Treasury to unveil incentives for private capital

Posted by Marc Hodak on March 22, 2009 under Invisible trade-offs | Be the First to Comment

They’d better be good.  They will have to induce private investors to risk investments in assets so toxic that they threatened to bring down the entire global financial system.  Are these assets worth 60 cents (bankers wish)?  Thirty cents (closer to the market)?  Twenty-two cents?

Here is the game the government is playing:  the lower the bids, the more likely the banks all go “boom” since they will have to recognize the low bids on their books, revealing most of them as insolvent.  The higher the bids, the fewer banks will be seen as insolvent, but the more likely taxpayers will get sodomized, yet again.  Is there a fair price that threads the spread?

Unfortunately, the government has been working overtime to keep that spread wide by compounding the uncertainty that will be faced by investors.  That uncertainty significantly reduces the value of those “bad” assets to them.  Will the loans have to be paid back according to the contracts that were written?  Or will the contracts be modified by judicial fiat?  Will Treasury and the Fed provide sufficiently clear rules for their participation?  Will they then change the rules?  And then, there’s the newest and biggest uncertainty:  What does the winning investor get to keep?  Joe Wiesenthal plays the rest of the tape:

Picture it: John Paulson makes $500 million buying distressed assets, after only putting up $10 million of his own cash, while the government puts in $90 million. The bet works out. Some newspaper reporter explains what happened, and next thing you know, Barney Frank is talking about how those are the “people’s profits” and how this is no time for hedge funds to be feasting off our carcasses — even though that’s the exact point of the TALF.

Will the profits get confiscated via some clever spread-the-wealth tax scheme that non-hedge-fund public wildly applauds?  How does an investor build that risk into their decision-making?

That’s what Obama and Geithner are sweating out right now.

Update:  Obama is seriously backpedaling from governing out of anger.

“Let’s see if there are ways of doing this that are both legal, that are constitutional, that uphold our basic principles of fairness, but don’t hamper us from getting the banking system back on track.”

Unfortunately, Congress’s wider net for a 90% tax on TARP recipients is legal (in a tautological way), very likely constitutional, and looks “fair” to the people protesting Wall Street and the folks who applaud them.  Whether this reaction helps or hampers government plans to get the banking system back on track remains an open question.