Thursday, February 5, 2009

"Lemon Tree, Very Pretty"


The foot pounding to avoid lemon socialism, in which citizen-taxpayers "agree" to socialize the risks and privatize the returns can be heard across the plains. Openly agree, one should say, to contrast with the regular way, which is to have lemon socialism hidden in laws and regulations (from both political parties) that enable misalignment of risks and rewards.

But, these days, we have to eat the lemon. At least on the banking side.

Obama's team will never socialize the big banks, fully, despite that the best case for it might be purging a generation of dead-head management and elevating some people who really do know the risks of modern financial products and markets. (Cleaning out corporate boards is another good idea, as should have been done wholesale at Merrill and Lehman, right?)

So, what other choice is there?


The best combination is for the Treasury and Fed to work together. The Treasury provides the risk capital and the Fed has available infinite leverage (at least for a time).

The private sector, particularly the distressed assets crew, knows how to value assets no one wants, much. The best of all worlds is to share risk-capital with the private sector, to scare-up a public-private partnership, and leverage it with the Fed-Treasury combo. That's one way to get past the problem of government getting duped in setting/taking a price on things its bureaucrats don't understand.

Another risk-sharing is to pre-package large-bank bankruptcies, allowing banks (and some non-banks) to trade out of their debt-obligations at or near market prices or at zero, if necessary. A restructuring of their liabilities will allow further risk-sharing with public funds. How? Well, the Treasury can 'substitute' the erased liabilities with recourse provisions. The banks sell assets at a price to the Treasury, who picks up an amount of risk consistent with the Treasury's economic forecasts, but the banks share or assume risk that the asset values come in below that.

Exchanging debt obligations for recourse guarantees is another public-private risk sharing that might work, if it is enough in the mid-term to avoid a terrible, terrible long-term.

The truth takes only a few words (to borrow a famous phrase from Chief Joseph). This might be the American solution, one that contrasts with the way that Europe have done so far and that Japan did a long while ago.

I wrote this in 20 mintues this morning. I have no idea what is taking weeks and weeks to conceptualize, inside the Obama team, unless it is the gory detail of regulatory structure redesign or a forward-looking, step-by-step to step around too-big-to-fail.

Maybe they are trying to decide what to do with housing market intervention, first? That would make sense. Soon, they should have had enough time for a masterpiece, though, so my expectations are high.

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