Treasury Secretary Timothy Geithner's plan to fix the bank problem is coming into focus this weekend. Based on initial reports it appears the Obama administration is going to attempt a variation of the "bad bank" cum "private investor" approach that was employed during the Texas Savings and Loan meltdown twenty years ago. This is probably why Paul Krugman is so teed off today:
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.
....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.
Krugman is exactly right (did I say that?). In fact this plan is every bit as much a moral hazard as the mortgage bailout plan because it fails to punish the parties that necessarily should accept the risk for participating in the upside of the credit excesses that preceded the crash: the stockholders and bondholders of the financial institutions that will be selling the assets under Geithner's plan. Without getting into the minutiae of bankruptcy and creditor law that has served this country well for over a hundred years it must be said that turning this well informed area of the law on its ear in a time like this is insane.
In Geithner's plan large banks and financial institutions will sell "toxic assets" to buyers that will pay for their purchases with what is essentially taxpayer dollars because the Obama administration proposes to lend the buyers the funds on a non recourse basis. Even my eight year old understands that the currency in this game is no different than the notes I handed her last night when we played Monopoly.
Tim Geithner is getting rolled by the banks on this. Tax payers are going to ultimately fund a scheme that will enrich the very guys that helped create this problem and the only thing standing between this proposed heist and déjà vu all over again is a Congress with a spine. It would be helpful if there was a Republican out there with the sense to see what this clueless administration is advocating, but I'm beginning to resign myself that it may be necessary to destroy the place in order to save it. Sigh....