Sentences to ponder

I think it’s very telling that in two days of hearings and two weeks of discussion we have yet to see *any* detailed mechanism for how Paulson’s plan will increase the supply of, say, inventory loans.

Here is more, mostly on the commercial paper market, interesting throughout.


Very interesting, as usual, Tyler. In order for a legislative fix to work, it has to meet two tests. First, the diagnosis of the problem has to be correct and second, the cure has to be targeted correctly. Even allowing that near misses may have some benefit, what are the chances that the Congress and President will be 2 for 2?

Of course, if a lot of the problem is a matter of confidence and trust, a placebo may work. But $700 billion for a placebo?

One issue that hasn't (as far as I know) been mentioned is the fact that non-recourse loans are peculiar to the US. Amending US mortgages so that lenders had recourse to the borrower if the mortgage failed at a loss would surely be an effective market mechanism to *help* reduce the moral hazard in the current/previous situation..?

The other thing we have yet to see is banks, despite their alleged hunger for deposits, offering to pay more than desultory interest on them. If the TED spread is so wide, why are retail interest rates so low?

ZBicyclist, the problem is that it's not clear who is vulnerable to the bad mortgage debt. Even an institution that doesn't hold any mortgage debt itself might hold paper from some other institution that does, and thus be vulnerable to the failure of that institution. So out of fear, no one lends to anyone.

That said, beyond preventing a panicked freeze of essentially all credit, I don't want a government plan to get inventory loans pack to their previous levels. Because they assumed unrealisticly low default rates, lending institutions have been lending too much. Credit markets should contract. We should have a recession. What some people seem to want is to try to keep the party going longer; effectively, they want the government to borrow for them so that everyone can access capitol at the same, low rate the government can. That is not what we need.


Pennywise goes to Washington.

Am I imagining things, or is the Treasury's plan to guarantee money market funds likely to have a much bigger effect on credit markets than the rescue bill that the Senate passed? And of course, the MMF plan is much more likely to make money than the Senate bill...

Why do we need a gargantuan rescue plan instead of trying a few smaller ideas to see if they work?

David Write - "What some people seem to want is to try to keep the party going longer"

Here's the discourse I'm hearing:

Mr. Market-"Well that was a nice party, we should go home now. Maybe we could get back together next week?"

Senior Paulson-"No way dude, your not leaving now are you."

Mr. Market-"I'm really tired, it's like, 4 in the morning."

Senior Paulson-"Let's get some coke!"

Sonic Charmer,
I completely agree with you. As economists we have to use data to solve a problem, I have seen no data to support this 700 billion dollar amount because there isn't any data. We also have no idea what the value of these bank assets are, which means we don't know if this plan has even a 10% chance to work. But sadly, economists do not make public policy. However, our government will do what they always do when a problem arises, "throw money at it and hope it goes away, if that doesn't work blame it on your predecessor".


We also have no idea what the value of these bank assets are, which means we don't know if this plan has even a 10% chance to work.

Yet merely knowing what the assets are worth is only one side of the equation. I actually don't agree with most peoples' assumption that there's some sort of huge mystery over how much this or that bond is worth; a bond's paydown structure, credit level, and basic collateral details are usually open knowledge, after all. What's a mystery is what the collateral will do in the future; it's something you have to project, and you can be wrong, and depending on the bond, being wrong by a small amount could make your valuation off by a large amount. (I hasten to add that this uncertainty over a bond's future cashflow is an intrinsic property of said bond; it's not going to be made to somehow go away by Paulson throwing money at the bond.)

But even if we knew all that - even if we somehow knew with certainty what future cashflow each bond would bring - we still have no real idea what Treasury plans to pay for that bond! Or how they plan to choose prices. They've talked about holding a reverse auction, yes, but they've also talked about paying the HTM value (which, by their own assumption - an assumption I don't necessarily agree with, but Paulson claims to - is significantly higher than the 'fire-sale' price). So which is it? Without knowing that, we basically don't know anything about the plan.

It's as if you run a business and one of the people under you says he's going to buy some sprockets, do you approve? "How much do they cost - how much are you going to pay per sprocket?" you say. "Haven't figured that out yet", he says. "Just please approve me now. Give me X dollars. To buy sprockets." You try another tack: "Okay, let's say I give you X dollars, how many sprockets will you come back with?" Him: "That's to be determined. That's a detail I can work out later. I just need X dollars right now."

The price is virtually the entirety of the plan. Or, to borrow bond lingo, 'There are no bad plans, only bad prices'. But we don't know the first thing about what Treasury will pay, not really. This is worrisome, and should be embarrassing to anyone who has been defending the plan without knowing what prices Treasury will pay (equivalently, how they will choose prices) for the bonds they want authority to buy.

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