Business Law Prof Blog

Geithner's Plan: They're All Fannie Now

Geithner's new ambitious plan hinges on one assumption -- some financial institutions are too big to fail. Once one buys into that assumption, government intervention becomes inevitable.  The banks that are too big to fail have the implicit backing of the United States government and the United States government must take steps to make sure that those banks do not misuse the implicit guarantee.  We therefore need a bigger, badder regulatory agency, more regulatory powers, and a right to take over financial institutions that are insolvent.  Inevitability, the regulation must go global, as the institutions must be stopped from moving offshore to do what they cannot do here.  The alternative, now dismissed, is that no financial institutions are too big to fail and that those financial institutions that make bad bets will cost those who own them and run them their investments and salary.  This system is the one we, more or less, used to have.  Once we leave it, we cannot go back.  This is a one way ratchet to global government financial regulation.

AIG: And Worse

Now there is news that AIGs successful subsidiary businesses, real insurance companies, are suffering from the pasting taken by the holding company executives over bonuses.  Moreover, competitors in the insurance business are complaining that the insurance company subs, too retain business, are aggressively offering lower rates "subsidized by the government."  And, by the way, Senator Dodd's wife was on the board of one of the subs.

Geithner's Toxic Asset Plan: Can It Be Gamed??

I hope Geithner has stopped all the ways to game his proposal.  I am not hedge fund guy, paid millions to game the markets, but I suggest the following.  A hedge fund makes an investment of $7 in a bank's toxic assets and, under the program,the government matches the investment with another $7 and with a loan for $86.  The fund then hedges its risk with a default swap, written by the selling bank itself perhaps for a small fee (added to the purchase price), for a $7 loss if the investment (on resale or collection) does not pay back the loan with interest and $14.  The result?  All upside to the fund, all downside to the government with the largely free use of government money. The incentive for the fund?  Take huge risks on the worst bank assetsin order to make a killing with government money.  Will the government stop the hedges?  Not if it wants private money to get in the program.  No wonder the financial stocks are soaring: another opportunity to play the government for a sucker.

Sweden: A Raw Capitalist Compared to the US

We have been lectured by China on monetary prudence and now we are doing something that Sweden will not due, bail out car companies.  Sweden refused to bail out Saab.  "Let the markets decide," Sweden announced.

Government Prints Money

We used to laugh at small country dictators who, once having ruined their country's economy and having borrowed beyond their country's capacity to pay, decide to inflate their currency.  Their inflated currency worked for a short period of time, allowing debt repayments with cheap cash, and then created hyperinflation.  The United States, through the IMF, used to lecture these small country dictators on the inappropriateness of the tactic -- advocating reduced government spending and balanced government budgets.  Now, we are the violators.  The government is buying billions of its own debt (Treasuries and Fannie and Freddie debt) from banks and crediting the banks with cash through the banks accounts with banks in the Federal Reserve System.  It is the equivalent of printing money; it increases the supply of money in circulation and, unless reversed, will lead to hyperinflation.  The government believes they can time the credit markets -- increase the money in circulation and then, when inflation appears, decrease funds in time to stem inflation.  It is a dangerous gamble, too dangerous.