Mar 23, 2009

The Geithner Plan: A Primer

So, it's finally arrived: Tim Geithner delivered a new baby plan via The Wall Street Journal, presumably because last time he tried to give a speech all hell broke loose.

Some are cautiously optimistic, while others think it is dead on arrival.

So, what is the plan? I, here, will attempt to explain, as I understand it now.

We all know that there is a credit crisis. This is caused by bad assets (mostly bad mortgages) being spread throughout the financial sector in the form of securities. The problem? No one knows exactly where they are, since when they were securitized, they were all chopped up into little bits. Because they are who-knows-where, banks aren't willing to lend, since they don't know when the next shoe will drop and another investment of theirs will collapse. The entire credit system comes to a standstill.

Enter the Geithner plan:

  1. Lend money, through TARP and the FDIC to investors (mostly hedge fund managers) for the purchase of bad (and potentially bad) assets. Lend 85% of the purchase, expect 15% to be paid by the investors. The 15% gives them a stake in the success of the enterprise.
  2. Give management of a "Public-Private Investment Program" (P-PIP?) to the hedge funders.
  3. At the same time, the Federal Reserve will join with the Treasury Department to expand the lending that they can.

OK--that seems simple enough. What the administration is hoping is that:

  • First and foremost, the balancing sheets of banks will be cleared of crappy assets (I keep trying to get people to call them 'crapssets'). This (hopefully) will make them healthy and happy again, lending as carelessly as in days of yore, like 2006.
  • The banks will make some money from the sale of the bad assets, though they will still take a significant loss. Currently, since no one is willing to buy them, the assets sit on the books at no cost (thanks to mark-to-market accounting). With the new P-PIP (what a lame acronym), there will be a separate market for bad assets, away from the banks' coffers.
  • Hedge fund managers will invest in these bad assets, paying little for them (but more than zero), hoping to make a veritable fortune when (and if) they reach maturity.
In the end, it means that banks will be cleared of bad debt, taxpayers will be recouping a portion of any bad debt that survives to maturity, and--most importantly--the credit markets will start moving again.

However, as Paul Krugman notes in his New York Times editorial (linked above), Geithner is banking (pun definitely intended) on one thing that no one can guarantee, and that is that the bad assets (crapssets) will actually end up being worth more in the end, and not simply remain as the worthless sheets of paper they are now. Christina Romer thinks that the market will determine that the bad assets are undervalued. Krugman's point is that that assumption may not be true, and if it isn't true, there will be major consequences, since no one will pay for the assets, they will stay on the banks' books, and taxpayers will be out a few more billion dollars. Additionally, the Obama administration will be out of political capital, and a second try may not be possible. He says:

"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.... What an awful mess."

We shall see what happens, since a large part depends on investors. Are they willing to buy into the idea that these crapssets are worth more than everyone thinks?

Unrelated: the New York Magazine has a great article on "Obama's Brain Trust" of economic advisers.

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