We are learning more about the US Feds efforts to improve securitized mortgage markets. Specifically, the legacy loans program and the legacy securities program are designed to entice private investment involvement in turning around the credit crises. There is a good review of the Toxic-asset proposal in today’s Wall Street Journal.
The incentives have to be generous enough so as to attract private investors but not so generous that a risk free return is funded by tax dollars to the benefit of private interests. So what is a reasonable return for assuming this risk? How will these prices be established? The public purse will be best served by a wide and broad market with many participants. Some will get better deals than others but on average many participants will serve to get the prices right and move the market to an equilibrium position, balancing risk assumed and return yielded. If we end up with a closed shop -where access is limited to a few players, then the likelihood of a subsidy from taxpayers to a small number of market dominant players is enhanced. PIMCO spokesman Bill Gross has already voiced his firm’s intention to support the program.
Joint ventures between government and private investors are complex and rightly the subject of increased scrutiny by all interested parties. If you are a tax payer then you are a stakeholder. There is a big cost to focusing on limiting return through regulation. There have been a series of announcements from AIG that executives will return some bonuses. These relatively small victories act as a dis-incentive to those that are considering participation. There is a view that so called excessive future gains may be clawed back by government after the fact. Increased perceived risk (regulation) will require an offsetting increased future return.
In my view, well executed programs will result from a large number of independent private interests bidding for these assets. More participants results in better asset pricing. Better asset pricing will reduce the likelihood of subsidies to private interests from taxpayers. It is in all of our interest that the program become accessible to all parties willing and able to assume the risk. We need many participants and we should encourage bidders. We have had enough focus on punishing executives and managers of financial firms. It will not help to discourage their participation. We need to get past the need to find and punish the parties responsible for this mess and instead focus on the task at hand. Increased effort to identify and pursue manager bonuses is an unnecessary additional cost to the bailout.
