Peter Gallagher

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.