Sunday, March 29, 2009

The Geithner plan: Business as usual

As the G20 prepares to meet, there was hope that the Obama administration would explore innovative ways to tackle the financial crisis. However, it is difficult not to be disappointed with the rescue plan unveiled by Tim Geithner last Monday. The plan aims at getting private investors to buy off the toxic assets that weigh on the banks’ balance sheets. To achieve this, the government will match every $1 of private investment with $1 in equity (thus earning 50% of any future profits), and up to $12 of non-recourse loans – loans that will not be reclaimed if the investor decides to walk away.

This is very much business as usual. If things go wrong, the taxpayer is in for a huge loss ($13), while the downside for private investors is very limited ($1). If things work out well, private investors will reap 50% of the benefits made on the $14 investment – a highly lucrative leverage effect when compared to the initial $1 investment.

The justification is to have the market (rather than bureaucrats) price the toxic assets. However, there is a flaw in this argument. Obviously, the higher the leverage offered through matching non-recourse loans, the more money will be invested through the plan, and the more expensive these toxic assets will be bought off from the banks. By deciding the leverage ratio offered to investors, bureaucrats are effectively setting the overall price that will be paid to banks for these assets.

Once the government has (indirectly) decided the amount of resources it wants to transfer to banks, all market participants will do is cherry-pick between assets. There may be some value in this (having armies of financiers work their way through hundreds of billions of toxic assets), but it comes at the expense of transparency and control over how taxpayers’ money is spent.

From this perspective, it is easy to see that the Geithner plan amounts – again – to a huge transfer of resources toward banks in the hope that they will resume lending. Again, the plan is rewarding the failure and reckless behavior of banks, with little democratic control or oversight over how taxpayers’ money is spent. Meanwhile, public attention is being diverted to petty things such as the row over AIG bonuses, even though the sums involved are trivial compared to those at stake in the rescue plan. (To put things in perspective, AIG’s bailout package is worth over 1,000 times the $165 million in bonuses that provoked public outrage.)

Tellingly, the Telegraph reported that “It is understood that the PPIP was only finalised after Treasury officials, led by Mr Geithner, spoke to a number of senior bankers on Wall Street, including JP Morgan Chase chairman Jamie Dimon, in the hope of getting a plan that was workable for the market, following the dismissal of Mr Geithner's earlier attempt to solve the financial crisis.” Would anyone seriously expect the plan not to be geared to bankers’ advantage in these conditions? In the end, bankers will benefit hugely from this new transfer of resources (whatever the outcome of the plan, as soon as they sell their toxic assets they are off the hook), investors stand to make high profits with little risk, and the taxpayer may lose it all if things go wrong.

Sadly, all we can do now is wish that the plan will work. If it doesn't, there may not be a second chance. The recession may soon be much deeper, and all the harder to fight. And Congress may understandably be reluctant to spend any more money, even on a good plan.

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