The Geithner plan, as viewed from Oz

by John Quiggin on March 27, 2009

My column in yesterday’s Australian Financial Review was about the Geithner Plan. It’s paywalled, but I often republish on my blog the day after (can a right like this be acquired by prescription) and I thought readers might be interested in this one.

The reaction of markets and economists to the bank rescue plan announced by US Treasury Secretary Tim Geithner has been revealing. Stock markets loved both the Geithner plan and the announcement, a few days earlier that the US Federal Reserve would create a $1 trillion loan facility to assist in the purchase of dubious asset-backed security.

By contrast, the US dollar fell sharply against other currencies, including the Australian dollar. Oil prices, denominated in US dollars, rose accordingly, although more accurate measures, based on a basket of currencies showed much less change.

This divergence is not so surprising. The plan is, to put it mildly a high-risk option. If it succeeds, the benefits will largely accrue to holders of stocks in general, and even if it fails, it will certainly benefit banks and their shares, which make up a substantial part of the major market indexes.

If the plan fails, on the other hand, it will be bad for holders of US dollars and US government debt, which is being issued at an alarming rate.

A similar divergence can be seen in the quoted reactions of economists. The views of ‘market economists’, representatives of financial businesses on whom the press commonly relies for instant reaction on such matters, were overwhelmingly favorable. By contrast, the responses from economists who actually undertake research into how the economy works ranged from outright rejection to the most tepid of endorsements.

In many ways, the endorsements are more damning than the criticism. Berkeley economist Brad DeLong, who has been among the most prominent supporters of the plan sees it as the best that can be done without new legislation, which would almost certainly fail in the wake of the outrage over massive bonuses paid to the executives of failed banks. And, he says, it might lay the groundwork to convincing doubters of the inevitability of bank nationalisation. Writing in the New York Times, he says ‘“We tried alternatives like the Geithner Plan and they did not work” might well be an effective argument several months down the road.’

Joseph Stiglitz and Paul Krugman are among the many who disagrees. Krugman points out that the design of the plan gives private investors in dubious assets an effective put option. If the assets rise in value, they get much of the gain, but if they fall, the loss can be put back to the US taxpayer. And, against DeLong, Krugman argues that the financial and political resources used up in a plan that has little hope of success will not be available to support nationalisation.

Supporters and critics agree that the Geithner plan depends critically on the assumption that the ‘toxic’ assets on bank balance sheets, such as securities backed by home mortgages, are actually worth substantially more than the market is willing to pay for them at present.

There is an even more fundamental assumption underlying the Geithner Plan. Geithner, like Larry Summers, Robert Rubin and Henry Paulson, is deeply committed to Wall Street and its economic model. Their plans are based on the assumption that, when the crisis is over, everything will return to ‘normal’ as this term has been defined for the past thirty years, with a global financial system dominated by financial institutions like Citigroup, Bank of America and Goldman Sachs.

The resort to yet another publicly provided put option reflects this thinking. Just as with the ‘Greenspan put’ and the ‘Bernanke put’ that created the crisis, the assumption is that governments must support the financial sector at all costs.

On the Geithner is view, some new regulations may be needed, but contrary to the rhetoric of the Obama campaign, real change is neither possible nor desirable. By contrast, Kevin Rudd has recognised that the financial crisis signals a ‘seismic’ change in the economic organisation of capitalism, even if not all his government’s policies reflect this.

What does the Geithner plan mean for Australia? On the whole, it is probably a positive. The fact that it is a bad deal for US taxpayers is less important to us than the magnitude of the stimulus involved. And the decline of confidence in the US dollar, while not helpful to exporters competing with US suppliers, will probably make allow the Australian government, and Australian banks, to borrow on more favorable terms.

The biggest risk is that the failure of the plan could discredit the Obama Administration and produce a leadership vacuum. That would be a disaster for the entire world. The US led us into this mess, and, like it or not, the US must lead us out.

{ 19 comments }

1

lisa 03.27.09 at 5:48 am

On the face of it, it is a crazy plan. It really seems intended to maintain the spirit of the bubble by re-0vervaluing the assets that got us into the mess in the first place.

I do not understand. I have heard it defended and I think it’s nuts.

I never thought the Treasure Secretary would make me want to cry. The Secretary of State, yes.

I’m having trouble accepting this thing. I thought the days of idiocy were over.

2

JoB 03.27.09 at 9:59 am

I followed the Krugman-side of the debate but I really think he’s letting his sense of fairness & his number-crunching induced belief in ‘the’ solution getting the better of his synthesis here.

If Geithner succeeds in his goal of a. involving non-state players in solving the toxic asset issue & b. restore normality to credit flow than that does not mean that the created unfairness (& I do not doubt that unfairness will be created by the plan) outweighs the immediate benefits to all. & more importantly: it does not mean that the created unfairness (and the unfairness that was still out there in heaps) cannot be tackled lateron.

Let me risk an Iraq metaphor: I don’t doubt it would have been unfait to keep Ba’ath officials in government after toppling Saddam but I also do not doubt that for the average Iraqi it would’ve been a more pleasant decade if many of these officials had been kept in office. (please do not get John’s thread into an Iraq spin, please).

The anti-Geithner camp seems to me to be in risk of mistaking a static analysis for what can be dynamically achieved. This isn’t a minor risk. The pro-Geithner camp runs at least as big a risk if they’re just going to see whether this works & adjust course accordingly: at some point they’ll have to propose concrete international financial regulation i.s.o. beating around the bush at the level where everybody feels warm & cosy. Without such measures, whatever is done now (even nationalizations) is water under the bridge.

PS: John Q, I really believe the notion that the US ‘has’ to lead us out of this one is one of those ancient myths of the Ancien Régime that we’ll have to shed – I’m very disappointed at Obama’s rhetoric in this one (as in his appeal to personal responsibilities, togetherness et al.).

3

wjd123 03.27.09 at 10:53 am

Of banks and regulations:

When I moved into my neighborhood 30 years ago I put my money in a local bank that bore the same name as the neighborhood I lived in. In time that bank was taken over by another neighborhood bank–just not my neighborhood. Then it was taken over by a mid-sized bank who headquarters were in another state. Finally, this bank was taken over by one of the big five.

I don’t like any of the big five. I don’t trust them. How they could take over my mid-sized bank while claiming insolvency is beyond me. I suspect I’m being played for a sucker.

I haven’t moved my money because of inertia, bother, and convenience–the only other bank near me is also one of the big five.

There is one and only one reason I don’t worry about insolvent banks with my money: the FDIC. Now the Treasury wants to use it to allow these crooks to assist in removing toxic waste from my banks books. I’m losing faith in the FDIC. I’m starting to panic.

4

James Conran 03.27.09 at 11:05 am

I think the point, picked up on by JoB, about America leading the recovery is an interesting one. The perhaps misplaced confidence of this assumption only really struck me when I read Yglesias last night saying how “all the Europeans I’ve spoken to are expecting a U.S.-led or Asian-led recovery; they’re just kind of laying low and figuring that they’re well-positioned to weather the storm.”

This seems utterly true (minus the Asia part) and possibly a terrible mistake. How influential, I wonder, is this cognitive, “US-centric” factor in explaining Germany’s seeming complacency on the policy front in the face of their own haemoraging economy?

Obviously the US is going to remain a huge part (and probably very much the leading actor) of the world economy post-crisis, and clearly the EU’s policy capability is hugely limited. But: the EU is, taken together, the world’s biggest economy and nobody at all seems to envisage the possibility that Europe should/could lead a recovery.

5

Barry 03.27.09 at 11:18 am

“Let me risk an Iraq metaphor: I don’t doubt it would have been unfait to keep Ba’ath officials in government after toppling Saddam but I also do not doubt that for the average Iraqi it would’ve been a more pleasant decade if many of these officials had been kept in office. (please do not get John’s thread into an Iraq spin, please).”

I’d put it more as if Saddam and the Ba’ath Party had been left in charge, subsidized heavily, with no more supervision than they could dodge on even an off day.

6

tib 03.27.09 at 11:47 am

Simon Johnson has an article in the Atlantic discussing the need for systemic reform, and the global nature of the problem. He discusses the pattern where countries turn to the IMF after “elite business interests” become too entwined with government and come to rely on implicit government guarantees to take bigger and bigger risks. In this case the problem is global, and nearly all governments have become somewhat captive to elite business interests. The problem is highlighted in the U.S., but countries that try to ride out the storm without addressing that core problem are likely to lag in recovery.

Facing the problem is particularly difficult for President Obama (though not as bad as it would have been for a President McCain, Republicans are completely detached from reality). Obama distinguished himself from his Democratic rivals with a particular reliance on market based solutions. Obama’s opponents in the Democratic party argued that market solutions to deep problems like health care and income inequality had failed, and that it was time for government to reassert itself. We will see how deep the crisis must get to force Obama to abandon his core economic principle and recognize that the big private capital markets will have to be restructured before the U.S. recovers.

7

Slocum 03.27.09 at 11:48 am

Supporters and critics agree that the Geithner plan depends critically on the assumption that the ‘toxic’ assets on bank balance sheets, such as securities backed by home mortgages, are actually worth substantially more than the market is willing to pay for them at present.

To me, it seems clear that the the toxic assets have no underlying ‘true’ worth that can be discovered by either an auction of committees of government experts. By that I mean, the ultimate value of those assets will be determined much more by the course of the economic downturn and recovery than by characteristics of the securities themselves. The value of the securities will depend on default rates and housing prices which, in turn, will depend on economic growth and unemployment rates. So to price these securities is to make a bet on the timing and strength of economic recovery. And, of course, there’s a feedback cycle — the timing and strength of economic recovery depends on the success in handling toxic assets. So good luck putting a price on all that.

But in this case, I don’t think it makes too much sense to worry about whether some private equity funds realize too much profit, since that’ll be the issue only in the case of economic recovery which meant the plan worked. And if it fails and government is stuck with the losses? Well at least the government won’t be stuck with all the losses (which it would have been in a nationalization approach).

8

tib 03.27.09 at 12:03 pm

Slocum @7,

You realize, of course, that if the plan fails then the government will have to nationalize those insolvent banks. We will have overpaid for the RMBS, lost the money we put out in non-recourse loans and we will have to cover large chunks of the nationalized bank losses.

The only upside is that Geithner is relatively constrained in how much he can dump into this plan. There is little TARP money left and Congress won’t be giving him any more after the AIG bonus issue.

9

annie 03.27.09 at 12:20 pm

Just the part about the market liking the plan: financial people are contemptuous of the plan. What they think is uncharacteristically savvy of Geithner is his timing its release with the inevitable end of quarter oversold bear market rally.

10

Slocum 03.27.09 at 12:27 pm

You realize, of course, that if the plan fails then the government will have to nationalize those insolvent banks. We will have overpaid for the RMBS, lost the money we put out in non-recourse loans and we will have to cover large chunks of the nationalized bank losses.

The overpayment risk seems rather minimal — take Krugman’s back of the envelope figures:

http://krugman.blogs.nytimes.com/2009/03/23/geithner-plan-arithmetic/

In his example, the expected value is 100, but with the non-recourse loans, the bidders are willing to bid 130 of which 20 is their own money. Which means the government is in for 110 instead of the 100. In the current scheme of things — BFD. Given that I think the Geithner plan is more than 10% more likely to work than straight nationalization, so I prefer the Geithner plan even after taking Krugman’s point into account.

11

JoB 03.27.09 at 12:36 pm

James, that was my sentiment – the world is drugged for over a century on Americans coming in to save the day, the Americans seem hooked on the idea as well which is arguably worse. But the real problem is maybe even deeper: why does some country or something have to ‘lead’ in order to get to the rescue? ‘Leadership’ seems oddly characteristic of the 20th century’s worst.

Barry, that’s simply not true. Denying that something happened and that that something had an impact on the leadership under which it happened is not very helpful. Even if your frustration is correct that not enough has happened to those used to calling the shots, my point was that some sense of quick revenge is not necessarily helpful for anybody.

12

Zamfir 03.27.09 at 12:55 pm

My Dutch government gave a “we will take any losses below a certain threshold” guarentee on 30 billion euro worth of toxic loans by ING, the largest bank in the country, probably including a several billion euro “Geithner put” in the terms. Before that, it nationalized the second bank in the country, paying 20 billion for it.

If you take in account that the US economy is 20 times larger than the Dutch economy, I am surprised at the ease with which these plans happened here, compared to the trouble it takes in the US.

Whether the Dutch are too easy or the Americans are too careful is beyond me to judge, but in this respect Europe is clearly not waiting for the American example.

13

Barry 03.27.09 at 1:05 pm

“Barry, that’s simply not true. Denying that something happened and that that something had an impact on the leadership under which it happened is not very helpful. Even if your frustration is correct that not enough has happened to those used to calling the shots, my point was that some sense of quick revenge is not necessarily helpful for anybody.”

How many Wall St elites are still in charge, despite having to be bailed out? AIG is an exception, and it seems to function chiefly as a money laundering device, to send over $140 billion to ‘counterparties’.

14

beezer 03.27.09 at 1:10 pm

The scope of this, and other like minded discussions, is indicative of a deep crisis and not just a financial one. The discussion has, in many ways, evolved into fundamental review of philosophies.
With resource shortages on the doorstep, my guess is we’re in for a series of crisises. I enjoy, in a disimbodied way, the conversation. But I’m certain not to enjoy the seriel appearance of crises.

15

Russell Arben Fox 03.27.09 at 1:14 pm

I’ll say what I’ve been saying for a while: well intentioned as it is, Obamanomics just isn’t socialist (or populist) enough.

16

JoB 03.27.09 at 1:20 pm

Barry, you’re leading me into a discussion that’s going nowhere but: I guess most but not all – be that as it may, I’ll not give them the honour of determining what needs to be done next (if there are feelings of revenge, I’ll flip out a Dirty Harry movie & at least enjoy it)

Zamfir, yes – one paradigm we should shift is the doctrine of EU-bashing (but the Dutch had the advantage of embezzling a lot of the billions from the Belgians) – now guess where I’m from ;-)

17

Zamfir 03.27.09 at 1:41 pm

JoB, remember Bernie Maddof? Stealing mere billions is something for minor players, like European governments. Real Wall Street leaders hardly get a bonus when they steal a few billion from their neighbours.

18

JoB 03.27.09 at 2:16 pm

If only they would have limited themselves to stealing from their neighbours ;-)

19

engels 03.27.09 at 2:42 pm

The management of any systematically important bank that has to be
rescued by the state should be disbarred, as a matter of course, from
further work in the financial industry. As substantial fine should also be
levied … Managers are, in an important sense, public servants. If they
abuse that trust, they should be treated accordingly.

Martin Wolff, Why Globalisation Works

(see also Jump You Fuckers!

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