Joseph Stiglitz on the 'Ersatz Capitalism' of TARP II

Jacob Sullum | April 3, 2009

In a New York Times op-ed piece, Columbia economist Joseph Stiglitz, a Nobel Prize winner who chaired Bill Clinton's Council of Economic Advisers, argues that the Obama administration's plan to relieve financial institutions of their "toxic" mortgage-related assets amounts to "ersatz capitalism" based on "the privatizing of gains and the socializing of losses." Because the investors the government is encouraging to buy the assets with extremely generous subsidies will have very little of their own money at stake, Stiglitz says, they won't be buying the assets so much as buying options to buy the assets, options they will exercise only if the investments turn out well:

The government plan in effect involves insuring almost all losses. Since the private investors are spared most losses, they primarily "value" their potential gains. This is exactly the same as being given an option.

Consider an asset that has a 50-50 chance of being worth either zero or $200 in a year's time. The average "value" of the asset is $100. Ignoring interest, this is what the asset would sell for in a competitive market. It is what the asset is "worth." Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership!

Assume that one of the public-private partnerships the Treasury has promised to create is willing to pay $150 for the asset. That's 50 percent more than its true value, and the bank is more than happy to sell. So the private partner puts up $12, and the government supplies the rest—$12 in "equity" plus $126 in the form of a guaranteed loan.

If, in a year's time, it turns out that the true value of the asset is zero, the private partner loses the $12, and the government loses $138. If the true value is $200, the government and the private partner split the $74 that's left over after paying back the $126 loan. In that rosy scenario, the private partner more than triples his $12 investment. But the taxpayer, having risked $138, gains a mere $37.

Comments

ED|4.3.09 @ 2:34PM|#

oh well.

|4.3.09 @ 2:35PM|#

I think "fraudulent" would be a better word than "Ersatz" which translates as "substitute" or "replacement".

Socializing losses and privatizing gains is just a kind of theft on a grand scale.

I'm not sure what the long term effects will be, but they will be bad.

|4.3.09 @ 2:37PM|#

yo, fuck tarp II

T|4.3.09 @ 2:37PM|#

I think "fraudulent" would be a better word than "Ersatz" which translates as "substitute" or "replacement".

Yeah, fraud sounds like what they're perpetrating. But it's okay when the gummint does it.

|4.3.09 @ 2:38PM|#

Welfare for Wall Street? Must be those damned Republicans again.

Harvey|4.3.09 @ 2:47PM|#

I'm surprised this appeared in the NYT.

|4.3.09 @ 2:50PM|#

Wondering how this will play out with mark-to-market out of the picture.

The banks will probably just dump the worst securities and hang onto the better ones.

I did me some learnin' the other day on Gresham's law and Lemon Markets.

That's what this is going to be. The banks will dump only the crappiest securities on the taxpayers - who are being effectively forced to buy them. There will be little to no gains. The taxpayers will merely be paying off the bank's losses.

Kunal|4.3.09 @ 2:50PM|#

It's awesome how Stiglitz speaks crap most of the time, yet makes eminent sense on issues on which I agree with him.

|4.3.09 @ 3:03PM|#

So, if it works banks improve their ability to extend credit and lend which got us into this problem in the first place, and if it fails we're just poorer? Yay.

Even if it works and we can make our money back with a little profit, the government will not give it back to us, they will spend on something they choose, because they are teh smarter den us.

travis|4.3.09 @ 3:10PM|#

isn't this still better than giving the banks another $600 billion? woo, we're making progress. they have to put up a twelfth of the funds. and we as taxpayers still have a chance of making some return

High Every Body|4.3.09 @ 3:18PM|#

I am wondering where MNG is. The threads have been Gaza vs. Andromeda free today.

|4.3.09 @ 3:34PM|#

See? The government has stepped in to avert a market failure. Or something.

|4.3.09 @ 3:35PM|#

With any luck, MaunderingNannyGoat has thrown himself down the same well as joe.

Kieffer|4.3.09 @ 3:38PM|#

Unless they wait and see whether there are any profits, and simply socialize them after the fact AIG bonus-style.

|4.3.09 @ 3:44PM|#

And yet prominent Hedge Fund manager, Ray Dalio of Bridgewater associates, refuses to take part in the government "partnership". At least on of the best investment minds thinks it won't be all roses for the private capital...

|4.3.09 @ 3:48PM|#

The threads have been Gaza vs. Andromeda free today.

?? Can someone explain that reference? I get the Gaza part, but Andromeda?

|4.3.09 @ 4:03PM|#

He doesn't want his bonus to be fucked with, domo. That, and/or he is worried he'll still lose his 12% investment.

creech|4.3.09 @ 4:10PM|#

So if we are all screwed as taxpayers, how can we make a buck on this as investors? Buy BofA stock or what?

Cavacatus diaboli|4.3.09 @ 4:18PM|#

Thanks to Stiglitz for this clear description.

And his point is?

If you want to attract investors to put money into bad debt, this is the way to do it.

If you want the government simply to buy this security, you're talking about something radically different (the seed of a sovereign wealth fund, maybe). The government would pay substantially more and have all the up or down risk. The risk proposition would probably change too, given that the government is not in the business of buying and selling private securities, and would be less likely to get a good deal than a market professional.

Maybe that's what Stiglitz would prefer. There are certainly arguments for doing it that way. But if you want to intervene in the market, short of simply buying bad debt and hoping it's not really bad debt, this is the way to do it.

pkrugman|4.3.09 @ 4:33PM|#

Joe should really know better than to say things like this.

Bald Idiot|4.3.09 @ 4:44PM|#

Stiglitz' observation that the taxpayer is paying for this is correct, of course, but his analogy to stock-options has some implications that are not correct.

With stock-options, the option holder assumes no risk. With these assets, however (as Gary Becker recently pointed out), the prices will be inflated to the point where the price equals the expected value. The beneficiaries of taxpayer largesse are not the option-purchasers; the beneficiaries are the companies who now have (and should be responsible for) the "toxic assets."

alan|4.3.09 @ 4:54PM|#

Kunal | April 3, 2009, 2:50pm | #
It's awesome how Stiglitz speaks crap most of the time, yet makes eminent sense on issues on which I agree with him.

I was thinking the same. J.S. has a gift for that.

|4.3.09 @ 8:12PM|#

There are certainly arguments for doing it that way. But if you want to intervene in the market, short of simply buying bad debt and hoping it's not really bad debt, this is the way to do it.

I disagree. Outright nationalization would be simpler and less open to abuse or the production of perverse incentives and unintended consequences.

It's a bailout of the banks either way. Stilgitz's point is that this CAN'T work unless the taxpayers lose. If we buy up the good assets and turn a profit, then banks lose, and the problem isn't solved.

The banks are fucked. They loaned out their reserve capital to the housing market and lost it all on subprime mortgages. The only thing that will fix them is to shovel them a buttload of money.

That or letting them fail and other banks replace them, but the morons in Washington can't tell the difference between the banking industry, and the specific banks that make up the banking industry.

|4.5.09 @ 10:19PM|#

It's awesome how Stiglitz speaks crap most of the time, yet makes eminent sense on issues on which I agree with him.

Everyone speaks crap most of the time, except when they are arguing for a point I already agree with, in which case they make a lot of sense. I don't know how it always works out that way.

Granite26|4.6.09 @ 12:02PM|#

Devil's Advocate, but isn't the taxpayer's RoI coming in when the banks are functional and the economy is moving again?

That's the end goal the gub'ment is shooting for, right?

The question shouldn't be 'Are we getting soaked in this investment?' as investors, but 'Is the benefit to society at large worth the expected cost?' as public citizens.

Can't answer it, but it makes things look a little more reasonable.

It's been a while since I've seen stats on how bad these 'toxic assets' really are. How many of the funds have crashed completely?