The Geithner plan has now been leaked in detail. It’s exactly the plan that was widely analyzed — and found wanting — a couple of weeks ago. The zombie ideas have won.
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.
To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad — I mean misunderstood — assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.
But it’s immediately obvious, if you think about it, that these funds will have skewed incentives. 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 isn’t, that’s someone else’s problem.
Or to put it another way, Treasury has decided that what we have is nothing but a confidence problem, which it proposes to cure by creating massive moral hazard.
This plan will produce big gains for banks that didn’t actually need any help; it will, however, do little to reassure the public about banks that are seriously undercapitalized. And I fear that when the plan fails, as it almost surely will, the administration will have shot its bolt: it won’t be able to come back to Congress for a plan that might actually work.
What an awful mess.
Update: Calculated Risk and Yves Smith have similar reactions.
From 1 to 25 of 672 Comments
Summers’ argued last week that the private exposure would be substantial – but today’s Times page one reporting suggests it could be as little as 5%. An awful mess indeed.
— JimBy dealing first with the seemingly impossible financial industry crisis, the Obama administration may already have lost public support for dealing with energy and other issues with large infusions of cash. They may be forced to explore other routes to promoting the development of solar power, for example.
It’s time for you to dust off your excellent editorial(s) supporting taxing gasoline to keep it at a $4/gallon level. As you explained, this will encourage the private sector to choose the best alternative energy companies in which to invest, at no “net” cost to the public. The private sector will make better choices, and government money is short term. If we might later see <$2/gallon gasoline, nobody will have the confidence to seriously move these new technologies forward.
This will have the added benefit of motivating the public, instead of the government, to demand more fuel efficient vehicles.
Finally, the government needs to get past the fact that they must prevent large auto (just one example) companies from failing. The market will be poor for many years, and without some attrition, none of the companies can be successful.
— Robert BedoukianThese assets are misunderstood. People don’t understand that the government intends to reflate the nominal value of real estate in this country — and absolutely NOTHING will stop them from doing it.
They are taking the easy path to solving this problem — print money — and therefore spred the losses among everyone who holds that money, because as the nominal value of real estate again goes up, so too will the nominal value of gasoline, etc.
You solve the real estate problem by effectively imposing an “inflation tax” on everything else.
So, you will some day live in a million dollar house but you will sit in it complaining that you can’t afford a $100,000 car or $8 a gallon gasoline.
— IvanIf these are indeed no-lose bets, and the private-public partnership is to be in some way managed by Treasury, why wouldn’t it be possible for the public to buy into it much the same way that they can participate in Treasury auctions via Treasury Direct of some such?
— jhmGee – what a surprise! Paul Krugman hates an Obama plan!
— carrieObama, we hardly knew ye …
— Bob CawleyIf I have my brain cells properly wrapped around this proposal, this sounds like propping up paper value with real cash. Isn’t that a pyramid scheme?
— margieWhat say you get a bunch of other distinguished economists together and write a serious letter to the president, copy to the major newspapers, explaining in as plain English as you can just why this bank deal is a bad idea. Someone’s got to do something to stop this plan. I am very afraid there will be no second chance when this idea flops and we may never recover.
I’m sure no Pulitzer prize winning economist, just an average citizen who has been following events, and this idea of the zombie banks, which is a good way of putting it, just seems very WRONG to me on the face of it. I do not see how it could ever work! And I cannot understand why anyone would think it could.
I have real trouble trying to understand exactly what the fear is, of dealing with this head-on – take over the banks, clean them up,, reprivatize them. Is there some valid “economics” reason why the administration seems so terrified of doing this? Can it really be that they are willing to risk THAT MUCH, just because they are just too close to the bank system and personnel? That seems so reckless. But what is underlying the big reluctance to just deal with it head-on?
— Teresa ShankPaul you hit the nail on the head. This plan is equivalent to the bundling of mortgage securities, that let the bundler profit with little or no skin in the game. It makes one wonder if Obama is nothing more than a beast controlled by his BANKSTER backers. Don’t forget these BANKSTERS were the largest contributers to his campaign. It is almost like this administration and the last are intentionally making the wrong decisions. Giving non-recourse government loans to private institutions doesn’t seem like a good use of public funds. in fact if these loans go bad it might impair the FDIC in the future and lead to old fashioned bank runs.
— Aaron KramerI’m terribly disappointed in Obama. He talks the populist talk, but his actions on the economy from picking Timmy-boy Geithner on show that his real economic goal is not to fix the economy, but to preserve the Wall Street status quo: their outrageous incomes, fraud disguised as “financial products”, their sense of being masters of the universe and therefore entitled to whatever they want, and their complete disconnect from the real world..
As far as the economy goes, the only difference between Obama and Bush is that Obama “takes responsibility” for his policies and actions. Of course, there are no consequences to his “taking responsibility”, so it’s not much of a difference.
— MikeIt’s funny, isn’t it? Obama made a terrible decision picking Geithner, and that one single decision may be enough to sabotage every other ambition he harbors for his presidency.
Professor Krugman — can you explain one aspect that wasn’t clear from the article? As I understand it, private investors can make a bet with only 3% money down. Taxpayers take on the remaining 97% of the risk. Not a bad deal for the private investors, of course. But one thing remained unclear: how would any profits, if any were to materialize, be divided?
Do private investors get 100% of gain for only 3% of risk?
— FrancoisPaul – I agree with your astute analysis ENTIRELY. Yet, why don’t the actual planners and decision makers get it?
Ever get the feeling we’re all hostages and we know what the dire outcome will be?
— Jay CambridgeMAI agree this plan is horrible, but is there an alternative other than nationalization, which looks like they have some morbid, irrational fear of? I just moved my 401k into a stable asset fund. It is obvious that this “Great Ressission” is not going to get the serious (non political) attention it requires.and we will just have to wait for all this to unwind.
— LenOh, Paul, … as long as we have a communicator in the White House who communicates … we’ll be fine.
— annaI was thinking … for a couple of decades, Americans have been told that they need only “transferable skills.” What exactly are “transferable skills?” Smile, firm shake, the ability to write a manipulative memo, communicate (what exactly)?
Can a civilization of “transferable,” mutually replaceable people survived? Are we sure that content really, really doesn’t matter?
Does this mean I can buy $1,000 worth of risk-free financial assets for $150.00? Where do I sign?
Seriously, I’ve wondered why no one’s floated the idea of dealing with the “misunderstood” assets by converting them into some sort of bond wherein the investor’s principal is government-insured. As a working individual some years off from retirement and having close to no confidence in the markets my retirement savings are invested in, I’d be attracted by a guarantee that, though I might not get rich, I wouldn’t lose my shirt either. Or to put the question another way: What kind of policy would make the taxpayers, who are footing the bill for all of this, the beneficiaries of the “heads-I-win-tails-you-lose” scenario Geithner et al seem wedded to?
— DCBanks are currently unable to make loans. Why not a national bank that makes low interest loans? It would infuse capital into the market without the added expense of making profits. The banks could then slowly work out their balance sheet problems by the stimulating effect that government loans would have on the economy. Some would fail. Others would eventually be able to make more loans as their financials improve.
As the economy improved the government could sell those loans to the banks effectively over time getting out of the banking business.
— Anthony BreaThis plan will be implemented and fail as you predict which will force Obama to offer up Geithner as a political sacrifice. This will placate some critics but Obama will have squandered an enormous amount of political capital while empowering the Republicans to lay the blame for the entire mess at the feet of the Democrats. The mismanagement of this situation really boggles the mind.
— RobertProf. Krugman,
You are so right. This plan is obviously the product of regulators with no idea how the capital markets function. The key to the solution is to recognize the problem, which is that the entire system was overleveraged, AIG most of all. Forgive me for thinking that the solution might be to remove the leverage from the system, instead of propping it up with taxpayer dollars. Geithner is essentially saying, since we don’t know what that subprime-backed CDO-squared is worth, we’ll use taxpayer money to play it safe and assume it is worth 100 cents on the dollar. Fact: it is worth 0 cents on the dollar, and the sooner you admit that the sooner you get to work on abrogating all the contracts such as AIG’s CDS which should never have been written in the first place.
— Mike BlumIs it time to stash what cash we may still have?
— BWDDoes anyone have any analysis as to WHY Geithner might think that these bad assets are actually worth anything?
— ScottIts ever more apparent that President Obama, the man in charge, is not interested in initiating real change as regards the broken financial system. As the weeks go by, one can’t help see the reality: Obama has kept Bush’s economic team in place adding a few Clinton-era deregulation-enablers, while maintaining essentially the same economic policies that brought to an ever deepening recession. Its interesting that the President is not listening to a host of well-qualified economists like Dr. Krugman, Robert Reich or even Paul Volcker, who have abundance of past experience and a record of prescient advice that turned out to be correct over the past decade. Our only hope may be the President’s puzzling lack of involvement in policy making–handing over large matters–the stimulus bill, health care reform–to Congress and allowing them to come up with a solution. If senators like Sam Brownback, a conservative Republican, can be advocating for a 1930s style Federal govt. run Reconstruction Bank to seize “zombie” banks and corporations and sell parts of them off, then maybe there is hope, but I wouldn’t bet on Congressional consensus any time soon.
— stokesA related term of art that was used during the lead up to the Texas S&L thing was “regulatory forbearance,” which I always took to mean “cover your nose, look away and hope for the best.”
— bdbdthis is even more ridiculous than the original tarp. Instead of the treasury overpaying for bad loans outright with some small chance of upside. They are going to bring in hedge funds to take the upside with treasury, fed, FDIC taking the downside. All in hopes of fooling people into believing that our banks are capitalized. Given the recent actions of congress who wants to engage in a contract with the us government – if the masses start to yell and scream (and this will really anger them when they see how this works ) the crongress might just change the terms retroactively
— MacMr Krugman,
— john milksWhy do you think this plan will almost surely fail? I don’t disagree with you but please provide more details. Why might it succeed? Surely there is a chance that it will.
What can We The People do to stop this awful mess from continuing down what truly seems to be a disastrous path?
Obama seems to be firmly behind Geithner and his plans.
I despair that this once-in-a-lifetime chance to help our nation become a less corporate controlled country, and a county more supportive of our brilliant entrepreneurial capitalism is being ruined by the Geithner/Summers/Ruben team.
What can we do?
— Mary Margaret