There’s a remarkable story being reported in the New York Times. It’s remarkable in itself, and also because as far as I can tell, it’s only being reported in the Times.
It’s a proposal by the Treasury for a radical way of restarting private participation in credit markets. I’m only going to give you the barest outlines of this with minimal analysis, because I can’t be sure the Treasury really means it.
For many months now, “securitizations” have come to a near-standstill. That’s the much-maligned process through which whole mortgages get “sliced and diced” into mortgage-backed securities and sold to the world’s investors.
Through a different but analogous process, other kinds of consumer loans are also securitized: car loans, credit cards, and student loans. (The goal is always to give an investor a piece of paper with a credit rating, a semi-annual coupon payment, and a maturity date. Mortgage analytics and risk management are more complicated, but beyond that, the process is the same.)
Securitization matters because banks can’t provide credit now that most of them are so far undercapitalized. Securitization is an alternate process through which investor funds are channeled into the consumer credit markets.
Except that securitization, which resulted in multi-trillion dollar issuances as recently as 2007, is now completely frozen. Only a negligible amount of new asset-backed securities are currently being issued.
So since the Treasury can’t figure out how to get banks lending again, they decided to look at securitization instead.
What’s missing from the securitization market today is leverage. There is some theory that a fabulous amount of money (hundreds of billions, at least) is sitting on the sidelines, waiting for an opportunity to flood back into the market. But it can’t purchase asset-backed securities (and thus revive consumer credit) without financing.
Up until 2007, such financing was readily provided by banks. We already know about what happened to them as a result. They got their heads chopped off.
So now, the Treasury is proposing that you, the taxpayer, should be the source of leverage for investors who want to buy newly-issued asset-backed securities. If the world’s banks can do it and only lose two to four trillion dollars in the process, why not you too?
The way this would work is that an investor would put up anwhere from five to fifteen cents on the dollar to buy an ABS (backed by mortgages, credit card receivables, student loans, auto loans, whatever). And the Treasury would put up the rest at a low interest rate.
But there’s an enormous difference between this process, and the one that all-but-destroyed the world’s banks: rather than forcing investors to take any losses on the ABS, all losses would be borne by the taxpayers.
We’re giving the world’s investors the same bubble-era opportunity to make double-digit returns on their investment, with an infinitesimal amount of risk. It's as if the government wants to save the economy by triggering another asset bubble.
You might think this is just stupid. I think it's far beyond stupid. I think it sounds just as wantonly destructive as if the government had deliberately chosen to release bubonic plague into the streets. That’s why I can’t believe I'm reading this right.
But let’s go back to the reporting. Why is this appearing only in one place? Is the Treasury trying to manage the economy by press release? Did they float this as a trial balloon to see how the public would react?
But why do that? The top people at Treasury can get the world’s best experts on the phone any time they want. Even more, they can get the world’s most powerful market participants and ask their advice.
Or can they? One thing about Henry Paulson: like him or not, he had a personal relationship with enough of Wall Street’s movers and shakers to know what was really going on at all times. It’s a measure of the difficulty of the challenge facing us that, with all that, he didn’t come up with better solutions.
But Tim Geithner so far isn’t inspiring that kind of confidence. Why is a major, major idea being floated to New York Times reporters like this?
This story also appears at MarketsAndPolicy.com.