We can see the worsening result of UK government to intervene too much in the market. The problem of UK bailout is not only bailing out assets inside UK but also assets outside UK owned by UK bank or to be owned by UK banks in the future. It means that UK government use public money from fiscal policy (causing higher debts or higher taxes in the future) or monetary policy (higher cost of fund or cost of living on high inflation) but the amount should be much higher than UK government and all expectation if you look at only the size of domesticcredit in UK.

The bailout mechanism is causing higher-than-expected public debt or higher-than-expected magnitude of central funding because of the capital mobility. When injecting money into UK banks, the money injection must cover the assets of UK-named banks, like RBS, that are flowing around the world and instead UK-named banks put money in UK, they will put most of all money elsewhere meaning that it causes the capital outflow to get the better return like ASIA-or-China assets but it would cause the higher risk if Asia or China face the same problem in the future, causing debt increase without control. Although UK banks do not put money outside UK, the liquidity in UK will cause the capital outflow from the expectation of lower return or negative return of UK currency in UK.

It is the same as the central bank facility that cannot solve the liquidity problem if there is money outflow. In case of UK, the more money injection from BOE maybe receiving from US swap line, it would rather exacerbate the higher outflow from banks and cause the uncontrollable debts and facility without exit strategy.

Doing too much (reckless intervention) may cause worse-than-expected results because of the capital mobility from the expectation on credibility of government and central bank. This is the same event happening in Asia crises, when Asia central bank support the banks at the controllable level (Asia has low public debt and affordable reserve) if considering the domestic credit figure, but the level of intervention is growing without bound until collapse due to capital outflow without bound (Asia central banks intervene near their abilities and can not reverse until all people are scare that are causing more capital outflow incentive and Asia do not control capital movement during intervention.)

No one knows whether American should consider the capital mobility effect on the intervention but the suggestion of capital control by Prof. Krugman used by Malaysia in Asia crises, may be a part of it, must be considered.

Joe Nocera describes a plan by Mike Mayo (of Deutsche Bank) that sounds awful similar to the CONDITIONAL REIMBURSEMENT idea I describe above.

That’s not surprising. It’s an obvious and practical solution to the thorny problem of valuing and purchasing toxic bank assets.

You wrote “The scale needs to be massive”, which could be amended to read “The impact needs to be massive” while the taxpayer cost could be dramatically more efficient than the TARP implementations seen to date.

I’ve been persuaded by the work of MIT’s Ricardo Caballero that there exists an efficient policy prescription. E.g., Caballero and Arvind Krishnamurthy wrote in FT.com:

The main implication of rampant uncertainty for the TARP and its relatives, is that capital injections are not a particularly efficient way of dealing with the problem unless the government is willing to invest massive amounts of capital, probably much-much more than the current TARP. The reason is that Knightian uncertainty generates a sort of double- (or more) counting problem, where scarce capital is wasted insuring against impossible events.

I strongly recommend a careful review of Ricardo Caballero’s pair of VoxEU columns (January 23rd). In Part 1, Caballero argues “that the global financial crisis is really a run on all explicit and implicit forms of insurance, which is showing up as a freezing of credit markets at all but the shortest maturity.”

In Part 2 he offers the most promising policy prescription that I’ve seen: “Specifically, I argue that an efficient solution involves the government taking over the role of the insurance markets ravaged by Knightian uncertainty.”

When I first read his December 17th essay Normalcy is Just a Few Bold Policy Steps Away I thought he was on the right track. But I don’t see that his policy prescriptions are being debated — why not?

I thought of the problems with uncertainty also. But I don’t think it is a problem, because the rules for CONDITIONAL REIMBURSEMENT can be structured in such a way that they are not onerous.

At the time that the assets are liquidated, if the there is a loss for the government, but the financial institution is incapable of making up the loss, then the liability to the government can simply be dismissed. Of course, this would mean that the government takes a net loss on the asset, but this should happen fairly infrequently. Remember, we are talking about banks which have great earning power and profitablity during good times.

Alternatively, to further protect the tax payer, financial institutions, which are incapable of making up the governments loss when the assets are liquidated, can be given extensions to make good on the loss. If after the extension they are still not capable of making up for the loss, then the liability would be dismissed.

The main point here is that finacial institutions would be allowed to recover and prosper so they could meet their obligations to make good any loss of the government on the assets the government bought from them. Knowing that these assets are guaranteed to not bring down the banks eliminates much of the uncertainty about their solvency.

At the risk of being repetitive, I will repost this comment. I think it is a good idea, though not ideal. Ideal only exists in Plato’s cave.

VALUING TOXIC ASSETS

It seems the most difficult problem with the Bad or Aggregator bank is the fact that it is next to impossible to accurately value toxic assets which financial institutions now hold. To be able to do so requires seeing into the future.

This leads to a problem of great inherent risk for the government in purchasing these toxic assets to clean up the banks’ balance sheets. What is a fair value to pay for these assets?

If toxic assets cannot be valued accurately at this point, why should the final value be established now?

I think the assets should be purchased by the government in a conditional manner. Call it CONDITIONAL REIMBURSEMENT.

Under such a system, the government would offer to purchase a questionable asset for the best estimate of what the asset would currently fetch on the open market. This may be considerably less than what it is valued at on the bank balance sheet. To make up for the loss, the government would provide capital injections into the bank in exchange for equity shares.

Over a set period of time, say three years, the government would be obligated to liquidate the asset at the best price it could obtain.

If the government ended up losing money, then the financial institution would be required to reimburse the government for the difference. Because this would happen in the future, the financial health of the bank would likely be much better (the recesssion would be in the past, the housing market would be stabilized) and the bank would be able to make up the government’s loss.

On the other hand, if the government ends up selling the asset for a significant profit, then a certain percent of the profit should be awarded to the bank in the form of a tax credit.

It seems this would be one way to ensure that the government does not end up losing money on the toxic bank assets while it also allows the banks to be made sound and solvent in the here and now.

What makes this a valid proposal is the fact that banks are enormouse generators of revenue and profit in good times. If the final reckoning of the bill owed by the banks to the federal government is postponed until after the economy has recovered, the banks will be able to deliver and the tax payer will come out ahead.

That seems to be the goal we are seeking.

Subsidiary issues: 1) “Toxic” has been a moving target….for example, 6 months ago, GE Credit paper probably traded well. Most anything is toxic today, including Louis XIV tables purchased by brokerage executives. 2) Is it possible that the traditional banking model (deposits, loans and mortgages held in portfolio) cannot be profitable? 3) One has to wonder whether the Glass-Steagal Act made sense after all. 4) While public policy is working hard to find a way out of the crisis, bank executives still seem to be clinging to the possibility of 2007 returning…until these folks get some religion, there will only be “bailouts” instead of “reconstruction”!

Don Beane

The rationale against nationalization is that we’ll have lobbying and politically directed influence in credit. How is that different that what we have now? It’s clear that the TARP-1 was a giveaway to certain non-performing banks who then gave bonuses to their employees early to avoid the shut-down. I guess I’d trust Obama’s group more than Wall Street at this point.

I think if there’s too much focus on getting taxpayers’ money back, the bailout will end up not being a bailout at all, becaused people will just factor in all the added costs to the banks resulting from the “bailout” and maybe decide that they still aren’t in good shape. If everyone starts dumping their bank stocks, won’t the US government end up holding the bag? Isn’t that de facto nationalization?

Yes, we are talking about large sums of money. But they are simply large, not so horrifically large that they should be rejected simply because of their size.

You say, “get it right the first time” and then “the scale needs to be massive”. “Right now, people are talking in terms of $1trn-$2trn”… “my sense is that we will be talking about sums in the $5trn range, or perhaps even close to 50 percent of GDP”.

That is $5trn-$7trn. What is a few trillion between friends?

Actually, there are worse things than a failed banking system. Namely a failed banking system PLUS trillions of dollars of unnecessary debt.

To mix up a few metaphors.

The way to avoid a slow-moving truck is to jump rather than stand there transfixed in the headlights wobbling. If you do not know which way to jump then jump any way and make it a big jump. Most directions will take you out of the path of that truck, and a big jump will take you well clear. You could of course be jumping straight into the truck but, hey, that’s the breaks.

On the other hand, if the light you see at the end of the tunnel is the headlight of a train coming straight towards you, and you can’t jump out of its way, then running towards it is not the smartest thing to do. For God ’s sake, run in the opposite direction!

Incurring more and more debt in the face of a GLOBAL economic collapse is lunacy. You will end up like Britain with a collapsed banking system AND £33 thousand more debt per taxpayer.

All that the trillions will have done is give the economists and politicians the get out that “we did everything we could”. Trillions to save a few red faces. A lousy deal, if you ask me.