The NYT is ran an online discussion of the new Geithner Plan yesterday. The worry I expressed there is whether the Plan is scalable – i.e., it could work at a modest level, but to really have impact it needs to be huge. And, as it gets larger, I think we’ll see a political backlash.
Looking back over the comments of the day, my position put me closer to Paul Krugman but not too far also from Mark Thoma (look at his response to me, further down the discussion). Brad DeLong came across as the most positive, but even he is doubtful that the planned purchases are large enough – he makes the point that the Administration couldn’t get Congress to agree on any additional money for this purpose, but this puzzles me.
The Administration (1) has not really made this case on Capitol Hill (my contacts there tell me), (2) is asking for lots of money to do other things (their strategy was overweight fiscal from the start), (3) hasn’t communicated well a more general sense of priority or urgency – if we don’t fix our banking system how many other good things are possible over the next decade?
By Simon Johnson
The Baseline Scenario 
Since this plan seems to be instilling some confidence in the stock market, what impact would rising bank stock prices play in the financial stabilization of the worst-off banks?
My sense is that the US Executive Branch is focused on their social agenda. To achieve that ambitious agenda, they need to get the financial crisis off the front page (and out of the minds of the Members of Congress). They don’t seem interested in fixing the problem, perhaps because they recognize the effort and time it will take. While I am not a big fan of Buffett, his comments on CNBC regarding focusing on this crisis, to the exlusion of other initiatives, until you have won the battels, seemed directly on point.
exactly – as time goes by people will start to realize just how foolish that over wrought fiscal stimulus was: it set the wrong priorities, set forth an ill advised agenda and used up capital, both political and budgetary, that should have been spent on the real problem, the banks.
Will the plan for mortgage assistance work to undercut the new financial plan?
If mortgage rates are lowered and people are allowed to let their loans go to foreclosure w/o consequence won’t the financial instruments based on those loans decrease in value? Won’t that lead to those “toxic assets” declining in value causing losses to the private investors and the taxpayers through thier contribution?
You need to take charge of the debate.
It appears that the Geithner plan will be either to small to completely solve the situation or will fail miserably and leave the FDIC and Fed on the hook for a lot of money. Either way the administration is wasting useful ammunition.
I suggest that one of you, the economists who run these blogs (Krugman, Johnson, Kwak, Yves, Hempton, etc…), start building a fleshed-out backup plan for Geithner or his replacement to take off the shelf when the current plan fails. One of you should act as redactor. Put out the skeleton of a plan, have others publicly comment, incorporate useful comments, revise the plan (indicating points of dispute), repeat the process until we have a completely coherent and well-thought out plan to present to Treasury. This transparent process will educate the public while creating the best possible plan giving the circumstances.
The term “toxic waste” first shows up in financial circles in the mid-Eighties – it’s a shorthand for the “Z” tranche, the equity-level piece, in a mortgage pool securitization, in which all negative outcomes get absorbed first. (cite: Liar’s poker, M. Lewis).
Now, when we speak of “toxic debt” we are apparently speaking of tranches of securitizations of more seniority (even up to the so-called AAA tranche) – the dubiety is more focused on the underlying assets. The exact size or dimension of the toxic domain seems unclear, however.
My question is: exactly what proportion, what “chunks”, of financial holdings are toxic ? And why would holding A be toxic, and holding B not, if both are correctly accounted for ?
Baseline Scenario,
Since I haven’t said it before, thank you for creating a sandbox for people like me to play in.
Also, thanks to the mostly very thoughtful commentators.
I would appreciate it, if a banker and an economist (amateur or professional) could set me straight. As I understand the Plan, it will allow banks to sell dodgy assets. This will have two effects. First, certain capital ratios (Tier I and all that) will improve. Apparently, loans are now (somewhat arbitrarily) limited by poor ratios. Second, banks will have more cash. As a result of both, they can then lend more money to Main Street. My questions: How much cash, how much will be lent, and will the stimulus to the economy create a positive feedback loop that makes the assets less dodgy and fees up more cash to lend?
A homespun analogy is starting a fire with a limited amount of tinder. Using a little bit with multiple attempts can use it up without getting the fire going.
I just finished reading “Toxic Assets Were Hidden Assets” by Hernando de Soto in today’s Wall Street Journal—“nobody knows precisely how many there are, where they are, and who is finally accountable for them.” Baseline Scenario and S. Johnson’s MIT online lectures have repeatedly called for transparency, but none of the players seems willing to comply including Congress (you cannot count their ridiculous TV-facetime hearings). In this post-Enron era, I thought the U.S. Govenment was the only entity that could get away with off-the-books accounting.
“…I think we’ll see a political backlash.”
The New York Post is reporting that BAC & C are overpaying for AAA-rated MBS, the inference being that PPIP-targeted banks can blend new inventory w/old and maximize their benefit through resale to PPIP. Obviously it’s not as fiscally egregious a scenario as paying $165 million in contractually obligated bonuses but personally I would like to know more about what they’re up to. If the story is correct, perhaps we can muster a small amount of righteous indignation for any of the annointed banks who refuse to mend their wicked ways.
THe special purpose vehicles that brought us ENRON, amazingly also brought us the black box banksters.
Mr. Johnson and commentators:
I recently listened to an NPR story about the takeover of a failed bank in semi-rural Washington State–a riveting story.
http://www.npr.org/templates/story/story.php?storyId=102384657
The takeover, done with the advantage of 3-day holiday weekend, took 80 experienced FDIC employees, the employees of the failed bank, and employees for the bank which bought the failed bank 3 days. By contemporary standards, the bank was tiny. Extrapolating from the failed bank’s listed assets and the listed assets of our Wall Street mega-banks, a similarly efficient and speedy takeover of a mega-bank would, with the same asset to worker ratio, would require a force of ONE MILLION people.
Given that these mega-banks are at the heart of our financial system and that a disruptive takeover of any one of them could reverberate and wreak havoc system wide, what does this say about the task of nationalizing these behemoths?
I would differentiate between the structural integration of one entity with another vs the transfer of ownership. With respect to nationalizing behemoths, so far we’ve seen Wachovia ‘nationalized’ by WFC, Washington Mutual & Bear Stearns ‘nationalized’ by JPM and Merrill Lynch ‘nationalized’ by BAC. The integration of the operations of the organizations will take time but that process should be invisible to customers/depositors beyond the logo change. Govt guarantees exist within several of these deals, thus the difference between this and an FDIC takeover of a small community bank is merely of scale.
I read the debate–I have to say that Mark Thoma was going up the Ladder of Inference when talking about how ad hoc interactions with banks…in this scenario were bad. Not all things ad hoc are bad…in fact, these are wild times–I don’t believe we want a regulatory system that is structured around this level of (temporary) wildness–precisely b/c “Banks, hedge funds, insurance companies and the like are willing to stay involved only if this does not bring onerous additional government scrutiny.”