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January 20, 2009



I'm afraid I agree, Deb. It looks like we are about to get screwed again. "Gothamsgroup" has been gifted twice and still looks like a zombie bank. At least if the govt took over, we could clean up the books and start them off fresh.


There's a subtle point that I don't think any commentator has explained: it is possible for the same institution to be insolvent under current management and solvent under new management because of what is called the "discount rate." The discount rate is the rate of return that people expect on capital.

When the federal government takes over, the cost of borrowing of the institution immediately drops. It can refinance its liabilities much more cheaply because the discount rate of the federal government is so low that it is profitable to lend to the formerly insolvent institution. It can replace corporate paper at, say 10%, with Treasury bills at 3%. The cost of servicing those debts drops by half. Although the balance sheet is not immediately altered, since the new liability is owed to the "parent corporation" (the USG), solvency ceases to be a pressing issue... except, perhaps, for the "parent corporation."

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