The improbable and the impossible

Sherlock Holmes, the brilliant detective who was invented by Arthur Conan Doyle while swatting flies in his clinic, made a very profound statement in one of his stories. He said – “when you have excluded the impossible, whatever remains, however improbable, must be the truth.” He drew a line between possibility and probability, thus stating the obvious. But, apparently, US Treasury Secretary Geithner hasn’t read Holmes. From Reuters

Treasury secretary Timothy Geithner on Tuesday said difficulty in setting a value on banks’ toxic assets was a continuing hindrance to their ability to lend and borrow.

On this, Lucas Engelhardt of the Mises blog writes

Apparently, Secretary Geithner has discovered that it is “hard” for the government to “set” the “value” of toxic assets. (Pardon my quotation marks.)

I’m sure he’s right, given that he’s simultaneously trying to:
1. Set the value so that the banks look solvent.
2. Set the value so that the assets can be sold without bank balance sheets deteriorating.

The problem, of course, is that establishing (2) requires that we value the toxic legacy assets according to what they can actually be sold for. Something economists like to call the market price. But, (1) requires that we value the toxic legacy assets above the fair market prices. No force of will or “clever” policy can change that fact.

So, it seems that Geithner has realized that a task that is logically impossible is “difficult”. At least his understanding is moving in the right direction.

I am not sure I get Engelhardt’s point. Geithner requires that most banks are “solvent” after the toxic assets are removed from their balance sheets. He also requires that taxpayers are not being “swindled.” That’s what the whole “public-private” “partnership” is about. But the banks “are” insolvent if the assets are valued at “market price” – they will go kaput. So the assets will need to be valued at way above “market price” to keep them solvent. I guess that takes care of (1). But isn’t (2) (1) rephrased, or is it a “I am insolvent to the tune of 10 billion dollars, and I don’t want to go beyond that” statement?

Whatever it is, Geithner’s “plan” is impossible purely on the insolvency-swindle dichotomy. If he pays way over the “market price,” (it can’t be determined unless there “is” a market) the taxpayer is being swindled. If he pays less, the banks are insolvent. Not difficult, but impossible. He should either worry about the taxpayer, or about the banks, or simply leave the matter to the market which will then fix the problem in its own ruthless way – by bringing down a few thousand banks.

If we call Holmes’ statement Holmes’ Razor, then “For me, the impossible is merely ‘difficult'” would be Geithner’s Razor. He should be careful with it. Otherwise he might nick someone, or something.

I read the comments on the above blog post and found a link to this crazy idea by a top economist, who’s a … Keynesian. The only things that need “targeting” are such economists and the central banks. That’s why you shouldn’t trust the government, or its currency. But you can’t trust gold either – not because of any problems with value, but because of thieves like FDR who could throw you in jail if you didn’t surrender the gold. As long as you have a State, particularly the crooked one of present day, you are bound to be fucked either way. A funny but spot-on comment – “Hey Mankiw — how’d you like a negative salary this year?”

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Comments

  • Lightonsun  On April 22, 2009 at 4:50 pm

    I think to control further shrinking of once big balance sheets the toxic assests need a value but doing that in a zilch market would make them insolvent…I never understood how something can be VALUED in a bad market….when I think of it all I see is a vicious circle

  • Lucas M. Engelhardt  On May 19, 2009 at 11:14 pm

    I just ran across this.

    The point I was trying to make was more about the balance sheet value of the legacy assets that the banks have – not the ones that they sell to public-private partnerships. (So, I was thinking about the “accounting rules” side.)

    If banks “mark-to-market” the legacy assets (which fulfills my condition 2 – banks can sell the assets without their balance sheets deteriorating), then the banks will be revealed as insolvent. If banks “mark-above-market” the legacy assets, then banks might look solvent (they’re over reporting the value of their assets), but when they sell the assets, the balance sheets deteriorate, since the proceeds are not sufficient to cover the balance sheet value.

    The case you talk about is more focused on the government purchase side, and your analysis is spot-on.

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