Q: But at least some economists know how to fix this, right?
A: We think so. We recommend four things:
(a) The Federal Reserve should purchase Treasury bonds for cash in as large a quantity as needed to push their prices up as high as possible. For if Treasury bonds are expensive, then investors will likely shift some of their demand to mortgage and corporate bonds, push up their prices somewhat;
(b) Even after the Federal Reserve has pushed Treasury bond prices as high as they can go, it should keep buying Treasury bonds for cash in the hope that if people's pockets are full of cash, they will spend more of it, and that extra spending will directly pull people out of joblessness and into employment;
(c) The government should run big, even extra-big, deficits so that its spending--like the government's wave of spending during World War II, like the wave of spending that followed the Reagan tax cuts of 1981, like Silicon Valley's wave of spending during the late 1990s, like the wave of spending on housing in the 2000s -- will also directly pull people out of joblessness and into employment; and
(d) The government should undertake additional measures to boost financial asset prices and thus make it easier for those firms that ought to be expanding and hiring to obtain finance on terms that allow them to expand and hire.
Q: "Additional measures to boost financial asset prices"?
A: Of which the Geithner Plan is one part. The Geithner Plan is to take about $465 billion of government money, combine it with $35 billion of private-sector money, and use it to buy up risky financial assets.
Q: Why is the government making the private sector kick $35 billion into this $500 billion fund?
A: So that they have skin in the game. The Treasury doesn?t want them taking excessive risks with taxpayers' money, buying financial assets at more than their long-term hold-to-maturity value, for example. So it?s requiring that private investors put some of their own money on the line, as well.
Q: Why should private-sector investors be willing to kick in $35 billion?
A: Because they stand to make a fortune if and when markets recover and financial asset prices rise toward normal values. The government will be taking $13 billion a year out of the fund off the top in interest, and splitting the remaining profits with the private-sector fund managers.
If the fund does well over the next five years?returning profits, say, of nine percent per year-- then the private investors get (a) a rate of return on their super-risky equity investment of 14 percent, plus (b) the equivalent of an "annual management fee" equal to two percent of the capital under management. If the portfolio does less well?say, profits of four percent per year-- they get a still-healthy but sub-market return of 10 percent per year on their equity.
And if the portfolio does badly--loses one percent per year?they still have to pay back their loans from the FDIC and consequently lose 5/7 of their investment. Those are attractive odds.
Q: Isn't this just a massive giveaway to financiers?
A: Whether the financiers who invest in and run this program will make fortunes time alone will tell. But they will be a different set of financiers than those who got us into this mess. And if they make fortunes, they will make the government a bigger fortune.
A "management fee" of two percent of assets under management per year is one that many sophisticated investors have been willing to pay to private hedge funds, and they have topped it off with an extra 20 percent of annual profits ? a fee the Treasury won?t be paying.
Q: So the Treasury is doing this to make money?
A: No: making money is a sidelight. The Treasury is doing this to reduce unemployment.
Q: How does having the U.S. government invest $500 billion in the world's largest hedge fund operations reduce unemployment?
A: The sudden appearance of an extra $500 billion in demand for risky assets will reduce the quantity of risky assets other private investors will have to hold. And the sudden appearance of between five and ten different government-sponsored funds making public bids for assets will convey information to the markets about what models investors are using to value assets in this environment. That sharing of information will reduce the perception of risk somewhat.
When assets are seen as less risky, their prices rise. And when there are fewer assets on the market, their prices rise too: it?s simple supply and demand. With higher financial asset prices, those firms that ought to be expanding and hiring will be able to get money on more attractive terms that make expanding and hiring more profitable, etc.
Q: Oh.
A: The administration will do more. This plan consumes $100 billion of second-tranche TARP money. But there is a potential second-round stimulus in September. And there is still $250 billion more left in the TARP to be used in other ways.
Q: What if this goes wrong? What if the public-private investment portfolios don't earn nine percent or four percent per year -- or even lose value at one percent per year? What if instead they lose value at a rate of 10 percent per year so that in five years the government loses half its money?
A: Then we have worse things to worry about than government losses on TARP-program money--for we are then in a world in which the only things that have value are bottled water, sewing needles, and ammunition.
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