Spero Consulting

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.)