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Shuts and Failures

by Michael Maiello

Deadman's picture

Public-private partnership proposal poses plenty of problems

by Deadman 3/21/2009 - 3:12 pm   |

Oh goody. Looks like we're about to hear the details of Geithner's long-awaited financial stability plan, which has as one of its key components a public-private investment pool designed to help rid our system of the toxic assets rotting away on bank balance sheets.

Apparently, the Treasury will hire four or five private investment managers to run a fund that will purchase the assets. The government will then match whatever monies the private firms manage to raise and invest.

Sounds simple enough on the surface, but is it just me, or do bad things generally happen when government and the private sector get into bed together?

What often ends up occurring is one of two things:

1) The private companies - because they get all sorts of government breaks and incentives, including in many cases the assumption of losses should really big disaster strike - end up making decisions that do not properly assess risks vs. rewards, resulting in ultimate failure, whereupon the government must become more fully involved anyway. It's exactly the kind of privatizing profits, socializing losses phenomenon we've seen with the current crisis. And it's the taxpayer who gets screwed.

2) OR, public policy concerns get in the way of maximizing profits, and the government feels like it must step in to protect the interests of the American populace. In this case, the private enterprises get screwed, and are either forced to alter their investment strategy in inefficient ways or watch as their investments or 'outsized' gains get confiscated in one manner or another.

We saw both 1 and 2 when it came to the Fannie Mae and Freddie Mac disasters, and watching the AIG fiasco unravel is like watching the same story over and over again.

Though your ideology may affect the way you ultimately view the AIG situation - either management knows the company is too big too fail so they are not spending the taxpayers resources wisely, or the government is being forced by public outrage to get involved in company decisions that would be better left to management - we should clearly have done one of two things: Let the company fail and allow the private markets to work their destructive magic (and risk systemic collapse as its unpaid obligations filter through) or fully take the company over and end this charade that AIG is still a private entity. Anything would likely be better than this half-assed, want-it-both-ways solution we currently are trying.

In most cases, public-private partnerships are just clever ways to try and remove large obligations off the balance sheet of the American government (but merely postpone the costs), and justified under the guise that private industry can do things cheaper and more effectively.

I'm sure there are instances where public-private partnerships have been successful (if you know of any, please let me know in the comment section), but when the goals of the two entities are ultimately so different - one wants to maximize profit, the other wants to address some sort of nonprofit-based public policy goal - it's no surprise the end result often ends up being a disaster.

Look, I know I'm doing the very thing I've been complaining about: Criticizing the new administration without giving its agenda or policies a chance (hell, in this case, I'm criticizing without even seeing the plan!).

Obama & Co. inherited this giant, sticky, complicated financial mess and are trying to be creative about fixing it without making our government go broke. There are no easy answers, and I frankly don't know what the alternatives are. But the idea that we're employing the same basic strategy that helped get us into this crisis strikes me as very unwise, to say the least.

This is a good post. I'm not sure that I disagree, but allow me to play devil's advocate. You write,

"The private companies - because they get all sorts of government breaks and incentives, including in many cases the assumption of losses should really big disaster strike - end up making decisions that do not properly assess risks vs. rewards."

Isn't that the point? Private companies don't believe that the toxic assets currently offer enough reward for the risk. But because there is a compelling public need to buy the assets, the government has to incentivize investors to buy something that they otherwise would not touch.

So the government component is clearly necessary, but what about the private side? I'm sure that DF would argue that the action should be wholly public, and it seems like you lean that way too. Again, I'm not sure that I disagree, but one benefit of the private component is that risk-reward is still a factor. An ineffective government official might substantially undervalue the assets to the taxpayers' detriment, but if he or she can't attract private investors, that suggests that the value is too low. So the private participation in effect keeps the government honest.

by Michael Wolraich 3/21/2009 - 3:38 pm

it's a fair point, and i tried to make it clear that our options aren't particularly great. A fully public strategy would positively overwhelm our balance sheet, and I'm not sure even the Fed could print enough dollars quick enough to absorb it all. (though i think the major risk is that the government overvalues these assets when buying them from the banks, not undervaluing them)

Here's the major question we need to answer: is our current crisis a matter of the markets being too scared and confused to properly value these toxic assets or are they indeed as low and invaluable as the market is now implying (i.e. is the 20-30 cents on the dollar we're seeing many of these assets trade at the right price level, or is it way underestimating the true cash flow and overestimating the levels of default?)

If it's the former, then perhaps this private-public partnership will work as it will remove some of the frictions and uncertainties that are overwhelming our markets. Sure, the prices of the assets may ultimately be a bit distorted by the government intervention, but it will be worth it if we can remove them from our banking system and get them to trade at higher, fairer value prices.

If it's the latter case, however, I think in the end, assuming we don't want to see the vast majority of our citizens homeless and in dire financial straits, we pretty much have to assume that these toxic assets are part of our nation's balance sheet whether we like it or not, and it's more a matter of how and when we want to absorb them.

I'm not qualified enough to judge which is the case in our situation (though my gut says it's the latter), but it's a key question.

by Deadman 3/21/2009 - 4:19 pm (re: Genghis)

We're pretty much in agreement, but my even less qualified gut says the latter. Not because I know anything about their value but because I believe that the market psyche is extremely pessismistic right now. When it's optimistic, I assume that assets are overvalued, when it's pessimistic, i assume that they're undervalued.

by Michael Wolraich 3/21/2009 - 4:39 pm (re: Deadman)

i think you meant the former, but i understood!

by Deadman 3/21/2009 - 5:03 pm (re: Genghis)

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