Generally, I find myself in agreement with Paul Krugman. It’s a safe place to be: in agreement with a Nobel Laureate. And truth be told, since I’ve only really been paying a lot of attention to the economy since the dawning of the ARM mortgage dustups, I’ve largely learned what I know about economics from exactly Paul Krugman.
So its a bit weird finding myself disagreeing with him now. I’ve agreed with him in the very recent past, in any event. And I’m not at all sure I know what I’m talking about. But watching this toxic asset debate go back and forth – with most liberal economists agreeing with Mr Krugman on most points – I’m still left feeling that the disagreement boils down to him wanting to be right more than a policy argument on it’s merits.
But first, a bit of background: the problem in a nutshell right now is that there’s a bunch of “assets” floating around out there which are part of that “false wealth” I’ve talked about before. They’re securities and funds made up of the collateralized debt from mortgages and credit cards of millions of Americans, and well, they’re worth exactly shit right now. Their worth has been grossly overestimated in the recent past, and now with the panic of November, that worth is by most estimates underestimated. But since the capital a lot of banks would normally use to borrow and lend money is wrapped up in these assets, those banks have neither the money to lend nor the means to dump the “toxic” assets they have.
Paul Krugman and others have recommended that the best course of action would be to take the banks over in bankruptcy, renegotiate contracts, dump toxic assets and once they’re free of the debt associated with those assets, send the banks back into the market. This is the “Swedish Option” that you hear about. Tim Geithner’s plan is to enter into a partnership with solvent banks and investors, offering to buy 85 to 90 percent of any asset those investors choose to buy. This is basically a means to inject capital back into that market, saving what assets are salvageable and encouraging investment by letting the federal government be the first girl on the dance floor.
Paul Krugman’s argument against this plan is, to summarize, that the entire Collateralized Debt Obligation scheme was one big dysfunctional mess and that the best thing is to simply let it all go away. That’s fine as far as it goes, but I’m a bit fuzzy on the details of his version of the solution. He says:
As economic historians can tell you, this is an old story, not that different from dozens of similar crises over the centuries. And there’s a time-honored procedure for dealing with the aftermath of widespread financial failure. It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books.
That’s what Sweden did in the early 1990s. It’s also what we ourselves did after the savings and loan debacle of the Reagan years. And there’s no reason we can’t do the same thing now.
OK, but if you guarantee bank debts – which in this case is to say that you’re guaranteeing some of the CDO mess – how is that different than guaranteeing the purchase of those same assets at a 90% ratio as in the Geithner Plan? Either way, the tax payer takes it on the chin in the event those assets turn out to be worthless. At least in the Geithner Plan there is some means to partially capitalize the markets, which is the only means to bolster their value. It seems to me that the Swedish Option effectively concedes that the market for these assets will not rebound in any way, which again, is disputed by a few economists and even conceded by Krugman himself.
Meanwhile, the Geithner plan absolutely does call for the FDIC to assume control of completely insolvent banks. It seems they agree on at least this part of the plan.
Krugman says that “there’s no reason we can’t do the same thing now.” I’m not so sure I agree with this part. I’ve noted just a few days ago that it seems like insuring these assets would be a pretty pricey affair. There’s got to be an upper limit to our ability to borrow, not to mention the political will to do such a thing.
I suppose perhaps Paul Krugman’s opposition to the Geithner Plan may be born out of the same desire a lot of us have: to see the whole CDO market burn. But as I mentioned in my video blog on this subject, what we’re really needing here is a structured denouement to the entire CDO fuckup. The idea of recapitalizing the false wealth system that got us into this mess is, like so many choices in this crisis, stomach churning. But assuming that Congress passes some of the reform measures that limit the over-collateralization of debt, we can hopefully keep this beast at bay.