Joseph Stiglitz on the 'Ersatz Capitalism' of TARP II


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.