In this morning’s post in Conscience of a Liberal (NY Times) Paul Krugman has had it with Tim Geithner’s bank plan, which won’t be unveiled until next week.
The Geithner plan has now been leaked in detail. It’s exactly the plan that was widely analyzed — and found wanting — a couple of weeks ago. The zombie ideas have won.
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.
Or to put it another way, Treasury has decided that what we have is nothing but a confidence problem, which it proposes to cure by creating massive moral hazard.
This plan will produce big gains for banks that didn’t actually need any help; it will, however, do little to reassure the public about banks that are seriously undercapitalized. And I fear that when the plan fails, as it almost surely will, the administration will have shot its bolt: it won’t be able to come back to Congress for a plan that might actually work.
What an awful mess.
Any plan to be successful has to put assets on the sidelines for a period of time. There is a pro-cyclical impact of the current status quo. Bank's look to off load bad assets which they dump into the markets penny on the dollars which then drive down prices on other portfolios which causes capital concerns and further dumping. If the plan has a hold feature it can't be worse then what is currently happening. The leverage component will help. I think their is regulatory component that has not been discussed. If the bank regulators merely push banks to build capital there will be no new lending (this is happening across the country). There needs to be a countercyclical approach at all levels.
ReplyDeleteThis is what has happened to the average, middle-class American. I believe that members of congress and Obama are all in this together. What makes it more difficult to swallow for me is that I once believed that only Republicans were corrupt. How naive is THAT?
ReplyDeleteMy eyes have been opened, I have been liberated, and now...here we are. Or, here I am.
Hi anonymous and Becky,
ReplyDeleteThanks for checking in. This article has quite an impact considering Krugman is a Nobel winning economist. I wonder if anyone in the Obama Administration is listening?
Whilst digesting Krugman you might like to check out 'As credit markets froze banks loaned billions to insiders' Stella Hopkins, Charlotte Observer. Carried on today's Mclatchydc.com. Top ten banks loaned execs, staff, CEOs $6-7 billion in insider loans. Moral Hazard anyone?
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