One of the determinants of how you feel about the Geithner Plan is what you think will happen if it fails. By “fails,” I mean that the buyers’ bids are lower than the sellers’ reserve prices, so the toxic assets don’t actually get sold.
Brad Delong, for example, is moderately in favor of the plan, even though he thinks it is insufficient. In his words, “I think Obama has to demonstrate that he has exhausted all other options before he has a prayer of getting Voinovich to vote to close debate on a bank nationalization bill. Paul [Krugman] thinks that the longer Obama delays proposing bank nationalization the lower it’s chances become.” (“Voinovich” is DeLong’s hypothetical 60th senator, whose vote would be needed in the Senate.) In other words, DeLong thinks that if this plan fails, the administration will be more likely and able to go forward with nationalization.
Paul Krugman, by contrast, is strongly against the plan, first because he thinks it has no chance of succeeding, and second because he thinks there is no Plan B. “I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second.”
I think the plan is likely to fail, or at least to be very insufficient, for reasons described elsewhere. I am also worried that the Obama administration has committed itself so strongly against taking over large banks that it cannot reverse course, at least not unless it sacrifices Geithner. So I expect Plan B to be more generous to the banks – which means it will have little chance of getting any money out of Congress (and the $700 billion will run out at some point). The increasingly friendly stance toward Wall Street also implies this course of events.
On the other hand, today’s reporting on what Bernanke and Geithner were actually asking for yesterday is a little bit promising. From The Wall Street Journal:
The bill, said Treasury, would cover financial firms that have the potential to severely disrupt the U.S. financial system. That would include bank holding companies and thrift holding companies as well as companies that control broker-dealers, insurance firms and futures commission merchants.
On my read of this passage (I haven’t seen an actual bill yet), the proposed legislation would enable regulators not only to supervise bank holding companies, which they can do today, but to take them over and wind them down just like the FDIC can do with depository institutions. If Treasury and the Fed have this power – and I think they should have it – it could improve their negotiating position relative to the big banks. It could also indicate that the administration wants to have this power in its back pocket just in case it needs to use it. (Using the AIG scandal to get this power is a clever political move.) I still don’t think this is Plan B, but it could mean that they want all options open.
Update: More information on the proposed new bill in the WSJ.
Treasury said the draft bill would enable the federal government to seize troubled bank- and thrift-holding companies as well as firms that control broker-dealers and futures commission merchants.
An Obama administration official confirmed that the legislative proposal would also give the government authority to shut down troubled hedge funds, which currently face minimal oversight. The government could potentially use the new “resolution authority” on any nonbank financial firm that is deemed to pose systemic risk, the official added.
By James Kwak
The Baseline Scenario 
Maybe the Geithner plan, and Obama’s seeming indifference to opposing voices, is a head fake for the banks. In other words, prop them up until you have the political capital to do what needs to be done. The gamble is that instead the banking lobby becomes more powerful. Big gamble, big stakes.
DeLong knows politics; he’s been there. Krugman, for all his brilliance, really doesn’t.
Most toxic “assets” will be sold, but at inflated prices relative to their true value. The Geithner plan will, in the short term, benefit the large banks and bondholders and, in the long term, lay the burden on ordinary taxpayers. It is essentially massive tranfer of money from the public to the private sector. The financial institutions who made these boneheaded investments need to accept their losses – period! The “to big to fail” argument is not sufficient. Many sound companies who made wiser decisions will take up the slack in a heartbeat, if the valuation is accurate and fair. I just don’t see how the Obama/Geithner plan will work absent a strong economic turnaround. But what will fuel that turnaround – more debt? 70% of the economy is consumer spending and the consumer is tapped out. Half the earners in the country have three weeks of liquid reserves if they were to lose their jobs. I keep hearing the empty phrase “we need to get our banks lending again.” Well, they are lending; they’re lending responsibly for a change. The solution to all of this is for the everyone, the entire country, to start living within its means. That is true course to financial stability.
Maybe the new legislation is Plan A…
What if the administrations lawyers told them that they can’t legally resolve, FDIC style, C or BoA under the existing rules? Then what? What do you do if your the Treasury Secretary.
Then you stall. You throw all sorts of (ultimately empty) promises and reassurances at the bankers, you give them a get out of jail free card, you promise to make them whole for as long as it takes, because if you don’t, the whole system explodes in your face. Maybe you even make it look like you aren’t hiring staff in DC, and thus aren’t ramping up to take over a monster like Citi, when secretly you’ve got an army of freshly laid-off Wall St. ‘talent’ holed-up in offices in NY, just waiting to pounce.
In the meantime, you do stealthily do everything you can to get the power you need, secretly hire all the people you’ll need, and lay the plans to seize the problem children once you have the power to do it.
Then, one Friday afternoon, after Congress passes a shiny new law giving you authority to resolve a monster like Citi, you hold a press conference. The President signs the bill … you flip open your cell phone … “Go” you say, and flip it closed … then you turn to the mic and announce that, as you speak, Citi, BoA, etc… have been seized. And the FBI is executing warrants to search the residences of all the executives.
Ok… I admit, that’s crazy. But it would make for great theatre!
— and that government of the banks, by the banks, and for the banks, shall not perish from the earth.
What is lost in all this is the basic economics. Economics 101 is supply and demand. With capital, the supply is the lender and demand is the borrower. After thirty years of supply side economics giving every break possible to the lenders, the borrowers are now broke. So the plan now is to have the taxpayers buy the bad debts from the lenders, in order to give them more money to lend. That doesn’t solve the problem of where to invest all this money, other than lending it to the government.
Money doesn’t fuel the economy, it lubricates it and those running the financial system have taken it as their God given right to drain as much as they possibly can, into their own pockets. Surprise, surprise, the real economy is now seized up. That’s what happens when you take all the oil out of the engine.
So now they want us to give them whatever’s left, with the promise that they MIGHT LOAN some of it back!!!!!! Other than that, the only plan is just to print more money. There was a reason capitalism functioned so well for so many years with a progressive taxation policy. Growth is bottom up, not top down and if a lot more doesn’t start raining down, not just trickling down, we are all in trouble.
The fact is that modern monetary systems are a tax based public utility and in matter of fact, it all belongs to the government, just like roads, courts, the military, etc. Political power used to be private once. It was called monarchy. The monarchists railed against mob rule, but democracy works by distributing the power as broadly as possible, through various layers of governance. Now we need to do the same with economic power. A public banking system would be as local as possible, attached to every level of government and channeling profits back into local needs. We don’t need it to be quite so innovative, we need it to be solid.
If people understood money as a public utility in the first place, we would be less inclined to drain value out of our communities and environment to put in a bank.
I’ll admit to being a flip-flopper on the Obama/Geithner plan. I hate the deference they have shown to the big financial players, and my outrage meter is running as high as anyone’s. But there is a political dimension to this– if Obama, just 60 days into his new Presidency, started liquidating the big banks and generally raising hell with Wall St., there is a chance that his entire agenda could go belly-up, as we waited many months for resolution of the financial mess. It’s not even clear to me whether Treasury has the resources to cope with all the administrative and logistical challenges of taking down institutions like CITI and BOA.
I want to see Obama succeed on health care and other vital reforms, and to do that he has to walk a political tightrope– it’s a tough act. Plus, he has an ornery Congress full of dimwit Republicans and regressive Democrats who aren’t reliable allies.
I’m cutting him plenty of slack….
I agree with Hektor regarding consumer spending.
You can make all of these institutions play fair but the word on the street (the actual street…) is sorry, I can’t afford it right now and can probably get by without it.
If I may mangle a movie quote here, “If you build it they aren’t going to show.”
I will be in the front row with a large popcorn & extra butter.
I would agree that is reasonable, as he doesn’t seem the type to be in the pockets of the bankers, but one to see a few moves into the future, but even if that’s so, he is letting out a lot more line than he has the means to wind back in. Given all the other problems to deal with, he had the leverage to come down hard on the bankers to begin with. Yes, they have the strings in their hands, but the puppet has grown far bigger than they will be able to control and now he is on their side. Can he switch back? Maybe.
The old paradigm is dead flesh that will be shed. It’s going to be messy and Obama needs to be the one doing the cutting between what is healthy and what is not, not saving what is gangrenous.
James – In Felix Salmon’s description of your chat session yesterday, he reports that an informant in DC told him later:
“Finally, my correspondent says he views as a virtue of the plan the fact that regulators will push banks to mark their assets to the prices set by the auctions, even if they choose not to sell their assets at those auctions. That will accelerate failures of insolvent banks — and if an insolvent bank is going to fail, it’s better that it does so sooner rather than later.”
http://www.portfolio.com/views/blogs/market-movers/2009/03/25/the-complexity-of-the-bank-bailout-plan?tid=true
Have you heard anything like this?
I’m no longer sure if I want to see Obama succeed on the agenda you mention. Yes, it has only been 60 days, but on the critical public question of the first half of 2008, we have gotten something darn close to a continuation of President Bush’s Iraq plans and on the critical public question of the second half of 2008 plus 2009 to date we have gotten crystal clear demonstration of Obama’s dedication to shielding bondholders with the a humungous commitment of taxpayers’ resources. Forget Geithner: these are Obama’s policies. Not for nothing was Senator Obama getting the second highest campaign contributions from Fannie while in Congress. I’m getting very nervous about exactly what change I am being asked to believe in.
Question:
Why the power grab by Geithner to rule over any and all “financial institutions”?
Answer:
So he can force them to participate in “Plan A”. If they don’t, they will be deemed to be “troubled” by the Treasury and liquidated.
If you stop getting lost in the minutia, you will realize everything going on right now is about power, not money.
I will be watching to see just what proportion of bailout funds to big banks go to buying up control of smaller, healthy banks to increase market share (and diminish competition).
Question: Now that Obama has put in motion a number of efforts to rescue the economy, are we likely going to repeat Japan’s lost decade?
Perhaps we should step back and evaluate President Obama’s overall crisis rescue strategy. As President Obama has pointed out, the banking fix is only 1 brick in the building of a new house that is the US economy. In the last 2 months, Obama’s team has already put in motion major efforts in each of the following area.
1. Fiscal stimulus
2. Monetary policy
3. Clean up the banking industry
Perhaps we can put our heads together and do a holistic analysis of how Obama’s over all plan is going so far. There is a natural interdependency among these. For example may be the Geithner plan doesn’t do enough to fix the banking industry. However, because of the monetary policy, homebuyers are attracted by the all time low mortgage rate and low housing price. This should help put a floor on the value of the mortgages on the bank balance sheet. Furthermore, banks are now enjoying a very high interest rate spreads that can help them earn their way out of their problem.
Originally, I cared mainly about us having an affective plan that will get the banking industry back to health. The issue of fair / efficient use of taxpayer money is a very distant secondary consideration in my mind. However, I am now really worried about the effectiveness of the Geithner plan. Any chance that Obama’s larger overall plan is sufficiently well put together that we’ll be fine even if the Geithner plan is less than optimal?
James and Simon, perhaps you guys can do a blog entry on this?
I don’t perceived any problems with investors buying toxic assets at inflated prices as long at the return to those investors comes from the banks after they ( if they could) capitalize. Inflated prices will bring more liquidity to the banks in the short term thus providing benefits to the consumers.
The problem I forsee is investors will buy these toxic assets as a relative low prices, low value, unless government guarantee a fair return to investors.
A government acting as a collateralize debtor to investors = Liquidity to banks = flow of credit = consumers spending increase = high risks to taxpayers
One of the key issues here is banks business plan. In some way governement needs to make sure banks are running in the right way and make sure they could capitalize on these opportunities. If these mean firing bank managers that what Government need to do.
Thoughts!
I’m reading H.W. Brands’ biography of FDR, “Traitor to his Class” right now. In it, Brands relates Wilson’s gradual shift from neutrality to intervention in WWI — and Roosevelt’s reaction to it:
“As a student of executive leadership, Franklin Roosevelt couldn’t help admiring Wilson’s mastery in allowing support for war to build. Americans in August 1914 had recoiled in horror from the very thought of intervention; now, in April 1917, their representatives voted 455 to 56 in favor of war.”
Could there be a parallel here to Obama’s approach to the economic crisis and the necessity to build public support for any action to cure what ails the banks?
The ONLY plan that will have a chance of working is for the Government to buy these assets at PAR and take warrants in the “selling” institutions to recoup the initial loss to the taxpayer.
I saw these “partnerships” just MILK the taxpayer during the RTC days. They will put in 15%, cherry pick the assets and hand the residue back to the taxpayer.
Am I the only person who can see this?
Dear Baseline:
You keep mentioning “reserve prices,” as in “By “fails,” I mean that the buyers’ bids are lower than the sellers’ reserve prices, so the toxic assets don’t actually get sold.” Why not just “prices,” as in “prices of toxic assets”? May I kindly ask you to post a blog entry explaining the meaning of “reserve prices”? I’m trying to keep up with so many other economics and Obama admin-related blogs that I won’t have time to search for your possible reply in the comments section. Grateful, John in Tokyo
Working people distrust corporations and the government. These people will not consume based upon public relations propaganda. They have pulled the plug on the existing economic culture. Working people have been forced through the cauldron because the rich made long term economic war upon them. Working people have now chosen a more sustainable lifestyle that is much more independent of the economic constraints of the old system. People are neither going to consume nor bail out the rich again. Krugman is right about that.
Warrior, it would be good if what you say were true, unfortunately, working people also have a short attention span, and a few headlines to appease, and suddenly they forget–this is the real tragedy, because without their memory, it will be just another day before long, and the truth will be buried under press releases.
Hektor gets an A+
John Merryman an A-
………
Obama’s choices (such as selecting and supporting Geithner)demonstrate he is either a gullible incompetent when it comes to financial matters -or- the scariest of the scariest in the bankster league: a highly charismatic sociopath. I suspect the latter. (Note: I consider myself a progressive independent: socially & fiscally responsible.)
……………………….
There should be only one plan, measured debt deleveraging through bankruptcy and restructuring. Let the cards fall where they may and let’s get to the floor, so we have something stable to build upon once again. In fact, this IS what will happen – it will just be worse if we create continue to act as if the prosperity of the 90’s can be recreated by continuing to spend beyond our means. It’s insane.
Yeah, detox ain’t fun or pretty. But at least it gives you a chance to get “unhooked.”
A lesson in oration: http://www.youtube.com/watch?v=94lW6Y4tBXs
If only we had someone so articulate in Congress…
If congress gives the FDIC the power to force a financial institution into receivership, this could be a very powerful bargaining chip.
One of the biggest hurdles for the banking plan is that banks selling toxic assets may not want to sell for a reasonable price, even with the subsidy. Obama can just tell banks that if they refuse to offer a significant write down with the auction reserve price, that this is their last chance and that they will be seized.
One of the things that Bernanke let slip was that they didn’t think it was legal to seize AIG involuntary, even if they had wanted to. After this Bill financial companies will no longer have this protection.
LOL, I don’t understand why nobody talks about how ludicrous this all sounds. Come on these are “toxic” assets! Why on earth would anybody want to buy these assets? And how twisted can things get? A private investors buys something worthless (that banks don’t want to own) but its ok because it’s not even their money, it’s the governments money.
And ultimately why is this all again just a plan that shifts around problems… I see no real solutions. Just problem shifting….
I’d very much like to see the plan in practice discussed more in depth, perhaps someone can highlight on this?
LOL, I don’t understand why nobody talks about how ludicrous this all sounds. Come on these are “toxic” assets! Why on earth would anybody want to buy these assets? And how twisted can things get? A private investors buys something worthless (that banks don’t want to own) but its ok because it’s not even their money, it’s the governments money.
And ultimately why is this all again just a plan that shifts around problems… I see no real solutions. Just problem shifting….
I’d very much like to see the plan in practice discussed more in depth, perhaps someone can highlight on this?
OH! You’re my new favorite blogger fyi
The question is, will there be any money left for a plan B?
Wow, that would be great. I second the motion of sitting down with a big bucket of popcorn — watching that unfold. However, armies of freshly laid-off Wall St. Talent tend to have big mouths, which would have exposed that plan by now.
I am a broken record on this. We all discuss these mortgage assets the banks own as if we know what they are. They have collectively taken a trillion dollar plus writedown but we are currently at an 8% default rate and a 3% foreclosure rate. There are $10 trillion of domestic mortgages. Yet we continue to assume these assets are massively over valued. Assuming a 15% foreclosure rate (pretty extreme I think) and a 10% recovery rate (historically at 50%)) that adds up to $1.35 trillion in losses. I realize i am missing something, but what? Please don’t say “credit derivatives” because they are zero sum. The banks are all making happy music about the first quarter. Why are we assuming these assets are “toxic”. Can some one please describe these assets and why we are assuming losses even greater than I am hypothesizing? My point is, this seems as if we have past the worst point.
The toxic asset plan proposed by the U.S. Treasury on Monday, March 23, 2009 is a double subsidy. First, it is a subsidy to banks and their shareholders and creditors. This first subsidy increases moral hazard. The second subsidy is to hedge fund managers who profit at taxpayer’s expense.
Simon and James,
Have you read the study by William Lucy of UVA? I am oversimplyfying, but he basically is saying that MBS are hard to value, but their prices are substantially lower than implied by the underlying value of the mortgages. He uses foreclosure data, home values/family income ratios, “stress testing” home values to 2000 levels, and concludes that mortgage losses are less than $150 billion. The remaining losses are due to mark to market declines from lack of transparency in MBS. Do you have any comments on this study?
Why would the fact that they may be zero sum equate to them not being a problem? Some will win some will lose.
I am more curious about what happens if the plan works. Like last fall, I am curious to know the goal of the plan. Is it really to induce banks to lend? Are we really giving them taxpayer money so they will be cajoled into lending to insolvent taxpayers? That seems roundabout. Unemployment insurance and food stamps for all would be a better bet.
The plan may, or may not work – short-term. It will fail long term, and that is without a doubt. America is doing what it always does – go for the quick fix / feel good solution. Your economic problems in America are massive. For decades, your politicians and CEO’s have always defaulted to the short term solution to an issue. And their key concerns were NEVER the long-term health of your economic future. They always did what was right for themselves first, their special interest groups, their political party, and then……way down the list…..came doing what was best for “the people”. You have borrowed yourselves into oblivion for decades, subsidized your lives beyond comprehension with borrowed funds, and relentlessly made financial promises you, and even your children will NEVER be able to re-pay. I think what amazes us all watching this mess unfold from far away places, is how shocked you all are that this is happening now. Your own government refuses to go by the laws it passed regarding accounting standards. Because, if your government had to show exactly how much their real liabilities were, it might awaken the american people as to exactly how broke you really are. To many of us outside looking in, we now see exactly what the American economy really is: the biggest Ponzi scheme in recorded history. Your broke, in fact your past broke. Broke would be a step up for you right now. Your Social Security system is a Ponzi scheme, your Medicare ‘ Medicaid system is also. A few weeks ago, you folks, the alleged “Titans Of Finance” had to send Hillary to china hat in hand begging them for more loans. By the way, they said “NO”. “Big Ben” Benanke’s solution? Start the presses!! I don’t think we’re in Harvard School of Finance and Economics anymore Toto. Welcome to The United States of Banana Republic. What is absolutely amazing all of us, is that your leaders solution is to do the same thing all over again THAT GOT YOU TO THE EDGE IN THE FIRST PLACE !!!!!!!!!!!! You all deserve whats coming. I’d sell that BMW if I were you. In about 18 months it’s going to be worth zero….the value of your dollars. Good job, Titans Of Finance !! You seem to have out smarted yourselves. Enjoy starvation. It’ll be good for your waist lines.
So much heat, so little light.
That’s exactly what it looks like.
The public doesn’t want to put any more money into the banks right now, so nationalization would be hard to push through. And in any event, the legal framework for taking over a large institution like Citi and giving haircuts to its creditors just doesn’t exist.
Among other things, the Geithner plan is a gigantic exercise in price discovery. Thanks to the subsidies and the massive size of the program, the bidders will pay fairly generous prices. If the banks still won’t sell, it will be hard for them to justify the carrying values of their portfolios. Institutions with large portfolios of non-credible portfolios will be pushed to write them down, increasing the likely need for intervention.
While this process is playing out (supported by the ‘stress tests’, which will give additional data about the quality of bank portfolios), Congress can put an FDIC-type framework into place for resolution of large, systematically important financial institutions.
Then, if the results of price discovery show that certain institutions are insolvent, the public may accept the need to put more capital into banks – knowing that there really is no alternative, and that existing shareholders (and possibly creditors will be wiped out. And the legal framework for doing the deed will have been put into place quietly, without much fanfare.
There is a coherent political strategy at work here, and it’s quite encouraging to see how the pieces all fit together.
Joe Nocera, in the March 28 edition of the NYTimes, sees it much the same way: “it will be far more politically palatable for the government to recapitalize the banks — or close them down, or even take them over, if need be — knowing that we finally can value the bad assets. You really can’t nationalize a bank without being able to make an ironclad case, to the public, that it is hopelessly insolvent. The P.P.I.P. will help make such a case.”
This makes perfect sense. The program will produce price discovery, which will make it harder for banks to carry assets at above market prices, which will make it more likely for banks to be revealed as insolvent. This will make it more likely that intervention will occur early, instead of after an extended period as a zombie.
(Of course, another effect of the program will be to push up prices of some assets, as a large amount of low-cost capital is deployed to buy them. This will benefit banks holding these assets, and will reduce their need for additional capital (whether public or private). But won’t the price get bid up to levels that result in the taxpayer losing money for sure? The sliver of private capital in the program is designed to reduce the risk of that happening — prices will not get bid up beyond the point where the bidders think they can still make a generous return.)
Instead of being angry with Wall Street why don’t we pull all our money out of it!
They will have no fuel and Ponzi scheme will stop.
I have liquidated my investments in September of 2008.
Svetlana,
I was an idiot. I trusted them. Something I will never do again. I’m screwed now, because i’m an idiot that never followed history. They screwed everyone after WWII, and continue to do so. All they care about is money. Everyone in America seems to think that they have to have a big house and an expensive car to justify their “success”. Yeah….real successful. They did it with OUR dollars, and continue to hide behind their “deep concern” with world peace. What a pathetic group. It’s really about stealing money, and everybody else’s savings so they can have, what they view, as a comfortable lifestyle. I think the one person that defines what America REALLY is, is Paris Hilton. I can only be thankful that I’m not one of them. However, they have successfully stolen all of my pension fund savings. At my age, i’m not sure if I can recover. My wife and children are now terrified that we will never realize the fulfillment of our plans. But, this is Norway, so we’ll see. I continue to hope that the inherent honesty and perseverance of the Norwegian people will save us from the American greed and theft that has led several of our pension funds to disaster. Hope. It’s all we have anymore, and “honest” work ethics. Pray for us, we’re broke now. THANKS AGAIN AMERICA !!!!!!!!!!!!!