It is peculiar that the words value and fair emerge in time of bourgeois crisis
proper. here is another example below. Why so when the price, a deus ex machina
and an absolute fetish was the optimal resource allocation mechanism where
moral and social welfare considerations can only be deduced after the more than
'adequate' functioning of a positive science. When the price of wheat trebled
few months ago by speculative pressure and killed the poor the fund and the
bank were advising price hedging and not price control... all but do not touch
the price for it clears the market and many irrelevant lives in the third world
with it. as for the relevant lives of the rich who will probably jump out of
windows, value in the classical political economy sense, kicks in and we have
price reverting to value, which is an objective social category that is a
historical store of value. long term trends figure in and average costs
approximate social costs. what would
be interesting is to have one of these IMF policy papers on the third world
reproduced in the same way for the USA.
Had labour in the US been powerful politically it would marched on Washington
and set up the guillotines.
When the tide recedes, paraphrasing Minsky, so many would have been swimming in
the nude. however, given the lopsided power structure the only ones that will
be caught in nude are them homeowners. on the up side as more value is drawn
from production, i would watch out for blackshirts in the urban USA metropoles.
Here's proof of naivete when politics was withdrawn from political economy to
make economics.
September 25, 2008Financial TimesBagehot plus RFC: the right financial fixby
Larry Kotlikoff and Perry Mehrling
The credit crisis is two problems not one, both a liquidity crisis and a
solvency crisis, but they are interrelated problems and so too must be the
solution. We can solve both problems at the same time by having the government
sell credit insurance policies of all kinds, and accept preferred stock as
payment. The credit insurance will set a floor on prices, and so restore
liquidity. The preferred stock issue will recapitalize banks that suffer from
an eroded capital base on account of asset value writedowns.
Problem one is the crisis of liquidity. One way to think about this dimension
of the problem is that everyone wants to sell the assets and no one wants to
buy, so the price of the assets is beaten down below fair value. Another way to
think about it is that everyone wants to buy credit insurance and no one wants
to sell, so the price of insurance is bid above fair value.
The Paulson plan focuses on establishing a market price of assets by offering
to buy assets. Our plan focuses on establishing a market price of insurance by
offering to sell insurance. Paulson wants to establish the price of assets by
using a series of reverse auctions, in which holders compete for the Treasury’s
money and the Treasury accepts the lowest price. We propose instead to
establish the price of insurance by offering to sell unlimited quantities of
insurance at a fixed price.
In setting the price of assets, the Paulson plan implicitly sets the price of
insurance, since the price of a risky asset is equal to the price of a riskfree
asset minus the price of insurance. Similarly, in setting the price of
insurance, our plan implicitly sets the price of the assets. So the two plans
are really just two different ways of doing exactly the same thing, but our
plan is simpler. Paulson needs to set the price of each asset separately, which
is a lot of prices. We need only to set the price of a few standard insurance
contracts.
What kind of insurance are we talking about? One such insurance contract, for
example, is the credit default swap on the various tranches of the subprime
mortgage ABX index. Once we set these index swap prices, then implicitly we set
the prices of all assets that are priced with reference to these index prices,
which is actually a good chunk of the troubled asset universe.
Where should we set our prices? In the case of the ABX swap we might set them
at the average swap price over the last three months. This will imply a very
low price for the assets, and a comparably very high price for the insurance.
We don’t know what the demand will be at these prices, but whatever demand
there is should be met. This is the modern equivalent of the ancient Bagehot
principle for handling a crisis: lend freely but at a penalty rate.
That brings us to problem two, the crisis of solvency. By setting the price of
insurance we establish a price of assets, which may well be below the value at
which financial institutions are carrying these assets on their books. Mark the
assets to market and you make the solvency problem worse. That’s the biggest
problem with the Paulson plan (unless he overpays for the assets, and that
raises additional political problems). In our plan, we solve the solvency
problem by letting buyers of credit insurance pay for that insurance with
preferred stock.
The result is that, after buying insurance from the government, buyers will be
able to carry the assets at par, or sell them at par (by packaging them with
the insurance) in order to raise cash. Either way the value of their assets
will be marked up by the value of the insurance, and that markup is also the
amount of recapitalization. Both problems are solved at the same time.
But what about the taxpayer’s exposure? In Paulson’s plan, the Treasury borrows
$700 billion by issuing Treasury bills and bonds, and using the proceeds to
acquire a huge portfolio of dodgy mortgage backed securities. In our plan, the
Treasury issues credit insurance policies and uses the proceeds to acquire an
equity stake in troubled financial institutions.
Looking forward in time, under Paulson’s plan, the Treasury holds the dodgy
assets to maturity, or until the underlying housing market recovers enough that
the securities can be sold, with the proceeds used to redeem the Treasury
borrowing. In our plan, the Treasury holds preferred shares until such time as
the financial institutions recover profitability and use those profits to repay
the Treasury stake.
This second dimension of our plan is the modern equivalent of the mechanism
used by the Reconstruction Finance Corporation in the Great Depression. Bagehot
plus RFC is the right financial fix.Larry Kotlikoff is professor of economics
at Boston University. Perry Mehrling is professor of economics at Barnard
College, Columbia
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