Friday, September 26, 2008

The government would have to pay more than the fair market price for these securities anyway. Warrants just make it less of a bad deal.

With regard to Mark Thoma's September 26th post, "Equity Warrants and Asymmetric Information":

The bigger reason is not asymmetric information; it's that the government would not be paying the market price for these securities anyway. They are worth too little -- in their real, fair market value, not just their fire sale value. It would too likely inject too little capital to prevent a severe liquidity crunch and recession.

It's not like these securities are worth $10, and that's what the government would pay, but when you add warrants that are worth $2, now the government will just have to pay $2 more, and so it gets them nowhere. The government was never going to pay $10 for these securities in the first place. They were going to pay like $15 for securities that were only worth $10 if they didn't want to take a significant risk of disaster. If you add the $2 of warrants it's better because the firms still get the $15 of capital that's necessary, but at least the government would now get $12 of value in return instead of just $10 -- It cuts down on how much the tax payers are giving away to the current managers and shareholders.

The best thing as I've said before would be just that the government buys (takes over) these companies for what they're really worth -- little or nothing -- then they inject the funds, buy the toxic securities, etc., and then sell the companies back to private buyers for a far higher price. This way the tax payers get the whole benefit of the huge cash injection, rather than the existing shareholders and managers.

Mankiw's a well trained and intelligent economist. He knows that Miller-Modigliani explanation was misleading. Why does he deceive for the Republicans? Well, I've listed reasons in the past which I'll reprint here:

There are several reasons why an economist might intentionally mislead for the Republicans:

1) There are relatively few successful university economists who support the Republicans, so there is much less competition for plum and high paying jobs in Republican administrations and propaganda tanks. Becoming a Republican crony can mean a lot of money and/or very high level government jobs, like Mankiw's job as Chairman of the Council of Economic Advisors in George W. Bush's administration. He's also currently a fellow at the American Enterprise Institute. Mankiw has a strong incentive to please the Republicans by misleading for them.

2) He may be an extreme Libertarian (more economic than social obviously), and very willing to mislead for that cause, even if he knows it hurts total economic, scientific, and medical growth greatly, and embarrasses him professionally.

3) He may be very Plutocratic, and very willing to mislead for that cause, even if he knows it hurts total economic, scientific, and medical growth greatly, and embarrasses him professionally.

4) He may have Slipperyslopeaphobia -- for details see my blog post.

5) A well intentioned reason -- He may think he can affect change to the historically disgraceful and brain dead Republican party better from the inside than from the outside, and in order to stay inside he can't displease those in control too much.