A First Look At The Geithner Plan

Well the equity markets love it. I’m speaking of the Geithner plan naturally. Aside from that, the reaction in the MSM and throughout the blogosphere is decidedly bipolar.

As usual with these things we have to learn add some acronyms to our vocabularies. Today start practicing on Public Private Investment Program (PPIP). Add to that legacy assets. Legacy assets used to be called toxic assets but you know how bad that sounds. Much better to say that we are buying legacy assets from the banks. Now you’re ready for the big time. Here’s the link to the government’s website with more than you probably want to read.

As I said, you can find whatever reaction that you choose. Paul Krugman thinks it’s crap, Brad DeLong loves it. Generally speaking, those that favor nationalization are among the antis. As Tyler Cowen said someone has to be right, it’s just hard to figure out who that is. I put up a short post last night with DeLong’s positive review. One of the better negative reviews came from Henry Blodgett at Clusterstock. Here’s what he thinks.

The trouble with the economy is that the banks aren’t lending.  The reality: The economy is in trouble because American consumers and businesses took on way too much debt and are now collapsing under the weight of it.  As consumers retrench, companies that sell to them are retrenching, thus exacerbating the problem.  The banks, meanwhile, arelending.  They just aren’t lending as much as they used to.  Also the shadow banking system (securitization markets), which actually provided more funding to the economy than the banks, has collapsed.

The banks aren’t lending because their balance sheets are loaded with “bad assets” that the market has temporarily mispriced.  The reality:The banks aren’t lending (much) because they have decided to stop making loans to people and companies who can’t pay them back.  And because the banks are scared that future writedowns on their old loans will lead to future losses that will wipe out their equity.

Bad assets are “bad” because the market doesn’t understand how much they are really worth.  The reality:The bad assets are bad because they are worth less than the banks say they are.  House prices have dropped by nearly 30% nationwide.  That has created something in the neighborhood of $5+ trillion of losses in residential real estate alone (off a peak market value of housing about $20+ trillion).   The banks don’t want to take their share of those losses because doing so will wipe them out.  So they, and Geithner, are doing everything they can to pawn the losses off on the taxpayer.

Once we get the “bad assets” off bank balance sheets, the banks will start lending again.  The reality: The banks will remain cautious about lending, because the housing market and economy are still deteriorating. So they’ll sit there and say they are lending while waiting for the economy to bottom.

Once the banks start lending, the economy will recover.  The reality: American consumers still have debt coming out of their ears, and they’ll be working it off for years.  House prices are still falling.  Retirement savings have been crushed.  Americans need to increase their savings rate from today’s 5% (a vast improvement from the 0% rate of two years ago) to the 10% long-term average.  Consumers don’t have room to take on more debt, even if the banks are willing to give it to them.

Personally, I think the plan has some holes but I’m inclined to say that we should give it a chance. Blodgett is right to say that the problems are bigger than just the banks but there isn’t going to be an all encompassing solution. Politically the Obama administration is just not going to sign off on any nationalization solution unless all other alternatives fail, so we might as well get on with it. Here are the specific problems that occur to me at this point in time:

  • Will the banks and the PPIP be able to agree on price?
  • Is $1 trillion enough? I doubt it.
  • Will the PPIP cherry pick the assets it buys and leave the banks in worse shape?
  • Will Congress play ball? Either now or down the road there is the potential for more populist rage inherent in the entire structure.
  • Will the private investors play ball? At some point, particularly if you already have more money than you can ever spend, there is no reason to make a target of yourself.

So here we go. Sorry for such a wishy-washy post. If you have some thoughts let me know. They might help me figure out a position on this.

Links-Here are links to some thoughts from others. Many also contain further links.

Paul Krugman, Tyler Cowen, Brad DeLong, Simon Johnson, Geithner in the Wall Street Journal

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