Rebuttal: Peter Wallison is wrong about buying bank assets

American Enterprise Institute senior fellow Peter Wallison writes in an op-ed in the Wall Street Journal that the United States government should avoid nationalizing banks by buying bad assets from banks at prices based on their cash flows rather than their market value:

Both taxpayers and banks could come out well -- and so would our economy -- if the government were to buy the assets at their "net realizable value," which is based on an assessment of their current cash flows, discounted by their expected credit losses over time.

The problem with this approach is that it requires the government to commit hundreds of billions in taxpayer money based on models of risk that didn't work: That's the whole reason we're in this mess!

Wallison says that the models take into account all kinds of doomsday scenarios, but here's one: What if there is some sort of biological attack on Florida that makes it completely uninhabitable and the value of every property there goes to 0 instantly? Then the models would be wrong and taxpayers would be on the hook for billions. Of course, that's unlikely, but the point is this: Models cannot possibly take into account every single potentiality and adjusting a few numbers in any model will change projected values for any asset.

Wallison essentially wants the federal government to go and buy assets for $10 that no one else would buy for $2 because, he assures us, the market is wrong. We have plenty of smart people who created this mess who can come up with models to show that these assets are actually worth $10. We're assured that the markets are "illiquid" and "not functioning," but that's only partly true. There are many well-financed private investors who could buy these assets. Why isn't Warren Buffett selling his entire stock portfolio to work out a deal to buy these "illiquid assets" that are trading for a tiny fraction of their "net realizable value"?

Does Wallison know something Buffett doesn't? Is he willing to bet his entire net worth on dodgy subprime debt? Of course not. But he does think taxpayers should do just that, and pay prices that are far higher than what any private investor is offering. That's too much of a leap of faith for me, and I don't see how it gels with the American Enterprise Institute, which says on its website that "AEI's purposes are to defend the principles and improve the institutions of American freedom and democratic capitalism -- limited government, private enterprise, individual liberty and responsibility. . ."

What does using taxpayer money to buy assets from banks at prices no one else would pay for them have to do with capitalism, limited government, private enterprise or individual responsibility? It would seem to be in direct conflict with all those worthy ideals. Elsewhere he writes:

In other words, Citi has marked some assets below their net realizable value, and selling them at a price lower than that value would be unfair to its shareholders. This opens a key route to a solution for the government -- buying the assets at the value that banks like Citi would be willing to sell them.

A "value that banks like Citi would be willing to sell them"? I thought they needed to sell them. If they're not willing to sell them at the price we offer -- a vulturous price based on the fact that no one else wants to buy them -- then they have every right to hold on to them! This is after all, still America, unless my GPS is malfunctioning.

The only fair way to establish prices for these assets is to use the market. If the U.S. offers $50 for an asset and no one else is offering more than $40, how is it in the best interests of taxpayers to raise the offer to $100? To protect the interests of shareholders? Because "it isn't fair"? If it's not fair then Citigroup can reject the offer and try surviving on its own. But the fiduciary duty of the Treasury Department lies solely with the taxpayers and remember: The more we pay for these assets, the greater the risk to the taxpayer and the lower the chances we have of making a killing off the troubles of Citigroup -- which should be the goal!

Here's what the United States government should do: Make an offer to Citigroup that represents a rock bottom price, the absolute minimum that the U.S. government would have to pay to beat out private investors. This is called vulture investing: preying on a distressed company's desperation for cash and willingness to pay whatever price is necessary for it -- kind of like Citigroup does when it charges college students 29.99% interest when they miss a payment.

It's a good time to remember that Wall Street banks have made billions of dollars by lending money to distressed companies and consumers, maximizing profits by charging the highest interest rates they possibly could while staying low enough not to lose the business to a competitor. If the United States taxpayer is going to buy troubled assets from the banks, it should employ the same model. And if Citigroup shareholders don't think that's "fair," then they have every right to let the company go into bankruptcy.

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