Having your price (and eating it too)

Consider two parts of Tim Geithner's new banking proposal. The first is an argument Treasury makes in support of the plan: private-sector price discovery. The Treasury fact sheet says that "to reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program." The second is the explanation for how the private sector investors will come up with the money to buy the assets: "non-recourse loans will be made available to investors to fund purchases of legacy securitization assets."

Since non-recourse loans are loans in which the borrower does not bear the risk of loss, the government is subsidizing the program's purchases. But if the government is subsidizing the purchases, why should we reassured that the private sector will accurately price the loans and securities in question? Aren't those prices, by definition, subsidized?

I can understand the advantages of price discovery: the private sector has better incentives than the government to come up with prices that reflect the assets' real worth. And I can understand why the government might need to subsidize the purchases. If you think investors are being excessively risk averse coming off their real estate high -- just as they were being insufficiently risk averse while riding it -- then it makes sense for the government to encourage them. But I don't think you can have it both ways. If the investors are too risk averse and need a nudge, why assume they'll discover the right prices? And if they'll discover the right prices, why do they need a nudge?

Reconciling the two requires constructing a difficult argument -- namely, that the private investors' ability to price assets is better than the government's, even though the private investors are too risk averse to get into an otherwise profitable market.

I can see why Geithner's op-ed in the Wall Street Journal mentions price discovery, but not the non-recourse loans. It's more comforting to think about the advantages of price discovery than the disadvantages of risk-free lending. But pretty soon we'll have to do more than think about this.