Geithner's shell game

Here’s how I understand this will work (see Carney and Salmon for details).

The government wants the banks to start lending, which they can’t do until they get their capital up, which they can’t do with all those toxic loans on their balance sheet.

The government could just give the banks the money, but that would be a “bailout,” and not too popular right now. The government also could buy the assets for the inflated values they’re currently booked at. But that would be a bailout and not too popular right now.

So we have an elaborate shell game. The government subsidizes private equity companies to buy the assets at inflated values.  Instead of just giving them wheelbarrows of money, they get non-recourse loans for most of the purchase price. Although most people don't understand this right now, they will come to understand that "non-recourse" means that the buyers are exposed only for the minimal payments they’re making on these hugely leveraged deals.

When we find out that the assets are actually worth what the banks really think they’re worth (as opposed to how they’re currently booked) the taxpayers, who provided most of the money, will bear most of the loss. Remember: the loans were non-recourse. If the assets are actually worth their currently fictional values, then the private equity companies will make money, possibly a lot.

Here are the problems:

• It may not work, because the banks will have to write down the assets to the sale price (albeit still more than actual value) and they still won’t have enough capital to lend.
• If the assets don’t go up, and the taxpayers find out they’ve been hosed, there will be hell to pay.
• If the scheme works and the private equity companies make money, the spotlight’s on them. They’ve been sucked into the maw of government assisted enterprises. The uncorporations have become corporations and will be regulated as such.
• The whole thing rides on a mountain of debt and phony asset values. The hope is that people will think the economy is worth more than it is, the stock market will go up, and the economy really will be worth more.  This is what is happening so far. But I thought that kind of Ponzi scheme was how we got into this mess in the first place.

How should we fix this? Here's how: Let the banks sell the assets for what they’re worth but don’t make them reduce their capital for regulatory purposes. This would be honest, and wouldn’t require any taxpayer money.