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Friday, September 26, 2008

Would the Cantor Plan Solve the Crisis?

From Brad DeLong:

**Sigh:** House Republicans and the Press, Brad DeLong: Hoisted from Comments: anonymiss:

Grasping Reality with Both Hands: You gotta comment on the current House Republican insurance plan. Time Magazine seems to think it's a real plan, not a Potemkin plan. I have no idea, but I think the people at Time are morons, so you MUST let us know if this is real or more nonsense from the guys who brought you "get rid of the capital gains tax! That'll fix everything!" http://www.time-blog.com/swampland/2008/09/the_republican_alternatives.html

Anonymiss is citing Karen Tumulty:

Politically at least, the [Republican Deputy Whip Eric] Cantor plan has a lot of appeal. By insuring these junky mortgage-backed securities, rather than buying them, the government presumably wouldn't be spending nearly as much money. In fact, it would be getting money from Wall Street, in the form of premiums for this insurance. This scheme would function sort of like GNMA. The very process of insuring these assets would help solve one of the biggest problems: Nobody knows what they are worth.

The problem, at least in the eyes of Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke, is that, while it would help the situation, it wouldn't work to stabilize the markets as well as their plan would.

Here's how it has been explained to me: Last winter and spring, when Treasury and the Fed analyzed a lot of options out there for what to do, they considered this insurance option. They decided that because the insurance option would leave the bad stuff on the bank balance sheets, it wouldn't give the banks the additional liquidity they need. They also believe it wouldn't create a market price that can stimulate trading, the way a purchase program would.

I'm not any kind of an expert on this stuff, so I don't know who is right here...

Let us see. On the one hand, the Treasury Secretary, the Federal Reserve Chair, and their staffs. On the other hand, an unstaffed Republican Chief Deputy Whip Eric Cantor who has not a plan but a plan to have a plan to ask the Treasury to design a different plan than the plan the Treasury thinks is best.

Cantor calls for "the Treasury to design a system to charge premiums to [mortgage-backed security] holders to finance [government-provided] insurance" against defaults.

The Fed and the Treasury have been looking at these issues since at least last winter. I suspect that the Treasury and Federal Reserve staff have decided that such federal government-provided insurance is indeed something we want to try to work toward as part of our financial system after the crisis is over--the "commitment fee" due in 2010 in the Fannie/Freddie nationalization makes no sense otherwise, for it is such a fee for the insurance on mortgages and mortgage-backed securities that Fannie/Freddie have gotten for free in the past but that Treasury wants to charge them for and also offer to others staring in 2010. But my belief is that Treasury and Federal Reserve staff have also judged that it won't work well enough to be a useful tool in handling the current crisis for speed-of-implementation reasons: we need to move to asset purchases--that banks need liquidity now, and we need functioning markets where securities are priced now, and you can buy assets a lot faster than you can set up insurance schemes.

Confronted with these two sets of opinions--a single unstaffed guy who is an expert in rounding up and feeding Republican House members on the one hand, and the Treasury Secretary, Federal Reserve Chair, and their staffs on the other, Karen Tumulty says "I don't know who is right here" because "I'm not any kind of an expert on this stuff."

So why doesn't she give her space at Time to somebody who is an expert, and does know who is right here? This is he said-she said journalism as self-parody.

Why oh why can't we have a better press corps?

And, beyond the fact that the proposal can't be implemented fast enough, I don't see the big savings either. The losses will still be there (assuming whatever confidence effect that would occur with this proposal wouldn't be substantially different from the confidence effect from a direct purchase of distressed assets, and I don' see why it would be), and there would be revenue from the equity warrants just like there is revenue from the insurance premiums, so where are the big savings? There are also higher administrative costs under the insurance proposal (and all the usual market failure worries such as adverse selection to worry about in the program design).

It can't be accomplished fast enough to help with the current crisis, there are no big cost savings associated with using this program to solve the crisis (even if it worked), so what's so attractive about it as a solution to our immediate problems?

Ah, I just found more from Justin Fox:

More on the Cantor plan to insure everybody's mortgage, Curious Capitalist: I've been doing a little checking around on Eric Cantor's idea to insure everybody's mortgage, which ... is now generating some talk ... of a blended plan that would combine increased insurance with purchases of mortgage securities. ...

The government already insures half the mortgage debt out there, Cantor & Co. argue, so why not just insure the rest?

It turns out that people at Treasury and the Fed actually did discuss expanding mortgage insurance when they were tossing around ideas earlier this year for halting the mortgage meltdown, but decided it wouldn't have nearly the impact on getting markets moving again that buying mortgage securities outright would.

When I emailed Mark Zandi ... of Moody's Economy.com ... he responded with that same worry plus some others:

Seems to me it doesn't address the fundamental problem that there is no market for these securities. How can you write insurance on these securities unless you know the risks you are taking and you can't know that unless you have a market. Reminds of that pink floyd song. Anyway, this is a much less effective way of addressing the problem and would very likely cost taxpayers more than the tarp. Perhaps most importantly most immediately is that since it is not clear how and if it will work it won't stabilize financial markets.

When I emailed back to ask which Pink Floyd song, Zandi was unresponsive. Anybody got any ideas?

Then I talked to Lou Pizante, a veteran of the mortgage-securitization business who now runs Mavent, a maker of compliance software for mortgage lenders. He pointed out the only way for the Cantor plan to work actuarily was for every last one of those $6 trillion in mortgage securities to be insured. Otherwise you'd just get the financial institutions with the crappiest loans on their books choosing to participate--which would amount to a giant bailout of the bad guys by taxpayers. So I'm not sure how you could do a blended plan of insurance and purchases, since you've got to insure everybody.

Finally, even if you do get every last mortgage in the country covered by insurance, there's the issue, mentioned in my earlier post, of figuring out to price it. Too cheap and it's a bailout, too steep and you make banks' problems worse. Which is true of the original Paulson plan as well, of course. But that plan is much more upfront about being a bailout.

    Posted by on Friday, September 26, 2008 at 10:53 AM in Economics, Financial System, Market Failure | Permalink  TrackBack (0)  Comments (53)


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