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The Geithner Plan Won't Work
Susan Walsh / AP Photo
Why not? Because it fails the president's own test: It won't get credit flowing again.
What is the Geithner plan? In briefest summary, it is the TARP—the Troubled Assets Relief Program—Bush Treasury Secretary Henry Paulson’s original plan to repurchase subprime and alt-A mortgage-backed securities from the banking system—dressed up to engage the interest of hedge funds and private-equity investors.
Under the plan, 7.5 percent of the purchase price would come from private sources as equity. The same would come from TARP—that is, from the Treasury—also as equity. Eighty-five percent would come from the FDIC, as a low-interest, non-recourse loan, meaning that if the loans default, the FDIC gets the assets but nothing else.
If the assets prosper, then public-private partners make money and the FDIC gets paid. If the assets default at high rates, then Treasury and the private investors are together wiped out. The FDIC would get the securities and sell them; its losses would depend on the price it can get. In this game, the banks benefit from a high price, the FDIC from a low one, in the initial sale.
The Geithner plan’s real design is thus not to help the market but to steer it. It is not to discover a price but to create a new one, based on rules the Treasury is just now making up.
In principle, an auction will decide what the price will be. But since participation is voluntary, only assets that meet the banks’ selling price will actually sell. We’re told the banks do not wish to sell for less than 60 percent of face value—to take a deeper loss might expose them as insolvent. Private investors will not buy for more than 30 percent, because they think the assets are trash. This disagreement explains why there is no market now.
Secretary of the Treasury Timothy Geithner’s idea is that his plan can help make a price, acceptable to both parties, somewhere between the ask and the bid. Council of Economic Advisers Chairwoman Christina Romer was explicit about this on Sunday: “We are trying to help the taxpayer by using the expertise of the market by trying to set the price for these toxic assets.” National Economic Council Chairman Larry Summers, responding to Paul Krugman, made the same argument: “I don't know of any economist who doesn't believe that better functioning capital markets in which assets can be traded are a good idea.”
But, obviously, the plan gives the banks the whip hand. If the price doesn’t meet their minimum, they don’t sell, or anyway not much, and that’s the end of the story. It won’t take more than an auction or two to find out.
The Geithner plan’s real design is thus not to help the market but to steer it. It is not to discover a price but to create a new one, based on rules the Treasury is just now making up. It is, in effect, to create a new asset, a derivative, that can sell where the existing, underlying security (also a derivative) does not. The new rules—especially the leverage and the non-recourse feature—create in effect a new kind of bond, with a very high expected return, accessible to those who take the toxic assets from the banks.
Thanks to the FDIC’s loan guarantee, there is a big upside if the assets do well. That upside is there to lure the rich guys in. That is why the big funds were happy; that is why the stock market went up. For the high rollers, this casino could be very attractive.
And what happens if the assets really are trash? Well, first of all, you’ve now put the residential-mortgage-backed securities in the hands of some pretty aggressive investors. Are they likely to be forgiving of the poor home buyers in trouble? And cooperative with foreclosure relief? It’s doubtful, I’d say.
Second, when the assets default, the investors are out 7.5 cents on the dollar. Treasury is out the same. And the FDIC is out the difference between 85 cents and the ultimate sale price of the assets. Which could be anything between 85 cents (or percent of the auction price) and zero. The banks, meanwhile, are in the money no matter what. As is helpfully pointed out here, it’s easy to construct mixed examples—with some of the assets going bad and the others staying good, where the investors make money. But the FDIC always loses and the banks always win.
How much will the FDIC lose? From IndyMac’s experience, just announced, it appears that the alt-A residential-mortgage-backed securities are being written down about 80 percent in resolution. We don’t know if other banks were as bad. But when the ratings agency Fitch examined the loan tapes for a small sample of highly rated RMBS (Residential Mortgage-Backed Security) in 2007, they found “misrepresentation or fraud in practically every file.” Geithner’s plan states that the FDIC “will employ contractors to analyze the pools” against which it will issue loan guarantees. One wonders whether this analysis includes a scrupulous examination of the underlying loan tapes, with public disclosure of the extent of missing documentation, misrepresentation, and fraud.
If not, it would seem that these assets could only be sold, at 60 cents, to gamblers—to investors who are willing to guess at what the assets will eventually yield. Possibly there are enough gamblers out there, to pay the prices that the banks require. But it seems hard to believe.
Then again, there’s another possibility. Suppose some “interested” party—say a banker’s brother-in-law—came in on the buyer’s side. Suppose they were to bid up that initial price, meeting or nearly meeting the expectations of the banks? In that case—miracle of miracles!—the assets would sell. The Treasury and FDIC funds would get engaged. And the mortgage-backed assets would fly off the books of the banks.
At first glance, in that case, the plan would look like a big success. Geithner would be a hero. Paul Krugman and I would have to shut up. Until, after a bit, it became clear that the assets were not actually worth 60cents on the dollar, but only 30 cents, or nothing. Then the FDIC would take its losses. But the banks would be home free.
Isn’t there an open invitation here, for the banks to bail themselves out? They have a huge interest. For a small inducement—the exposure of a credit-default swap—they can get a dollar of bad assets off their own books. Ultimately, thanks to leverage and non-recourse, the loss falls on the FDIC, and is recouped (if at all) by higher insurance premiums on all banks—not just the big ones, which have a lot of liabilities that are not insured deposits—but the small ones, too, who mostly avoided the subprime mess, and mostly fund themselves mainly through FDIC-insured accounts.
What’s not to like about that, if you’re a big bank?
The ultimate objective, and in President Obama’s own words, the test of this plan, is whether it will “get credit flowing again.” (I have dealt with that elsewhere.) Short answer: It won’t. Once rescued, banks will sit quietly on the sidelines, biding their time, until borrowers start to reappear. From 1989 to 1994, that took five years. From 1929 to 1935—you get the picture.
So why rescue them? The cost has to fall somewhere: As Milton Friedman, no less, liked to say, there is no free lunch. Let’s not forget: Behind all of this are mortgages and derivatives, which were called “liars’ loans,” “neutron loans,” and “toxic waste” by the people who issued them. There was fraud in the inducement, fraud in the conveyance, and fraud in the ratings process. The incumbent top management of the biggest banks either did this, or is complicit, or is complacent. And they all did very well, while the money was good.
And the reality is, if the subprime securities are truly trash, most of the big banks are troubled and some are insolvent. The FDIC should put them through receivership, get clean audits, install new management, and begin the necessary shrinkage of the banking system with the big guys, not the small ones. It should not encumber the banking system we need with failed institutions. And it should not be giving CPR to a market for toxic mortgages that never should have been issued, and certainly never securitized, in the first place.
James K. Galbraith, author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too, teaches at the LBJ School of Public Affairs, The University of Texas at Austin. He is formerly executive director of the Joint Economic Committee of the Congress.
John Talks Joe
Lloyd Grove is editor at large for The Daily Beast. He is also a frequent contributor to New York magazine and was a contributing editor for Condé Nast Portfolio. He wrote a gossip column for the New York Daily News from 2003 to 2006. Prior to that, he wrote the Reliable Source column for the Washington Post, where he spent 23 years covering politics, the media, and other subjects.
The Right Dumps Carrie
Jacob Bernstein is a senior reporter at The Daily Beast. Previously, he was a features writer at WWD and W Magazine. He has also written for New York magazine, Paper, and The Huffington Post.
Geithner's Stock Plummeting
Jeff Madrick is a contributor to the New York Review of Books and a former economics columnist for the New York Times. He is editor of Challenge Magazine, visiting professor of humanities at Cooper Union, and senior fellow at the New School's Schwartz Center for Economic Policy Analysis. He is the author of Taking America, The End of Affluence (Random House) and The Case for Big Government.
The approach relies, in large part, on the market. Unfortunately, these are the same institutions that created the problem. The issue is this: as the Fact Sheet Treasury released describing the PPIP Program notes,
"the financial system is still working against economic recovery." (No kidding.) As we noted in April, 2008:
"With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic."
Further, the solution outlined by the Administration relies heavily on the assumption that "these assets create uncertainty around the balance sheets of.. financial institutions." This is a false assumption: the behaviour of financial managers created the uncertainty. While we are not "in despair", as is, apparently, Paul Krugman, we recognize that any "solutions" that do not explicitly address the ethics and behaviour issues are, well, problematic.
All bailouts should be linked to putting cash and credit in the hands of American consumers,
With banks, bailout money should be a portion of actual US consumer loans and loans made to businesses employing and purchasing supplies within the US----post inauguration.
Bailout money should also be repaid----it should be an investment, not a form of welfare for rich incompetents or fraud perpetrators.
President Obama
Owes it
To the American People
To at least listen
To Geithner's critics.
Wall Street should not be allowed
To become
Our permanent government.
'By creating an urgent crisis that can only be solved by those
fluent in a language too complex for ordinary people to understand
the Wall Street crowd has turned the vast majority of Americans
into nonparticipants in their own political future. There is a reason
it used to be a crime in the Confederate states to teach a slave
to read: Literacy is power. In the age of the CDS and CDO, most
of us are financial illiterates. By making an already too-complex
economy even more complex, Wall Street has used the crisis to
effect a historic, revolutionary change in our political system -
transforming a democracy into a two-tiered state, one with plugged-in
financial bureaucrats above and clueless customers below.'
Matt Taibbi'The BIg Takeover'
Rolling Stone online
3.19.09
Obama is meeting with Bankers on Friday? Taxpayers grab your wallets!
At last! Somebody has called the thing by its right name. Fraud. The root of this economic crisis is massive, deliberate, conscious fraud at every level.
To call these fraudulent loans "toxic", as though some industrial accident had rendered them unfit for consumption, was a deceptive move in itself.
These are frauds. If you or I got money that way they would haul our asses off to jail. Rightly.
Want to restore confidence in the markets? Arrest the people who applied for, issued, approved, securitized and sold fraudulent loans and other financial instruments . Simple as that.
Galbraith on Yahoo tech ticker and another interesting piece by him in Washington Monthly
http://www.fundmymutualfund.com/2009/03/yahoo-tech-ticker-james-galbrait h.html
Galbraith on Yahoo Tech Ticker and another piece by him in Washington Monthly
http://is.gd/oNLS
If the IRS was abolished and a flat tax in its place, there would be trillions in the treasury, or close to it. Another moneymaker would be drilling our own oil and then we could afford the renewable energy programs.
What is YOUR plan again ?
You might want to send it the way of the White House for consideration ...
It's about time, TDB. Finally, a Texas straight talker telling it like it is. The bailout is a scam, pure and complex. It's buying some time, hoping the economy miraculously recovers from its debt-induced coma to save the big banks from insolvency, while responsible regional banks and hard-working Americans ultimately foot the bill.
Galbraith is absolutely correct. Put BofA, Citigroup, AIG et al in receivership, fuck the retention bonuses and get rid of their management.They were absolutely complicit in the fraudulent conveyance of mortgages that never should have seen the light of day.
Well done, Mr. Galbraith. You put Texas in a whole new light.
Geithner plan's seems to be loooooved by the Wall Street bastards that created the mess. Why don't all of us leave our positions as doctors, nurses, police, teachers, labourers, etc.. to ALL become 'investment bankers'. What an easy, obscenely well paid and brainless job that is! Then we can all get a share of the pie and f* up at will with NO repercussions.
Well, Galbraith certainly fuels GOP obstructionism in Congress as Obama labors to drag the country out of the Bush administration's tar pit. But I see nothing much constructive in having town criers walking the streets yelling "it won't work!" Just what is the bright, clear alternative that is intimated but not detailed by these self-anointed pundits? A do-nothing attitude doesn't seem to offer much for the many unemployed who "will work" if given the opportunity.
and the ponzi schemes continue........and the generations that follow us are consigned to lifetimes of penury.....with nary a grumble from the masses.....we have become the true "silent majority"
Obama is scared to death of a bank lobby which is "too big to control". Galbraith et.al. can say this stuff because they do not have to worry about re-election. Geithner is a Wall St. re-tread and we are about ot be tread upon.
OH, I UNDERSTAND THIS WHOLE MESS NOW ! OBAMA IS AMERICA'S SAVIOR, GEITHNER IS A MENTAL GIANT, AND HILLARY IS GOING TO BUY BACK ALL OF OUR WORLD FRIENDS WITH PROMISES, SMILES AND MONEY AND DON'T FORGET THE BASIC FACT THAT THIS WHOLE MESS IS BUSHES. DODD, FRANK, SCHUMMER ARE BLAMELESS ! THANK GOODNESS THAT THESE LAST THREE ARE IN CHARGE OF ALOT OF OUR 'NEW' MONEY AND GOVERNMENT OWNED BUSINESSES AND ARE TELLING THEM HOW TO DO THE JOB ! I FEEL SAFE NOW....... AS LONG AS I DON'T REMEMBER ACCURATE AND TRUE HISTORY.
http://loudcrickets.blogspot.com/2009/03/abba-another-bank-bailout-assessme nt.html
Here's my idea for the bank bailout...
1 Banks need to open up their books and Fed/FDIC evaluates assets (and identifies what can't be evaluated). I'm sure these assets can be accurately priced, which will be below the bank's marked value. Some banks like Citi are insolvent.
2 Fed rates all banks from weakest to strongest.
3 Fed then creates a timetable when the banks will be "released" to sink or swim; this will be staggered every 3-6 months or so, with the weakest banks getting "released" first. Once released, banks either then exist by getting private funds on their own or go bankrupt. Investors can pony up more of their $ if they think the bank is solid.
4 Fed props up ALL banks in the meantime w/Federal $ to pay for operating expenses.
5 If a bank is released and is insolvent, then the FDIC takes them over in receivership. Good assets are sold to highest bidder, bad assets are kept by FDIC and sold over a period of time (years). Stronger banks buy the good assets of the failed banks, making all of them stronger because they have a higher % of good assets.
6 Repeat the process over a period of 12-24 months until all banks exist on their own or are bankrupt.
Banks that sink:
CEOs get FIRED
Shareholders get NOTHING
Bondholders get NOTHING
Staggering the "releases" will make sure the system isn't overwhelmed with good assets: only 1 bank's "good assets" will be sold at any one time (if they fail), lowering the prices too much.
This also gives time for banks on the list to get their house in order, and everyone can see where each bank is on the list.
We can sell these bad assets for whatever we want, whereas the banks can't lower the prices to actual value lest they be declared insolvent. So they stubbornly cling to high prices for these bad assets, and hope that taxpayers will OVERPAY for them? If we're going to own these bad assets regardless, we'll take them over in a receivership like the FDIC does ALL THE TIME, and sell them when we want at the price we want. We can even wait years to sell these assets when they are more valuable, whereas the banks don't have that kind of time.
If we say this idea is impossible, what we are saying is that 100% of our large banks are INSOLVENT and even combined with all good assets from ALL the other banks, NO AMERICAN BANK would survive. If that is the case, what is the point of banks auctioning their bad assets in Tim Geithner's new PPIP? If there aren't enough good assets to make ONE bank solvent, then Geithner's plan will fail because even after selling off their bad assets, these banks will STILL fail. Right?
If we don't do this plan, what will prevent banks from doing the EXACT SAME THING 10-15 years from now? Let's see, make tens of billions creating an asset bubble, then let the taxpayer pay for the bad assets when the bubble pops: that's a situation banks can get behind. All banks will do is get themselves in a position where they are "too big to fail" and do the same thing: run up an asset bubble and rake in the $ before it pops. They will say this in 2019 after the next asset bubble pops: "sure, we did this same thing 10 years ago in 2009, but this time we REALLY thought we were buying good assets, and did we mention we're too big to fail?"
My plan costs the Government less (taxpayers will own the bank's bad assets regardless, why pay extra for them in an auction?), bankers/investors suffer for making bad decisions, and everyone inside the banks and out knows what the timeframes are.
We need to know more about the credit default swap things, and how they appear to be getting the bailout money by default.
That is part of the reason why AIG collapsed, but we are not told whether the gain, when GM defaults, will help AIG bounce back.
The reason why it matters, is that we are not going to get a return on the money possibly. And we won't know that until we get more information, who knows how long that will take.
America was built on return on investment, this could be a real serious error in assumption. And we should question it, and someone should ask somebody in power, if or more accurately how, we are being protected from the abuse resulting from betting on failure.
The money appears to be going into paying of the liability caused by credit default swap betting.
This will be effecting our future, at a time, when the president is assuring everyone that we won't get screwed again by banks, the way we were, it appears we are getting screwed by banks more now than before, even, while Obama speaks.
Assets = Liabilities - Equity, so do bad Assets mean, bad betting practice related to someone else's liability?
How much is this bail out money going into paying off liability, before the cost of liability increases through the betting on credit default swaps?
Thank you.
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