Why Geithner's Plan Won't Work

Short version: It's too late.

Economist Brad DeLong doesn't think so. It's a big mess of a plan that makes little sense to non-economists, but in a nutshell, this is it:

First the number -- $1 trillion. Don't even stop to let it sink it. It'll upset your stomach. $150 billion of that is coming from TARP fund already allocated. The FDIC is gonna create another $820 billion "in the form of debt," whatever that means. And then the government is going to require $30 billion from the guys that got us into this mess that they're going to hire to run the program, which will buy worthless pieces of paper from the banks in order to take "toxic assets" off their balance sheets and put them on the government's balance sheets.

Does this sound like a sound plan so far? But go ahead, read DeLong's Q&A about how it's going to work. Like, the hedge fund managers the government will hire to run this baby have to kick in $30B "so they'll have skin in the game," and they'll do it because, DeLong says, "they stand to make a fortune when markets recover or when the acquired toxic assets are held to maturity."

The operative word there being the two times DeLong says "when" in that sentence. In fact, "What happens if that doesn't happen" the one question DeLong didn't really answer when asked, although he did tell the sobering truth.

Then we have worse things to worry about than government losses on TARP-program money--for we are then in a world in which the only things that have value are bottled water, sewing needles, and ammunition

Yeah. Add to that that DeLong says the actual fix is gonna take $3 more trillion.

Further, DeLong didn't really get into the $820 billion FDIC is supposed to manufacture with something called "non-recourse loans." What that means is that the government is going to try to convince investors to partner up with the government to buy the toxic assets by waving these loans in front of their faces.

The problem is that the banks are much further gone than this. Take AIG, for example -- an insurer, of course, but all financial sector companies are more or less banks in some form these days. AIG has taken $170 billion from the government. Without it, it would be bankrupt. It's functioning still only because we gave it a bunch of our money. Lehman Brothers, for example, is no more because we didn't give it any money.

The big banks are all essentially bankrupt. Other banks might be doing OK, but under this plan, they're going to become the big banks that are now failing. Economist Paul Krugman:

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.

It's all based on whether or not the billions of dollars in bad loans are truly bad loans, or if it's a possibility that they're not really, and will eventually pull up. But nobody's actually checking to find out. They're guessing. Jamey Galbraith:

The way to find out who is right is to EXAMINE THE LOAN TAPES. An independent examination of the underlying loan tapes -- and comparison to the IndyMac portfolio -- would help determine whether these loans or derivatives based on them have any right to be marketed in an open securities market, and any serious prospect of being paid over time at rates approaching 60 cents on the dollar, rather than 30 cents or less.

Note that even a small loss of capital, relative to the purchase price, completely wipes out the interest earnings on the Treasury's loans, putting the government in a loss position and giving the banks a windfall. If I'm right and the mortgages are largely trash, then the Geithner plan is a Rube Goldberg device for shifting inevitable losses from the banks to the Treasury, preserving the big banks and their incumbent management in all their dysfunctional glory. The cost will be continued vast over-capacity in banking, and a consequent weakening of the remaining, smaller, better- managed banks who didn't participate in the garbage-loan frenzy.

Galbraith and Krugman are far from the only economists currently in utter disbelief at the stupidity of this plan. Well, actually, if the goal is to give bankers another shot at millions, then it's a very good plan. But there's a huge difference between rescuing banks and rescuing the bankers and the shareholders. One is a good idea, and the other is just a continuation of what's been going on for 30 years. Another Nobel Prize winning economist, Joe Stiglitz, had this to say in The Nation:

The politicians responsible for the bailout keep saying, 'We had no choice. We had a gun pointed at our heads. Without the bailout, things would have been even worse.' This may or may not be true, but in any case the argument misses a critical distinction between saving the banks and saving the bankers and shareholders. We could have saved the banks but let the bankers and shareholders go. The more we leave in the pockets of the shareholders and the bankers, the more that has to come out of the taxpayers' pockets.

There are a few basic principles that should guide our bank bailout. The plan needs to be transparent, cost the taxpayer as little as possible and focus on getting the banks to start lending again to sectors that create jobs. It goes without saying that any solution should make it less likely, not more likely, that we will have problems in the future.

By these standards, the TARP bailout has so far been a dismal failure. Unbelievably expensive, it has failed to rekindle lending. Former Treasury Secretary Henry Paulson gave the banks a big handout; what taxpayers got in return was worth less than two-thirds of what we gave the big banks--and the value of what we got has dropped precipitously since.

Since TARP facilitated the consolidation of banks, the problem of 'too big to fail' has become worse, and therefore the excessive risk-taking that it engenders has grown worse. The banks carried on paying out dividends and bonuses and didn't even pretend to resume lending. "Make more loans?" John Hope III, chair of Whitney National Bank in New Orleans, said to a room full of Wall Street analysts in November. The taxpayers put out $350 billion and didn't even get the right to find out what the money was being spent on, let alone have a say in what the banks did with it.

In my view, if it's too big to fail, it shouldn't be in private hands.

Henry Blodget, top dog at The Business Insider, gets even more specific:

What would be a better plan? Seize the insolvent banks, write down the assets to market levels, and make the banks' bondholders pay for most of the losses by converting a percentage of the bonds to equity. Then sell off and/or re-privatize the banks, which will now be well-capitalized.

This latter plan would wipe out shareholders and hurt bondholders--which is what the Treasury is trying desperately to avoid. It would also hurt the same taxpayers who are getting hosed in the Geithner plan -- because bank bondholders are generally insurance companies, pension funds, and other companies that taxpapers have a stake in.

It's still a better solution, though. It will fix the problem once and for all, it will likely cost taxpayers less, and it's the morally fair thing to do. And the bank equity and credit markets should recover quickly, once they see that the newly recapitalized banks are actually worth owning and lending money to.

But Geithner, no different than his predecessor Hank Paulson, doesn't want to do the right thing. He wants to keep the rich rich. Not much different from the Republicans, I'd say.

But it's almost like Geithner is the nerd kid in school trying to get some props from the cool kids. Remember what Bear Stearns CEO Jimmy Cayne said about him just a couple of weeks ago, talking how he felt about Geithner's decision to sell Bear?

The audacity of that prick in front of the American people announcing he was deciding whether or not a firm of this stature and this whatever was good enough to get a loan. Like he was the determining factor, and it’s like a flea on his back, floating down underneath the Golden Gate Bridge, getting a hard-on, saying, ‘Raise the bridge.’ This guy thinks he’s got a big dick. He’s got nothing, except maybe a boyfriend. I’m not a good enemy. I’m a very bad enemy. But certain things really — that bothered me plenty. It’s just that for some clerk to make a decision based on what, your own personal feeling about whether or not they’re a good credit? Who the fuck asked you? You’re not an elected officer. You’re a clerk. Believe me, you’re a clerk. I want to open up on this fucker, that’s all I can tell you.

Charming, isn't it? Geithner's just a clerk to the big boys, who clearly don't have a clue what they actually look like to the American people.

The good news, if any news can be said to be good in this mess, is that there's still a chance we won't quite fall to the level that bottled water and ammunition are the only things with value. It'll just mean that we'll have to actually do the right thing when this crashes. It'll just be a lot harder then.

News Writer
AWOP Political Contributing Editor
Author of Stop the Press Blog

Cross-posted at Stop the Press!

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