Timothy Geithner’s toxic plan

guardian.co.uk, Monday 23 March 2009 19.00 GMT

The last-ditch effort to save Wall Street will hurt taxpayers and still require another big bailout down the line.

Dow Jones up almost 500pts – top “winners”:
bank of america – 26% +
jpmorgan chase – 24% +
citigroup – 19% +
amex – 18% +

Dean Baker

Treasury secretary Timothy Geithner‘s latest bank bailout plan is another Rube Goldberg contraption intended to funnel taxpayer dollars to bankrupt banks, without being overly transparent about the process. The main mechanism is a government guarantee that would allow investors to buy junk with a 12-to-1 leverage ratio, where they only risk the downside on their own investment, not the borrowed money.

Ostensibly, this is supposed to reveal the “true” price for junk assets, as investors compete at auctions to buy assets under the new rules. But this story doesn’t pass the laugh test. All we will really learn is what price investors are willing to pay for these junk assets when they are given a large subsidy from the government to buy them. In reality, this plan is a way to use taxpayer dollars to get investors to pay far more than these assets are worth in order to give more money to bankrupt banks.

The results will be mixed. Some of the assets undoubtedly have some value. There are, no doubt, shrewd investors who have identified certain assets that they would have been willing to buy from the banks, but instead put off purchasing while they waited for a deal like this. Now these investors will have the opportunity to buy these assets with large subsidies from the government, allowing them to make substantial profits. (It’s not clear if President Obama will want to invite this new group of hedge fund billionaires, who got rich off this government programme, for photo ops in the White House Rose Garden.)

A second outcome is that many investors will see the subsidy and decide to dive in, recognising that most of any potential loss will be borne by the government. This route might prove especially attractive for one of the zombie banks, which would effectively have nothing to lose anyhow, since they are already bankrupt. In these cases, the government can expect to take substantial hits, since the investors would bid more than the assets are worth – and the government would be stuck with the eventual loss.

A third result of this path is that the subsidised class of assets would rise in value relative to assets that do not benefit from the government subsidy. This could cause banks that are relatively healthy, and therefore not taking part in this programme, to suffer. With investors opting to buy assets that come with government subsidies, the demand for mortgages or mortgage-backed securities that don’t have these subsidies might suffer.

A fourth likely outcome is that even with the subsidies, much of the toxic waste would stay on the banks’ books. There is a large gap between the price that investors have been willing to pay for these junk assets – which has been around 30 cents on the dollar – and the price that banks list on their books, which has been 60 cents on the dollar. If the government subsidies raise the price that investors are willing to pay by 50% (a very large increase), then the banks would still have to write down these assets by another 15 cents on the dollar in order to make the sale.

It is likely that the gap between the asking price and the offer will not be closed for a large portion of these assets, even with the government subsidy. As a result, the banks are likely to have several hundred billion dollars’ worth of bad assets on their books even after this plan has been put in place. The Obama administration will then be forced to go to Congress with yet another bailout proposal.

It is also worth noting that this is a situation that invites all manner of fraud, since there are very large government subsidies that could be appropriated through clever schemes. The Obama administration assured the public that the Federal Deposit Insurance Corporation (FDIC) will be closely monitoring the programme, but the FDIC does not have the staff or the expertise to effectively track a programme of this size. The situation is complicated further by the fact that many of the big actors are likely to be hedge funds and private equity funds, which are almost completely unregulated in the current environment.

It is hard to understand this plan as anything other than a last-ditch effort to save the Wall Street banks. Unfortunately, Obama seems prepared to risk his presidency on their behalf.

Comments in chronological order

Erdington

It would make much more sense to nationalize the Federal Reserve. Then money could be raised interest free to save taxpayer money. The private banks could then borrow money from the nationalized Federal Reserve at interest to also save taxpayer money or file for chapter whatever, auction off the toxic paper to the highest bidder and fire all the incompetent bankers, who got us into this predicament.

What about helping the folks who are being thrown out of their houses?

Inflationary you might say, but isn’t that better than stagflation?

This is supposed to be the government of the people by the people not the government of the banks.

PresidentD

It would make much more sense to nationalize the Federal Reserve. Then money could be raised interest free to save taxpayer money.

An absurd statement. How in hell could money be raised “interest-free”?

hideandseeker

Excellent analysis Dean.
However you fail to join up the dots – ie that Obama is a part of the banksters conspiracy to carry on with the mother of all financial heists until eveyone in the US is bankrupt apart from the financial elite. This show will roll until the public become so outraged that they take to the streets, then Obama will declare martial law for “national security” – get the picture…

Thehanginggardener

The underlying problem would appear to be that the Obama Administration and its Treasury department is philisophically incapable of entering into the required mind-set that would enable them to take the necessary decisons.

radman26

Clearly, the lunatics are running the asylum!

It was Geithner as head of the NY Reserve that pushed for the initial bail-out of AIG. Why is anyone surprised that his loyalties lie with someone other than the taxpayers or the public at large? Obviously, the plan is to front the “investment” bank onto solid footing and then worry about the economy in general. This nugget of lunacy presupposes that the “investment” banks are solvent, which they most certainly are not. All this does is re-inflate a debt bubble that will some day have to be dealt with. Where is the growth necessary to burn off the debt expected to originate from? Manufacturing? Banking? Real estate? War?

We just keep running ahead of the tsunami toward presumed safety without realizing we’re on an island and the tsunami is gaining on us from the other side as well.

thebley
This analysis follows that of Krugman and many many economists in the US. They are all predicting this new bankers bailout will be a disaster, both for Obamas presidency and american taxpayers. Why then is the uk media hailing the plan, falling over themselves to explain how the “downturn” is almost over. We will get the same spin and lies after the g20, when failure will be hailed as success. Obama and Goldman Sachs, Brown and RBS- now we know who is in charge. These abject politicians are ensuring a depression by keeping the criminals in place. Geithner’s plan is a crime, a felony, a morality nose dive. Brown will try to do the same here, in fact he already is-rewarding the corrupt and re-financing their crimes. This will end badly, not least for the majority of leaders who will parade their “unity” in London. The real world is catching up with capitalist greed, the super rich and the politicians who defend them. They are the toxic force and they must be neutralised for the good of all.

zeke2u

An absurd statement. How in hell could money be raised “interest-free”?

It’s not absurd. But in order to understand, one has to understand how money is created. Governments have the ability to make loans because of their ability to collect taxes. It’s this loan making ability that creates money – what’s absurd is giving money to the big banks which have failed, then have the Federal Reserve, which is owned by the big banks, charging tax-payers interest on the money we’re giving them.

integrity4me

It is also worth noting that this is a situation that invites all manner of fraud, since there are very large government subsidies that could be appropriated through clever schemes. . .The situation is complicated further by the fact that many of the big actors are likely to be hedge funds and private equity funds, which are almost completely unregulated in the current environment.

and from paul krugman. . .

In effect, Treasury will be creating — deliberately! — the functional equivalent of Texas S&Ls in the 1980s: financial operations with very little capital but lots of government-guaranteed liabilities. For the private investors, this is an open invitation to play heads I win, tails the taxpayers lose. So sure, these investors will be ready to pay high prices for toxic waste. After all, the stuff might be worth something; and if it isnt, thats someone elses problem. [The taxpayer’s]…

dow jones up almost 500pts – top five “winners”:

bank of america – 26% +
jpmorgan chase – 24% +
citigroup – 19% +
amex – 18% +

connect. the. dots.