Geithner’s trillion dollar gamble

 

Global stocks soared after US treasury secretary Tim Geithner announced his $1,000bn package to extricate toxic assets from the balance sheets of debilitated US banks. The dollar was also up against the euro and the yen. But while global equities rallied, many observers were still left sceptical or confused because of the lack of detail in Mr Geithner’s statement.

 

We found the most succinct description and analysis how the schemes works, and why it is rip-off, coming from Colm McCarthy in the Irish Economy Blog. Essentially the Geithner plans creates a vehicle in which private equity accounts for 3%, public equity for 12%, and the rest is provided as debt by the public sector the (through the Federal Deposit Insurance Corporation, FDIC). McCarthy makes the point that the private guys do the bidding, and they get the debt on such preferential terms (non-recourse lending, interest rates close to T-bills), that they are bound to end up with a profit.

 

The blogger Nemo (hat tip Felix Salmon) has produced an interesting post on how the Geithner Plan works in more detail, using a numerical example, which shows that from an investor’s point of view this is a Heads I Win Tails You Lose proposition. The only party that always loses, in all conceivable scenarios, is the tax payer. Paul Krugman came up with a similar calculation.

 

The FT's editorial argues that Geithner’s plan assumes that buyers and sellers will agree on a price for bad assets if the government is willing to subsidise them enough. But this implies that assets are not trading today mainly because of a lack of liquidity. But no one knows whether the market malfunction is due more to long-term losses or short-term liquidity risk. A virtue of this plan is that it should help us find out. But this is a gamble, which could fail in two ways.

 

(A short comment from us: We have noticed that the US blogging community is a lot more positive about the Geithner plan than the Paulson plan, even though they are essentially the same plan minus some insignificant details, such as who is in charge of the bidding process. So in our view the reactions to the Geithner plan are very a good metric of the partisanship in the US blogging community. Some bloggers like Krugman, Johnson and Naked Capitalism have  remained consistent throughout. Some of the others are merely telling us that they are Democrats, right or wrong.)

 

 

Projected fall in world trade

The WTO expects world trade to fall by 9% this year. This would be the largest contraction since world war 2.  After the oil price shock trade fell by 6.2%, the highest reduction to date. FT Deutschland reports that the RWI institute even forecasts a 12% fall.

 

German growth forecasts revised downwards

Bad news also for Germany, as the Ifo, DIW and RWI economic institutes revised downwards their growth forecasts, reports the FT Deutschland. Ifo institute forecasts a 6% fall under a worst case scenario, if e.g. world trade continue to contract on its current pace. The DIW forecasts a contraction of 4-5%, the RWI of 4.3%. The most pessimistic private sector forecast comes from Commerzbank, which is looking at 6-7%.

 

The security implication of the crisis

The German Foreign ministry sets up a special task force to evaluate the security risks resulting from the global financial and economic crisis. The Germans thereby follow the US counterpart by ranking the social and political repercussions of the crisis higher than that of a terrorist attack, reports the FT Deutschland. The scenarios include state defaults in politically unstable regions such as the Caucasus.

 

 

Risk aversion recedes

Prices on so called most-traded leveraged loans – loans to sub-investment grade companies – have recovered to the highest levels since October, reports the FT. Prices have been recovering since the start of this year after an onslaught of forced selling of loans by banks and hedge funds in the last quarter of 2008 pushed loan prices to record lows. However, Moody’s warned on Monday of rising loan defaults and said that recoveries for investors could deteriorate further during the course of 2009.

 

IMF gloomy over UK’s public finances

The IMF gets gloomy over Britain’s public finances , forecasting that the deficit will balloon to 11% of GDP in 2010, far more than the US (8.9%) or the G20 average (6.3%), reports the FT.  Falling profits and rising job losses are taking a toll on public finances, £17bn more than expected in the pre budget report of November last year. In February total receipts were £40.7bn down from £45bn, expenditures £26.7bn higher than in the previous year

 

John Taylor on inflation

A good comment by John Taylor in the FT this morning. He says that the Fed’s monetary policy has boosted the size of reserve account from $8bn  to $778bn by last week, which will go up to $3365bn by the end of this year, once all the announced programmes are implemented. There is no question that this will lead to inflation eventually, so the Fed will have to mob up some $3000bn, at a time when the Treasury is loading up with debt. In the long-run, the Fed is sacrificing its independence, he concludes.

 

The end of financial globalisation

Brad Setser has an impressive post on financial de-globalisation. According to the latest US balance of payment data, the US has become a net lender to the rest of the world. Foreign investors have been withdrawing more credit from the US than they have been supplying. Setser concludes that Bretton Woods II has come to an end. As the US is still running a current account deficit, this can only be due to US withdrawals of funds from the rest of the world. Setser gets so excited about these data that he says: “Words cannot really capture the sheer violence of the swings in private capital flows that somehow produced a a rise (net) private demand for US financial assets”

 

Eurointelligence wishes to thank the Collegio Carlo Alberto for their support to help us maintain eurointelligence.com a free public service.

 

 

---