In today’s (November 26) edition of The Wall Street Journal, there is a Deal Journal article entitled, “Paulson Plan: ‘Truly Idiotic.’”
Although we’ve not gone that far in describing TARP et al, we’ve been harshly critical of Mr. Paulson. In fact, we’ve mentioned that his series of actions don’t seem to constitute an actual plan, because the word “plan” implies a certain degree of, well, planning or foresight and forethought, and those prerequisites seemed absent in his Panic of ’08.
The quoted accuser in the Deal Journal article is Charles Calomiris, a prof at Columbia, and he make several good points, including “we’re using half-measures designed in an inappropriate way,” and “The problem is the completely opaque distribution of losses because no one knows how to value these mortgage losses.”
We’ve made similar remarks any number of times, and it is exactly those opaque joint distributions of cash flows (and therefore losses) that cause all the trouble and makes the pools impossible to value with any degree of precision.
While we do agree with his criticism, we don’t agree with his recommendations. Primarily his suggestion that “the government offer to buy any mortgage for 40 cents on the dollar.”
It is unclear how the 40% solution is derived, and thinking in terms of Akerlof’s Lemons Model, you can be sure that only one type of mortgage would be offered: one with a value between zero and 40% of face value.1 Thus, if the government commits to purchase any mortgage, it would certain over-pay, and thus subsidize the worst cases, and if the government does not commit, then it is likely the mechanism would fail with few or any transactions. (The difficulty of valuing the mortgages does complicate matters as does their current book value.)
Why not try a private solution? Why not offer mortgage investment tax credits or permit immediate and accelerated amortization (depreciation) of the purchase price of those mortgages and mortgage-related securities for prospective buyers? Then set low tax rates for prospective realized cash flows.
We’re sure that many buyers have some valuation model, but likely (and justifiably) do not trust it. Giving a 30% – 40% tax break should provide them with an ample cushion to take a chance. How could such a plan be any worse than a government-administered plan, or a government-regulated, fixed-price one? (Remember the government’s success at other attempts at price controls: both supports and ceilings.)
By the way, folks who think this Thanksgiving week’s mini-rally signifies that the worst is over are likely to be sadly mistaken. We do hope that we’re wrong, but doubt it.
Nothing has solved the overwhelming problem that the markets do not trust the large financial intermediaries, and those banks do not trust each other. The mortgage crisis informed about the banks’ shortcomings; so, solving that mortgage crisis won’t cause anyone to believe that the bank’s judgment has improved–at least for quite some time. In that respect, Mr. Calomiris is quite right. Mr. Paulson has done nothing to help.
Thank god we live in a country that can withstand such epic mismanagement. What was the total $7.5 trillion?
(New readers can search the archives from the past several months to find many related articles.)
- We admit to making several simplifying assumptions, especially the fact that the standard Akerlof-adverse selection-market failure model is a single-period static model, and the real world tends to be multi-period (let’s hope so, at least). ↩
