing the assets outright, the government attempts to minimize risk to taxpayer money. What is more, if the value of the toxic assets increases over time, government would split the profits with investors, providing an incentive for them to participate.

Even so, the plan is expensive. Geithner will use $75 billion to $100 billion of the remaining $700 billion TARP money to pay for it. And it might not work. If the value of toxic assets fails to rise or even declines, both taxpayers and private investors would eat the losses. After getting burned by bad mortgages in recent years, investors may be too uneasy to cuddle up in a long-term relationship with them now.

Two factors complicate matters further. First, it is extremely difficult to price these toxic assets. Writer Hernando de Soto explains why in an op/ed piece for today’s Wall Street Journal. In 2000, there was about $100 trillion worth of commercial paper floating around the economy, mostly representing tangible goods. Since then, financiers have issued nearly $1 quadrillion worth of new paper, mostly in the form of derivatives, such as mortgage-backed securities and credit default swaps. Unlike other commercial paper, derivatives are unregulated and untraceable back to the assets they represent.

Second, whatever these toxic assets are really worth, we can depend upon banks and the other financial institutions holding them to insist they are worth far more than speculative investors are likely willing to pay for them.

None of this deterred Geithner from going down on bended knee Monday in the pages of the Wall Street Journal and begging private investors to make him the happiest man in the world. “We still have a diverse and resilient financial system,” Geithner affirmed. “However, the financial system as a whole is still working against recovery . . . While this crisis was caused by banks taking too much risk, the danger now is that they will take too little.”

“Over time, by providing a market for [toxic] assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets.”

To be sure, the congregation cheered the announcement of the bans. The Dow was up nearly five hundred points on Monday and retained about three-quarters of it despite a drop on Tuesday. However, there was plenty of murmuring among parishioners over their doubts of hearing any actual wedding bells.

John Irons, Research and Policy Director at the Economic Policy Institute, tried to put on a glad face while remaining realistic. “The new plan could work. There was once a vast amount of money in these assets and restoring that market through risk-sharing and guarantees could help stabilize the financial system. But it could also fizzle – the assets might really be worthless (or close to it) and no public-private plan can change that.”

Shannon Zimmerman, Senior Analyst at the Motley Fool, was less inclined to mince words. “There's a Snake River Canyon-size chasm between the value banks claim for their toxic assets and the sum any sentient, non-daredevil investor would pay.”

Then there were the Dutch aunts and uncles of Congress. This group had no interest in the details of the ceremony; their focus was indignation at the price of renting a decent hall these days.

House Minority Whip, Eric Cantor of Virginia, complained that Geithner’s plan offered “little incentive for private investors to participate unless the subsidy is made so rich that it comes at the expense of the taxpayer.” Cantor continues to favor an earlier, cheaper Republican proposal to set up a government-sponsored insurance program for mortgage-related securities.

Finally, there was an outraged parent, played by Paul Krugman of the New York Times. Krugman is a traditionalist, albeit a liberal one, and he feels that when a young man acts irresponsibly and leaves his partner knocked up with unwanted assets on her books, the quickest and most effective means to get him to the altar is the business end of a shotgun.

Krugman bewailed Geithner’s plan as “disappointing. In fact, it fills me with a sense of despair.” He argues it is merely a recycling of the Bush Administration’s “cash for trash” plan, proposed and subsequently abandoned by former Treasury Secretary Hank Paulson. Krugman does not share Geithner’s optimism about the economy’s soundness or that toxic assets will rise again in value. “Financial executives literally bet their banks on the belief that there was no housing bubble and the related belief that unprecedented levels of household debt were no problem. They lost that bet.”

Although Geithner spent the last two days speaking strongly about the need for greater market regulation and asking Congress for new powers to oversee non-banking institutions, this does not go far enough for Krugman. He desires intervention much more aggressive, up to and including nationalization. “There’s a time-honored procedure for dealing with the aftermath of widespread financial failure. [Government] takes temporary control of truly insolvent banks, in order to clean up their books.”

Despite their understanding that marriage is no panacea, especially when entered into with a squeamish partner, Obama and Geithner believe the risks and costs involved are less than those associated with doing nothing.

In an interview with CNBC, Geithner said the alternative to his plan would be letting toxic assets remain on banks’ balance sheets, which he argued would create a “much longer, deeper recession.” His reasoning is sound. Hoping banks would work toxic assets off their balance sheets naturally over time wound up prolonging Japan’s economic downturn a full decade.

Geithner is using enthusiasm to make up what he lacks in suavity in order to sell his plan. What is left of his once-considerable reputation is riding on his success. He will march before an altar or likely find himself sacrificed atop one. He faces two daunting tasks – convincing nervous investors to join him and then convincing an incredulous Congress to give him still more money. Both parties are suffering from fear of commitment.

Perhaps Geithner can take heart from Letterman. Now that Dave has finally decided to take the plunge, he must be oozing optimism about wedded bliss. On Monday night, he gushed, “Well, things are going pretty good, let’s just see what happens in about ten years.”

Hmmm . . . maybe not. On the other hand, something tells me Geithner will not have nearly so long to wait for his answer.

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