Economies: Whoa, there Neddy: there's a fatal flaw in the plan

Obama sat at a big table yesterday and behind the smile, his brow furrowed. He delivered what he told everyone was good news. And the markets, first on Wall Street and this morning across the Asia Pacific region, bounced in glee.

Media reports across the world were full of smiling faces as business reporters lunged at the surge in share prices.

But hang on a minute. We are where we are because of a lack of risk assessment and a lack of caution. And because so many people jumped on news without working out what underpinned it.

So before joining the chorus of glee, a moment of quiet reflection might be in order.

For the past 18 months, the blame for what is termed "the global financial crisis" has been laid at the door of US money men: investment bankers and "hedge funds." They are the people who manage private equity and package it - and the investments into which it is put. There isn't anyone else to do it.

Obama says that his latest rescue package will buy up so-called "toxic assets" from banks. This, he believes will improve their balance sheets (for which read keep their capital adequacy ratios high enough to avoid regulatory intervention - and their attractiveness to shareholders) and release capital for new lending (much of which, if prudence is adopted, will be to refinance at lower rates existing business borrowing - but that's a very unlikely scenario).

Where will his billion dollars (USD1,000,000,000,000) come from?

Here's the interesting - and deliciously ironic bit - he wants it to be a "public private partnership" with the private part coming from private equity sources.

That, for those who have not yet worked it out, means investment banks and "hedge funds."

The investors will be invited to buy into packages of what amount to assets of uncertain value - we know it's uncertain because even the US financial regulators who are supposed to maintain line-of-sight supervision of bank balance sheets admit that the size of the bad debt problem is as yet unquantified.

And it can't be. In just the same way as the value of the securitised investments - or "asset backed securities" - has turned out to be nothing more than a guess (indeed, a bad guess supported by so-called rating agencies) based on an assumption that property increases would outweigh any bad debt in the bundles - the value of the new packages will be based on an assumption that at least some of the debtors will pay, and that the property of those who don't can be sold, generating enough to cover the compounded shortfall plus some useful return on investment.

The only way this works is if the value paid by the investors is significantly discounted against today's (declining) asset values. In short, the longer the investors wait, the cheaper the packages should become. Like a Dutch auction, the price paid will be gauged only when someone's nerve breaks and they buy in, fearing that it is becoming so cheap someone else will get a better deal.

So, in a combination of pawnbroking and greed, investment banks and "hedge funds" are being asked to rescue the situation they created by doing exactly the same thing they have been accused of doing to create the crisis.

Economies are cyclical and so, it seems, is the view the US government (and almost by lemming-like extension those in the UK and beyond) take of the financial sector.

Is this good or bad news? Who knows? But for sure, it's worth thinking about before assuming that a nice, safe and secure solution has been found.