One concern that’s been raised with the Geithner Plan is that banks might be able to game it in a trivial way by setting up special subsidiaries to play in the PPIP pool. Citi could, say, set up a company called CitiPPIP and give it some money. Then CitiPPIP overpays for Citi proper’s assets, leveraging up with federal funds. Then CitiPIPP loses some money (X) and the taxpayer loses some money (Y) but Citi proper makes money (X+Y) so in the aggregate we’ve effectuated a transfer of Y from the taxpayer to Citi under guise of holding an auction.
My understanding is that this would not be allowed under the description of the proposal that I’ve seen circulated. But Annie Lowrey and Noam Scheiber have both argued that maybe this is a good thing since, after all, it would recapitalize the banks.
I don’t think that’s right. The main inspiration behind the Geithner Plan is that it’s an effort to maximize the quantity of capital injected into banks relative to the amount of funds spent by the government. Thus, it’s supposed to help improve the situation without the administration asking congress for more money. To make this work right, you want to be pulling as much additional private capital as possible into the assets market. In order to accomplish that, the administration is proposing to offer investors something of a sweetheart deal. It’s not quite “heads I win, tales you lose” but it’s more like “heads I win, tales you suffer most of the losses.” But if the banks are gaming the system, then it ceases to be a sweetheart deal for outsiders. It becomes a question of “heads I win but it’s impossible to win, tales you suffer most of the losses but since losses are guaranteed I don’t want to play at all.” You wind up with a situation in which banks are recapitalized only to the extent that taxpayers pump funds in. If you can prevent the banks from gaming the system in this way, then the taxpayer money enters the system and private money comes in.
There’s also this matter of “restarting” the market in these assets. It’s not at all clear to me that the Geithner Plan will accomplish this, but it definitely won’t accomplish it if the assets all wind up in weird bank-owned vehicles. A gamed version of the Geithner Plan would also lead to a continuation of the situation in which outside investors and bank managers disagree about the value of the assets on the banks’ books, which will continue the situation in which banks find it difficult to raise private capital. A non-gamed version of the Geithner Plan, by contrast, at least might be able to make that work, at least for some banks.
As I say, I don’t think this particular form of gaming will be allowed. And certainly it shouldn’t be allowed.