Breaking the Toxic Asset Pricing Logjam

The previous post listed several reasons that the PPIP would best be implemented by simply having the government purchase loan pools directly, modify any defaulting loans, and then issuing notes based on the loan pools. In addition to the reasons set forth in that previous post, there is one additional, very significant role that the government can play in addressing the problem of toxic assets that no other entities can effectively accomplish. The issue of pricing the toxic assets has apparently not yet been seriously addressed, but it will be addressed sooner or later. However, as many have noted, there is a wide gulf between estimates placed on the value of toxic assets by banks and estimates placed on the value of those assets by potential buyers. Given that gulf, it is unlikely that many assets will be sold. However, it was also noted in the previous post that the problems causing difficulty in valuing those assets can be sensibly addressed, and that sensible analyses can then be performed to better estimate the value of those toxic assets. Of course, there may still be resistance by parties on either or both sides to accepting any values so calculated. If the PPIP relies on private parties to agree on mutually acceptable prices for the toxic assets, even more accurate valuations may not result in many successful purchases of those toxic assets.

However, if the government intervenes to purchase the toxic assets directly, then reticence to accept the estimated values placed on the toxic assets will not unnecessarily hinder the purchase of those toxic assets. The government has at its disposal two powerful tools for encouraging even reticent banks to sell their toxic assets at fair prices. For the time being, I will not elaborate on either of those options. Suffice it to say, though, that either tool could effectively break the logjam that we may experience if the private parties and the banks cannot find mutually acceptable price estimates for the toxic assets.