Steroids for the Rentiers

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1. The size of the TALF from $200bn to $1 trillion is a very big deal. It requires no Congressional approaval and the Fed seems ready to start buying assets this week or next. Not only will this Fed buying guarantee a revival of many securitised credit markets, but the 10 to 1 Fed leverage in the TALF structure will result in a huge expansion of the Fed’s balance sheet, which ought to be good news from a money supply point of view.

The ‘money supply point of view’ is meaningless with non convertible currency. In fact, adding to the Fed’s portfolio takes income from the rest of us. A $5 trillion portfolio with a 3% coupon removes $150 billion a year in private sector income, for example. Any good the lower interest rates do can be more than offset by the removal of interest income.

2. The public-private partnership (PPP) for acquiring toxic assets is simultaneously too complicated and lacking in detail. But a couple of things do seem clear: This will effectively be a “bad bank” designed to “cleanse” $1 trillion worth of “legacy” assets from bank balance sheets. The surprising element is that Geithner thinks he will be able to capitalize this bad bank partly with private money. This presumably implies that the toxic assets will enjoy some pretty generous government guarantees, which ought to be good news for existing bank shareholders.

Yes, investors will benefit risk free which adds nothing to aggregate demand, meaning unemployment will remain high and borrowers continue to struggle with their payments, while investors profit. And this is from the far left!

An alternative possibility is that the PPP will buy toxic assets very cheaply (which would of course be bad news for the disposing banks. This seems unlikely however because of the third and most important element explicitly stated in the Treasury’s background briefing, though not mentioned by Geithner in his speech (presumably because he did not want to sound like he was being too generous to the banks):

3. A Financial Stability Trust (FST) will inject convertible “contingent equity” into banks once they have cleansed their balance sheets by selling toxic loans to the PPP. This contingent equity will be available in unlimited amounts to banks with consolidated assets of over $100 billion. The most crucial point is that pricing looks very generous. “The conversion price [will be] set at a modest discount from the prevailing level of the institution’s stock price as of February 9, 2009”. In other words, if a bank needs to raise additional equity from the US government, this equity will be priced in line with this week’s market values and will not be grossly dilutive to existing shareholders like the capital injections into Fannie and AIG. This seems very generous to bank shareholders, especially as the Treasury is offering to buy bank equity at this price in unlimited amounts (although looking at the performance of US regional banks yesterday, the market clearly took a different conclusion).

More funds for the investor class.

4. Another generous element of the FST package is the approach to “stress testing” bank balance sheets: “The Treasury Department will work with bank supervisors and the Securities and Exchange Commission and accounting standard setters in their efforts to improve public disclosure by banks. In conducting these exercises, supervisors recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending.” In other words, banks will be allowed to continue using “hold to maturity” accounting, if the alternative is “overly-conservative” accounting which “inappropriately constrains lending”.

5. Finally, the purpose of the Treasury stress-tests will be to establish whether banks have enough capital to continue sufficient lending even “in a more severe decline in the economy than projected”. After these stress-tests, the Treasury will effectively insure banks against such a deeper-than-expected recessions by providing a “guaranteed buffer” of contingent capital (as described in 4 above). In other words, it looks as if the Treasury will provide a catastrophe insurance policy against a deeper than expected recession, probably at a pretty low price to the banks (certainly at a much lower price than infinity, which is what an insurance policy against economic depression would cost in the markets today).

And yet another distribution to the investor class.

This is trickle down economics that would make even Reaganites blush.

Seems working people have no representation whatsoever.