brooksjordan

Maybe It's a Political Problem continued . . .

I want to follow-up on my note from Tues about the Geithner plan to say, yes, it really does appear, from all accounts, to be quite rotten. Not just inefficient or lame in the way one can usually expect from gov’t, but downright rotten.

One of the best descriptions of this comes from Jeffrey Sachs in yesterday’s Financial Times:

http://snipurl.com/em7fm

You can read Sachs’s bio to get a better sense of who he is, here:

http://snipurl.com/eltrz

What he’s essentially saying in this piece, and others make the same point, is that the White House has to fix the financial system, which starts with the banks, in order to heal the economy. But, it doesn’t think it can go back to Congress and ask for the money to do so, so it has come up with the Geithner plan, which is supposedly based on a public-private investment approach.

The problem is, it’s clearly not an approach in which the private investors do anything worthwhile except inflate the price of the toxic assets.

It does seem logical, on the face of it, that these private investors are necessary to help determine the value of these toxic assets - this is why the Geithner plan claims they need to be involved. But as Jeffrey Sachs points out, it’s impossible for them to play that role when they only have to put up a small portion of the money to buy them and don’t have to repay the gov’t loans that make up the difference. The result is asset price inflation rather than “price discovery.”

Banks (and their shareholders) love this plan, no doubt, because right away, once the assets are bought from them at an inflated price, it goes a long way toward making them healthy. We, of course, have to wait and see if the toxic assets (that we overpaid for) are worth anything.

First of all, Sachs is absolutely right when he says: “This is an inappropriate institutional use of the Fed, the FDIC and the Tarp.” It’s inappropriate because it is public money - money that’s running out - that’s being used to support a process that enriches banks and private investors. We didn’t sign off on that either implicitly or explicitly via Congress.

So, that in itself is bad enough.

Obviously, the White House must believe that the end justifies the means (a renewed financial system), and this is the most expeditious way to get it done. It’s not.

But, more importantly, it is SO risky. What’s risky about it? In short, the toxic assets may be worth what we pay, only a fraction of what we pay, or maybe nothing at all. What everyone agrees on is that nobody know what they’re worth.

Meaning, of course, the gov’t could lose the money it’s using from the Fed, the FDIC, and Tarp on this bet, which is really the same thing as giving the money to the banks and private investors. Again, it’s very hard to believe the White House wants to make this bet, but perhaps it believes, even in this scenario, that the end justifies the means … if it fixes the financial system.

Both of these outcomes - using public money successfully or unsuccessfully and in both cases enriching banks and private investors but fixing the financial system - are prompting Jeffrey Sachs and others to use words like “robbery.” It isn’t right action and it’s fraught with political risk.

What it’s all leading up to, ultimately though, is, will it work? Will it actually fix the financial system? Will the banks be able to lend again even *after* they no longer have toxic assets on their balance sheets?

Many feel that the answer is, no, that will be insufficient, that it will be necessary to recapitalize them as well (even more than we already have) or, for the ones that are too weak, shut them down. All off this will require large amounts of additional funding from the gov’t.

The point is that if the Geithner plan blows up at some point because it’s ill-conceived, dishonest, and doesn’t work (or even if it does in a limited way), how is the gov’t going to justify using huge amounts of public money for another round of bailouts? The biggest risk is that the Geithner plan, which right now looks to the White House like a path of least resistance, will take away that option. In other words, it would be a battle royale, and, very unfortunately, it’s going to be Obama who is right in the center of it.

Meanwhile, people like you and me could really be suffering at this point because the economy is worse than ever.

Stop this plan, President Obama. It’s bad now, worse later, and may be a killer in the end. Only you can.