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The Paulson plan transfers potential mortgage default costs to the government. If banks don't fail and the mortgages do, the government is on the hook where they otherwise wouldn't be. The Brown plan doesn't diversify banks out of their risky assets, but the rest of the country (the non-financial sectors that actually employ people) is less likely to see the treasury diluted (inflation).
If the financial shock is small, the Brown plan is better as banks eventually recover and hopefully smarten up. If the shock is 1929, you'd rather not have bailed out the banks as wasting scarce public resources on such an employment-inefficient sector might trigger reflexive financial tipping-points; you'd rather have let the banks fail and saved the economy (subsidize daycare, teachers, nurses, home retrofits, wind turbine manufacture)...
An economic depression is a messy but effective way of addressing GHG emissions. Poor people buy counter-cyclical goods, for the record. Canada has made a mistake by electing a government that caters to the rich.

Phillip Huggan: if the banks have a capital/asset ratio of (say) 10%, then every 1% decline in the value of the banks' assets causes a 10% decline in the value of the banks' equity. So government equity investments in banks under the Brown plan would suffer a 10% loss. If the government purchased the assets directly under the Paulson plan, the government would only suffer a 1% loss. But the government would need to spend 10 times as much under the Paulson plan to achieve the same effect on the banks' capital/asset ratio, so the loss to the government would be exactly the same in dollar terms.

Nick-- How does buying (or selling) assets reduce leverage? How does changing the composition of the LHS of the balance sheet affect the RHS of the balance sheet?

Think about the difference between assets and capital. Then you'll understand the difference between that original Paulson plan and the Brown plan.

And when you consider the only way in which the purchase (sale) of assets can increase capital -- you'll see why it was opposed by so many players.

Nick, you're saying the Brown plan is better because it is less leveraged (not 10x, but I get the point)? I thought the whole point of the bailout is to create leverage; broadly, to try to make up for a vacuum in demand for safe assets/instruments that used to be bundled with subprime mortgages. I don't think the goal is for central banks to play sovereign wealth fund and try to time a real estate cycle. This is all a smoke and mirrors psychological ploy: both plans intended to spend $750B, didn't they? If the question was leave taxpayers on the hook for $75B or $750B, that's easy. But I think the question is $750B worth of mortgages vs $750B of mortgages, business loans, financial services and computer generated geckos.
Banks lent too many mortgages and I guess they feel it's safer (near-term) to leave one bubble than pop both the financial services and the housing bubble...
If fat-cats can't handle the leveraging power, reign in leveraging ratios.

As travis fast suggests, agency and scale effects are potentially important.

I suspect that most economists in that 'consensus' would emphasize transaction costs which would include but not be exclusive to agency issues.

Of potential political marketing importance, equity positions give the state a more direct say in window-dressing issues such as executive compensation.

Of a related concern is the risk of beggar-thy-neighbour policies such as increasing the maximum amount of insured savings deposits.

Ultimately a mixture of policies may provide learning-by-doing potential.

The difference is that it's easier to ask for 250 bln to buy bank equity than it is to ask for 2.5 trln to buy debt (assuming again that 10X leverage). Political resistance is dependent first and foremost on the headline number, not the details.

Economizer: I think you are right to bring up both the LHS and the RHS of the balance sheet (and I confess I always have to re-learn which is which every year I teach how banks create money). This is the way I think of it:

Under the (original) Paulson plan, the government buys a $100 mortgage from the bank, paying cash. So far no change in total assets and liabilities, or capital, or leverage, for the bank. Just a change in composition of assets. Second step is that the bank uses the $100 cash to pay off $100 of its liabilities (to save interest), so now assets and liabilities both fall by $100, the bank's capital is unchanged, so leverage falls, and the capital/asset ratio rises. (And the third final step is that the Central bank sterilises the cash injection by selling $100 of T-bills.)

I agree that if the second step doesn't happen, if the bank continues to hold the $100 cash (or swaps it for $100 in T-bills when the central bank sterilises), then the Paulson plan would not reduce leverage or increase the capital/asset ratio. But since the $100 in cash (or T-bills) is a much safer asset than the $100 mortgage, a capital/asset ratio which was previously inadequate for the average riskiness of the bank's asset portfolio becomes adequate for its now safer portfolio. (Leverage is not a problem if you borrow to invest in 100% safe assets).

Phillip: I am not saying (at least not in this post) that either plan is better; I am saying that (at least at first glance) both Brown and Paulson plans are the same (and that common arguments used to show the Brown plan is better than the Paulson plan are fallacious). The Brown plan has 10 (or whatever) times the leverage of the original Paulson plan, and so $1 under the Brown plan has 10 times the effect of $1 under the Paulson plan, but then the risk to that government dollar is also 10 times as great under the Brown plan as under the Paulson plan. So a $1 Brown plan is identical to a $10 Paulson plan. Both have the same benefits in helping banks; both have the same risks for the taxpayer.

Travis and westslope: Yes, I think agency, scale, and transactions costs are the key (all of course ignored in my post). But I didn't see any economists citing such costs as the reason to prefer Brown to Paulson. I did see economists say that it would be difficult for the government to put a value on the assets it buys under the Paulson plan, but then exactly the same problem arises when the government purchases equity under the Brown plan. To properly value equity in a bank, you would seem to need to value ALL the assets (and liabilities) of that bank. Of course, Brown could hope that the market is correctly valuing equity. But then Paulson could equally hope that the market is correctly valuing mortgages. Dunno.

Matt M: (sorry, I missed seeing your post when writing my post above): I have an awful feeling that you are exactly right. What makes it awful is that economists, not just the punter on the street, seem to have fallen for the same "headline number" fallacy.

For more on leveraging ratios, The Naitonal yesterday mentioned Canadian banks need to keep 7% of Tier 1 (?) assets on hand in cash, while in the USA this ratio is 6%. In the USA, homeowners can walk away from mortgages that go out of the money, while in Canada they can presumably be sued or something if this happens. So both banks and mortgages are slightly safer assets here.
So, say banks are leveraged 14/1 here, and 17/1 there. And mortgages, IDK, maybe average 2/5 is paid for already here, and with their subprimes and walk-away rule, maybe only 5/16 are paid for there. 14/2.5 here is banks are 5.6 more leveraged than mortages. 17 divide 16/5 is 5.3125 USA banks/leverage ratio. At the same time, business loans are much safer than mortgages, especially in the USA. Maybe a banks assets are 40% business loans and 40% mortgages. No real point to this post other than to highlight mortgages are leveraged too. If the rest of the world is subsidizing home ownership, we'd live longer by keeping the money in public coffers for education and healthcare spending. The rest of the world is reducing longevity.

Nick Rowe's optimism that Paulson had a plan, and that the plan would work at market rates, has never been substantiated. (If it had been, I would think about agreeing with him.)

Paulson was going to, and may still intend to, buy assets at "market rates" (note the quotes): rates approximating what he thinks the assets should be worth.

Let's say I have $1T market-value of those. Paulson is going to spend $700B. They're currently worth maybe 30-40 cents—let's be nice and say 40; the math is easier—on the dollar, which means I have a face value amount of $2.5T.

If you're paying the current market value $700B = $1.75T face. So 70% of the available paper goes to the Fed,* and there is a lower supply out there which might get demand going again.

THAT could have worked. Not the way to bet, but a possibility.

What Paulson said was, well, we'll just spend something closer to what those securities should be worth. And if they're not, well, we'll get equity from the banks when we sell the paper in a year or two.

But look what happens if Paulson pays, say, 60 cents on the dollar--a 50% premium to the market.

Two things: (1) Paulson can only buy $1.16T face of the securities; less than 50% of the total holdings and (2) other market participants never find out what the supply level might be in the gap from current market value (40%) to Paulson Price (60%). So if there really is demand around the 45-55 range—so long as someone else goes first—the market never finds it, and you spend the $700B and the patient is still in cardiac arrest.

So the Brown plan—take the money, and spend it to make money, and by the way, we get voting rights so if you screw around with it, there will be Consequences—is better than the Paulson Plan just because it has a chance of working. (The Paulson Plan, which will take no voting rights for "preferred" stock is just lunacy.)

Stephen Gordon's second plan (which I've seen variations on elsewhere) is more likely to work; $700B, as I noted a while back, could buy you the three remaining large US IBs and four large banks. Not to mention what you could do with GOOD management, instead of having Vikram Pandit or John Mack running the firm.

*Actually, somewhat less, because demand takes the price up some, so maybe by the end the paper is selling for 45-50 cents on the dollar, and the market can again trade.

Nick -- I'm afraid that's not the original Paulsen plan. Ken has the bottom line right above -- Paulson intended to buy the assets at above market value -- resulting in increased capital for banks. The way you describe the plan, it would have both been unecessary and useless.

Uneccesary because banks have plenty of liquid assets. If all they wanted to do was shrink the book, they could. Useless becasue shrinking the book is the last thing the US government wants banks to do. They want to prevent a credit crunch, not facilitate it.

What you've missed is that selling the assets to the Treasury at market value would not have improved capital ratios. Since the US equivalent of HB4855 went through, securities that are HFT or AVS are on the balance sheet at market value already. Selling them at that value does not improve capital ratios. And liquidity was not the biggest problem US banks had.

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