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Playing 'Let's Make a Deal,' or understanding just how "toxic" Geithner's scheme is

By       Message Ed Tubbs     Permalink
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Understanding the “plan” is neither as easy nor as interesting as say, when a pitch becomes a ball or a strike, but it’s a googolplex exponent more important. It’s YOUR MONEY! Or, more accurately: it’s the kid’s and grandkid’s money.

Know this first: Regardless there may be no good way out, there may be no desirable solution, the administration’s proposal to buy the toxic assets on the finance industry’s books is a terrible deal for everyone other than for the finance industry itself.

A most fundamental concept to grasp is that of market value: the price in terms of money that a willing and able buyer will pay to a willing and able seller, with both buyer and seller being fully informed as to the uses to which the sale item may legally be put, and with neither buyer nor seller acting under undue duress. Items suited to exchange on the market never have either a fixed or a static value. (A life preserver may have no value to you if it’s being offered while you’re traveling down I-80 in Nebraska, but another value altogether if you’re treading water 20 miles offshore in the Atlantic.)

Cost is never relevant to market value. Suppose you decide to manufacture anvils with built-in GPS’s, so the worker who’s hammering out horseshoes will always know where he or she is. No matter what it may cost to make such an anvil, it’s unlikely anyone on earth will pay what it may have cost to produce such a darned thing. “Cost” was the exchange paid by the purchasers of all the toxic assets that are now littering the books in the finance industry. What the market value may be for those “assets” — assets, only because that was how they were recorded on the purchaser’s books — is today wholly speculative; in common parlance, a best guess estimate. All that is now reasonably well supposed is that they sure aren’t worth what they cost. That’s because there are no buyers willing, or able, to pay what the sellers want, to get out from under them. And the reason they’re “toxic” is because they represent either a genuine liability, or a potential liability, while at the same time operating to preclude the owners of those assets from doing something else with the money they’re tying up.   

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But back to that GPS anvil scheme. Let’s suppose that you absolutely adore your spouse, and that you were talked into cosigning a $200,000 loan with your spouse’s uncle, so he could start a business manufacturing them. In fact, you so love your spouse that you didn’t much pay attention, or even much care, what the money was going to be used for. All you heard was that he was going to make a killing, and that you’d share in what were sure to be obscene profits. Indeed, a few years in, several were sold. Unfortunately, you also discovered those few years later that the stock iron used in the manufacture of the anvils contained trace elements of really toxic, highly radioactive plutonium.

And now, your spouse sheepishly comes to you, to let you know that Uncle Gustav hasn’t been heard from in two months, and that the last word heard was that he had changed his name to Jerry, had grown a beard, died his hair, and decided to become an anthropologist exploring the native tribes in a — not ‘the,’ but ‘a,’ — deep Brazilian rain forest. Technically you’re only on the hook for $200,000. But the potential liability . . .. That money you’d been saving so that you could “lend” it to your kids, for their college? Not any longer available; it’s got to be held safe and intact, just to cover the odds-on likelihood you’ll be sued when some anvil user develops cancer.

Relative to the countless number of investors holding paper that represent shares of investment instruments that went on their respective books as assets, we’re going to gather them all within a circle, a set we’re going to denote as “A.” Coincidental with, and a component of, the potential earnings those shares might have generated were potential liabilities that would accrue if the investments went bad; all of which were secured by bundled real estate mortgages, auto loans, boat loans, RV loans, loans to buy airplanes, and credit card balances. Unfortunately no one knows to what extreme limits those liabilities could prove to become; a few trillion to multiples of tens of trillions. Everything depends on how many folks find themselves in a spot where they’re unable to keep making the loan payments. Every day there are more and more of them.

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While the upside is a fairly well known $X, the downside is ($Xxy). And there are no investors locatable willing, or able, to pay some specific fraction of $X so long as ($Xxy) adheres to them. Yet, until the set A can rid its books of those assets, as with you and your anvil problem, whatever good assets are held must be held to cover the possible negatives, thus negating their use for more propitious investment alternatives such as business loans, home loans, auto loans, and the like. 

Oh, by the way, I used X because that generally represents an unknown quantity, or value. I used ($Xxy) because the parentheses represent negative unknown values, and these are really out there way, way into the unknown. But they’re a lot. (Sort of like what Donald Trump faces every time he decides to get married.)

The core problem is how to get them off the books of A when no one can or wants to buy them?

Treasury’s solution is: enticement; a lot of enticement. Here’s how it’s projected to work.

The government will go to Buyer B and tell B that if B will buy A, the government will subsidize the purchase 92%. In other words, suppose the speculated value is $1,000, the government will underwrite (guarantee) $920, and B will be on the hook for only $80.00. If the deal proves profitable, the government and B will split the profits 50-50.

At first blush, while it all seems a tad hazy neither does it sound all that bad, especially given the present circumstances, which range anywhere from terrible to apocalyptically worse.    

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But remember, no one really has a clue what those assets are worth. The transaction between the government and B thus recalls Monty Hall’s Let’s Make a Deal. “Do you want to hold onto the box that I have right in front of me, or trade it for what’s behind the curtain that Carol is standing in front of, or will you trade the box for the $50 I’m holding in my hands right now?”  (With interesting frequency, however, behind that curtain was Jay astride a donkey. Other times, he might be in front of a huge billboard advertising an all-expense paid luxury cruise up the Amazon, to a private resort in some rain forest. “The value of your dream getaway vacation is priced at TEN THOUSAND, THREE HUNDRED AND FORTY-SEVEN DOLLARS!”)

It would take a foray into John Nash’s game theory to explain why you should always trade the $50 for either the box or for what’s behind the curtain, and why B should — and likely will — take Geithner up on his offer. Simplified, your total investment to that point is composed of your labors to dress up in a humiliating costume and stand in line, outside the television studio. Furthermore, the $50 was never yours to begin with, and even if Jay is riding a donkey, no one is really going to let you have either Jay or the beast of burden. Whatever you agree to is fairly risk free to you.

Somewhat similarly, the profits on those currently toxic assets, presupposing there are any, will range from 50% of $P1 through 50% $P1+X. Let’s just say P = $1,000, or 100% of the given original value stated above. Your share thus becomes 50% of $1,000, or $500. You only invested $80 on the chance to secure $500. If the deal goes sour, however, you’re only out that $80. The American taxpayers pick up the negative, which you will recall is ($Xxy).

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An "Old Army Vet" and liberal, qua liberal, with a passion for open inquiry in a neverending quest for truth unpoisoned by religious superstitions. Per Voltaire: "He who can lead you to believe an absurdity can lead you to commit an atrocity."

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