Back in December 2008, Ben Bernanke was considering whether to print money (see Bernanke ticking off another inflation trick- buying Treasury securities). Last week, the Fed finally pulled the trigger. The reaction in the currency market was swift- the US dollar was sold down.
Today, US Treasury Secretary, Timothy Geithner announced a Public-Private-Investment-Program (PPIP) plan to revive the banking system. It was portrayed as the best-of-both-world type of plan because being a partnership between the public and private sector, the ‘expertise’ of the private sector will be utilised to value toxic assets. The reaction from the equity market was swift- the Dow Jones rallied more than 6% in one day.
From this, we can see that the government will do anything and everything to try to ‘cure’ the Global Financial Crisis (GFC). But no matter what they do, these two fundamental truth remains: (1) There’s no such thing as a free lunch- there’ll be painful losses and (2) Someone has to pay for it. So, who’s the one paying for all these losses? No prize for guessing- all of us, the tax-payers.
In the first case, printing of money sounds like a free lunch. But in reality, as we said before in How to secretly rob the people with monetary inflation?, the tax-payers will have to foot the bill eventually, in the form of price inflation.
In the second case, let us describe Geithner’s plan with a given example:
- Suppose you are a bank with a toxic asset that has $100 face value. Let’s say, the market is only willing to pay $20 for your ‘asset.’ What can you do?
- Under the Geithner’s plan, you approach the FDIC.
- The FDIC will auction your ‘asset.’ Now, this is a funny auction. To understand how funny it is, read on.
- Let’s say the highest bid by an investor is $84.
- The FDIC will lend the investor $72. This loan is a non-recourse loan. If the investor defaults, the FDIC cannot go after the investor’s other assets.
- The remaining $12 will be split between the investor and the Treasury. That is, the investor will pay $6 while the Treasury will pay the other $6.
- That toxic asset will be the play-thing of the investor (under the watchful eyes of the FDIC). Any profit from the sale of the toxic asset will be shared between the investor and the Treasury.
No matter how the government cut it, most of the risks are dumped on to the tax-payers. For the investor, it is like a cheap call option or a highly leveraged non-recourse margin loan at a very low interest rate.
Tags: Ben Bernanke, Geithner, PPIP, quantitative easing
