Shell Game

Кто кого? — В. И. Ленин

There are two ways you can look at the current banking crisis.

The first is that we are in the middle of a panic, and that this panic has frozen the markets for various complex assets. As a result, the few of these assets that do sell get sold for far less than their actual value. This seems to be the official administration view, as expressed in the bank bailout plan released yesterday.

This point of view requires you to believe some odd things. For one, you have to accept that none of the titans of Wall Street has been rational enough to snap up the incredible deals now lying in the street, hoovering up every "depressed legacy asset" it can find, knowing that in the fullness of time it will turn into a beautiful swan of value.

You have to somehow simultaneously believe that the government has a clearer view of correct price levels than the market (otherwise the Geithner plan makes no sense), and that the market does better at setting prices than the government (otherwise you wouldn't need private "partners" in the plan at all).

You have to believe that market prices are deeply irrational, markets are driven by emotion, and the government is both better and worse than the private sector at price discovery. This is a weird set of beliefs for an American government, especially one whose economic team comes straight from Wall Street, to hold.

The second way to look at things is that we are not in a panic, but in the painful process of deflating a credit bubble. Bank assets are not trading at pretend prices that we can just dismiss as a collective case of the vapors, but at prices near their actual value. The markets are frozen because price discovery would force banks to apply the cold, wet hand of reality to their balance sheets, and many of them would be bust. As long as you don't open up your vault and look inside, you can continue to believe it's filled with gold ingots.

If this second point of view is true, then the bank rescue plan is a shell game. Half a trillion dollars is going to make a one-way trip from the FDIC to a number of large banks, with a big taste skimmed off for the usual Wall Street intermediaries in return for their political support. The FDIC is not taxpayer-funded, but the FDIC also does not have a half trillion dollars. In fact, it is nearly broke. If asset prices fail to reinflate to pre-crash levels, someone is going to have to cover a half-trillion-dollar tab. For a hint as to who this will be, I suggest a visit to the nearest mirror.

Though the bailout plan seems complex, simple examples demonstrate that it is a sucker's bet. But for some reason you won't see this kind of critical analysis on the front page of the New York Times. Instead, today's paper has headlines about A.I.G. returning $50 million in bonuses (one ten-thousandth of the bank bailout cost), along with a People-style front-page article focusing on Geithner's struggle to convince Wall Street plutocrats to take more free money:

Mr. Geithner and other administration officials spent days briefing crucial people on Wall Street and working to line up endorsements from prominent equity fund managers and other private-sector “validators,” in particular two leading global investment management firms, BlackRock and Pimco.

Since BlackRock and Pimco stand to make more cash on this deal than the entire Times readership could roll in if it spent the rest of its life rolling in money, I don't really understand why these briefings took days to complete. Probably because the fund managers kept pinching themselves and demanding that Geithner furnish proof that they were not actually dreaming.

There's a nice American variant of the Lenin quote at the top of this post: If you don't know who the sucker in the room is, you're the sucker. As you read about this plan in the mainstream press, notice how everybody in it ends up a winner - the behemoth private partners who earn their guaranteed profit, the banks that get to trade their sulky, misunderstood securities for sweet cash, and the Treasury, whose superior understanding of asset value is going to earn it a mint. The plan is such a good deal for everyone that it's amazing we didn't try it sooner. And not a sucker in sight!