This is my third financial/economic/treasury round-up. I am not an expert in these matters so what I’ve been trying to do is bring some expert voices to the League in order to better flesh out these thoughts. If anybody wants to add more relevant links to the comments, I’d appreciate it, because this crazy treasury plan seems like bad news to me, but I want all the perspective I can get on it.
Treasury Secretary Timothy Geithner has published an explanation of his bank plan in the Washington Post:
We cannot solve this crisis without making it possible for investors to take risks. While this crisis was caused by banks taking too much risk, the danger now is that they will take too little. In working with Congress to put in place strong conditions to prevent misuse of taxpayer assistance, we need to be very careful not to discourage those investments the economy needs to recover from recession. The rule of law gives responsible entrepreneurs and investors the confidence to invest and create jobs in our nation. Our nation’s commitment to pursue economic policies that promote confidence and stability dates back to the very first secretary of the Treasury, Alexander Hamilton, who first made it clear that when our government gives its word we mean it.
Responsible entrepreneurs? Rule of Law? It strikes me that we’re working with some very misguided, very wrong-headed assumptions, and it seems Paul Krugman agrees:
The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.
To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad — I mean misunderstood — assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.
But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isn’t, that’s someone else’s problem.
Hale Stewart at HuffPo thinks the plan is “workable” however:
All of this hinges on two points:
1.) The banks wanting to sell an asset, and
2.) Private bidders arriving at a price the banks are willing to take.
These two points are critical. There is nothing forcing banks to participate in the program. And that is the real problem. And there is a big reason keeping the banks from participating: finding out that various assets aren’t worth anything.
However, assuming banks are willing to play this isn’t bad. I would change a few things — the most important being the government provided leverage. I think the private sector should pony up a whole lot more. But that’s just my opinion which is completely unsolicited.
In addition, no plan is perfect. There are no guaranteed solutions to any of our problems right now. Specifically, nationalization has a ton of problems associated with it. However, overall I think this is workable.
Brad DeLong has a good FAQ on the Geithner plan for those of us who are still rather muddling our way through all of this. He also divides the world into four groups of people, though James Joyner feels left out.
John Cole prefers the use of analogies, which are always nice:
If this were a medical emergency, it appears it would look something like this:
The Illness- reckless and irresponsible betting led to huge losses
The Diagnosis- Insufficient gambling.
The Cure- a Trillion dollar stack of chips provided by the house.
The Prognosis- We are so screwed.
If these guys are right, this will be the undoing of the Obama administration. Better enjoy this four years, libs.
This should be a major concern – however – this sort of plan has the potential to assuage the real pain for an indefinite period of time. It can prop up the banks and the economy, but the fact is the emperor will still have no clothes, the banks will be floating on bad assets that are cloaked as good assets, and the tax payer will be under water propping those up with an endless stream of credit to keep those “too bigs” from going under. So even if the plan works in the short term, it’s based on so many flawed assumptions that perhaps two years, perhaps five years down the road the rug will be pulled back out from under our feet. So Obama may very well take credit for success now and be reelected, but that doesn’t mean that come 2016 we won’t be looking at another failed Presidency and another failed economy.
Clay Risen is also dubious over some of these many assumptions:
The plan is to set up an auction, in which investors use large chunks of government money to bid up the price of mortgage-backed securities. I’m no expert, but two problems seem readily apparent. First, while I can see why an auction is great for under-capitalized banks, it seems a pretty bad way to “protect the government from overpaying for these assets.” After all, these are the same people who overvalued these assets in the first place.
Second, I’m wary of the idea that we can ever return to the market conditions that set the original value for these assets–which is the critical assumption underlying the plan. That moment, which came to a crashing halt last fall, was predicated on a delicate spiderweb of flush banks, complex investment vehicles and greedy and/or gullible counterparties. None of those exist today. We can’t go back to that just by temporarily raising the value of mortgage-backed securities, and we shouldn’t want to even if we could.
This means several things. First, one of the things you might think that an auction would do would be to help us to figure out what these assets are really worth. But while the auctions of troubled securities might do that, the auctions of troubled loans will not. They will, at best, help us to figure out what those loans would be worth if they had no downside risk. That’s a different thing entirely. And it means that this auction will be useless for figuring out what those loans are actually worth.Second, buyers will presumably pay more for these loans than they would have done had they had to assume their risks along with their potential gains. This might help overcome the gap between what buyers are willing to pay and what sellers are willing to accept. But it does so by artificially inflating the price of risky loans. Since we, along with the private investors, will be paying these artificially inflated prices, this is a subsidy to the banks, and should be recognized as such.Third, it’s worth reemphasizing this point: we, the taxpayers, assume a lot of the risks under this plan. This is one reason why, as Paul Krugman says, it’s a huge gamble on the proposition that the assets in question are undervalued, and will regain their value as soon as the economy returns to normal. If that’s true, then we will probably get our money back, though we won’t do as well as we would have done had we paid market prices. But if it’s not, then we will be left holding the bag. And it’s a very, very big bag.
Meanwhile, Simon Johnson makes a good point – essentially, that our financial system itself is the problem, and we need to change it radically if we are to avoid this mess in the future:
In any case, our top political leadership needs to really sell some version of the following message. We let the banks get out of control and the cost will be enormous; our debt/GDP ratio will in all likelihood rise from around 40% to over 80%. We cannot afford to have the same problem again. We must break the power of banks before they break us all. And if you don’t think banks can do that much damage to economies, just look around outside the United States – the world is full of countries where growth is slowed or distorted by a financial system that becomes too powerful. This is not about tweaking the existing U.S. regulatory system; it is about complete change and – in many senses – turning back the clock to a financial system that was simpler, smaller, and much less dangerous.
And this is the point that I’d like to make with this third round-up. I’m no economist, but it seems very obvious even to a layman such as myself, that the system is not only too complicated, but unnecessarily so and with very, very bad results. This sort of complication is not merely one of mechanics but of illusion. The banks want us to see them as something they aren’t – too big to fail. I don’t believe this. I believe that the nature of their bigness is the very impetus for their failure, and that the only way forward is for a complete take down of the banks. Let the government go in there and take them over and break them up and put restrictions on the size and scope that they are allowed to operate at. No financial institution should be allowed to be this big or to receive this much federal assistance.
Obama is in a position right now to walk one of two roads: either he will go the corporate route, leading the governments charge to save the banks, or he will go the road less traveled and use his political capital to institute radical reforms to our financial system. Right now, under Geithner, it looks as though we’re seeing more focus on bailing out the greedy bastards that got us into this mess and not ensuring that the system works in the future. This is short-sighted and stupid. I expected better from this administration.
As commenter Bob put it:
I’m fast getting to Peter Townsend’s position, “meet the new boss, same as the old boss.” Obama increasingly sounds like a well spoken Bush. I can’t believe I said that.
But it’s becoming fast apparent that this may be the case. Andrew Bacevich, in The Limits of Power, describes the American political system as being ruled by one party: The Incumbent’s Party. How sad that this is still the case. So much for the hype. So much for change. I hope I’m wrong…