A spoon-full of toxin

The pri­vate part­ners are not pric­ing the tox­ic assets at all, but an option on the tox­ic assets that has been cre­at­ed by the gov­ern­ment offer to bear most of the loss­es. The gov­ern­ment is putting up 92% of the pur­chase price in the form of equi­ty and debt, but receives only 50% of any gains (see this Finan­cial Times inter­ac­tive graph­ic expla­na­tion). When the pri­vate part­ners bid, they’re bid­ding on their expec­ta­tion of gains from the deal, not express­ing their view about the long-run price of the under­ly­ing assets.

Giv­en that the tax­pay­er will absorb almost almost all of the risk, the pri­vate part­ners will like­ly pay too much for the assets. That’s good for the banks who now own the assets but only because they’re mov­ing their riski­est debts to the tax­pay­er. Obvi­ous­ly it’s also good for the ‘pri­vate part­ners’. As Stiglitz says:

“What the Oba­ma admin­is­tra­tion is doing is far worse than nation­al­iza­tion: it is ersatz cap­i­tal­ism, the pri­va­tiz­ing of gains and the social­iz­ing of loss­es.”

But, isn’t it inevitable that the tax­pay­er will fund the recap­i­tal­iza­tion of the banks? Prob­a­bly. But the tax­pay­er is also enrich­ing the ‘pri­vate part­ners’. Now, guess who they are like­ly to be? The banks them­selves.

War­ren Mey­er has a nice, step-by-step expla­na­tion of the key Stiglitz points. JS makes some addi­tion­al obser­va­tions about ‘adverse selec­tion’ incen­tives, how­ev­er, that wonks will like.

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