What to think of the latest plan to get crummy mortgage-related assets off the books of large financial institutions? Two of the economists whose views I most respect differ widely on it. Paul Krugman hates it. Brad DeLong is more optimistic. The stock market, which is a poor barometer of public policy, totally loves it. In its wisdom, Wall Street could easily decide tomorrow, or next month, that it hates the plan. That’s been the pattern for the last six months of bailouts—excitement and exuberance that the cavalry is about to arrive followed by disappointment that it’s armed with pop guns.
We should sympathize with the dilemma the Treasury Department faces in trying to clean up this mess. As Treasury Secretary Timothy Geithner said last week: “Many banks in this country took too much risk, but the risk now to the economy as a whole is that you take too little risk.” (Moneybox made a similar point.) But who is taking the risk? And who stands to reap the rewards? The Treasury acknowledges that private investors will be subsidized to take on the ownership of what it’s calling “legacy loans” and “legacy securities.” (If these horrific securities are legacy loans, then the funeral industry should reclassify corpses as “legacy bodies.”) The Treasury cites as an example a loan valued by a bank at $100 that is sold for $84. In that instance, the private investor and the government would each put in $6, and the investor would borrow the other $72 from the government. If you’re keeping score at home, it means the private investor would put in 7 percent of the cash but would receive a much higher percentage of the profits.
The plan raises the disturbing question: Where the hell are the capitalists? Where are all the people who are willing to put their own money, and that of people willing to lend them cash, at risk in pursuit of profit? Why are Wall Street’s tough guys such a bunch of girly men? The Geithner plan assumes that Wall Street’s bravest investors won’t spend a penny or borrow unless the government is willing to cover losses, make loans, and give away extra profits. It assumes, in short, that these great businesspeople are afraid to do business.
Dislocations create opportunities for investors with the courage to jump in and the vision to extend their investment horizon beyond a year or two. Many fortunes were made by purchasing assets from the Resolution Trust Corp., the agency formed to handle the leftovers from the savings-and-loans debacle. After the junk-bond market crashed in the early 1990s, investors deploying new pools of capital jumped in, purchased the bonds, and used them to acquire control of companies—a bet that paid off handsomely. Earlier this decade, Warren Buffett and others pounced on telecommunications and energy-trading companies that had become impaired.
The current environment should be a great moment for vulture investors. We’ve just gone through the mother of all dislocations when it comes to debt. In fact, the New York Times reports, several name-brand firms are plunging into distressed debt. But while these firms have plenty of cash, and (limited) access to other people’s money, they won’t wade into the mortgage morass—without something like a guaranteed return.
Yes, the market for these assets isn’t functioning properly. But improperly functioning markets are a feature of life. Just as there’s always a bull market somewhere, there’s always a market in which something is significantly underpriced because of macroeconomic, geopolitical, or industry-specific issues.
There may be good reasons why capitalists aren’t yet lining up to buy discounted junk from banks. It could be that potential buyers have lost their nerve (although you can never lose money going long on the nerve of Wall Street operators). It could be that the prices at which sellers are willing to part with lousy “legacy securities” still aren’t sufficiently low to make these trades worthwhile without major leverage. It could be that investors today can’t fathom waiting a couple of years to get paid. It could be, as economist Mark Thoma suggests, that the combination of complex instruments and a totally FUBAR market makes these legacy assets simply uninvestable at any price.
Or it could be that Wall Street has lost its nerve. In this past decade, the controlling assumption of the financial-services industry was that you could have “wealth without risk.” Now it seems to be that you can have “capitalism without capitalists.”