Everyone is in agreement that something has to be done There also seems to be agreement that the root problem is a bunch of banks are going bust because they made bets on housing prices increasing and then double-downed on those bets and even 35-downed. Unfortunately for the rest of us, those banks were necessary to make loans that help businesses make things and help people buy those things.
But what to do exactly to encourage lending, rebuild confidence and help our country out of this current re(de)ce(pre)ssion? Bobby Jindal wants deregulation and a decrease in capital gains tax. He also salivates when he hears a bell. Ron Paul, if anyone asked him, would probably recommend buying gold and twiddling our thumbs. Among more proactive people there are two main views:
On the one hand you have the “Swedish “ (Swiss?) nationalization model: the Treasury takes over our most insolvent lending institutions and sells off their remaining valuable parts to other, more sound banks, who presumably would use those assets to capitalize loans to consumers and businesses, as it should be.
This plan has the drawback that for a time the government would be running previously private institutions. Most people agree that managing private banks is not something the government would be very good at. However, in the current situation, the Treasury Department probably couldn’t do a worse job than the private owners who drove these institutions into the ground.
Another drawback is that shareholders would lose a lot of value when the banks' assets are sold off in an auction that would resemble a fire sale. Some of these shareholders are the fabulously wealthy jerks who caused this mess, but many of them are your and Jon Stewart’s mother(s) who indirectly own stock through their pension.
As Arianna Huffington and Paul Krugman have pointed out, this loss is unfortunate and probably inevitable. If these banks are truly insolvent then nothing will make them solvent. That is a fact that no amount of clever financial shenanigans can defactify. However, Tim Geithner is willing to try.
The Treasury Secrety's plan is the other idea that is actually happening and as far as I can tell is really terrible. First the name: "The Toxic Assets Plan”. Is it a plan for toxic assets or a toxic plan for assets? Maybe a little bit of both.
Essentially, in the interest of avoiding nationalization, Geithner wants to help banks resell the assets that ruined them. Sort of like if your friend steps in dog shit so, to help him out, you lick his shoe. The Treasury will set up a government subsidized auction to encourage private investors to buy “toxic” (misunderstood?) assets from “ailing” (sneezy?) banks.
The nuts and bolts of how the government will encourage money managers to buy mortgage-backed securities from investment banks is described in a Time article:
an investor could put up $6, get matching investments from the Treasury for another $6, then obtain loan financing of $72 from the FDIC. This would allow the investor to purchase a security with an $84 auction price.
The loan from the FDIC would be collateralized by the security so, if the security turns out to be worthless, then the taxpayer is on the hook for the majority of the cost.
To put it in perspective, investors will be leveraged 6/1, which is pretty timid for a hedge fund, but this is solely for securities that are publicly acknowledged to possibly be nearly worthless. It is called “Toxic Assets Plan”; how much value does anyone think they will get? And if the securities turn out to be in fact worthless and the investor defaults on their FDIC loan, then the tax payer eats a total of 78 dollars to the investor’s 6. Not so risky after all, especially if they have already sold the security to a mutual fund in your 401K and charged a fee for the service.
As far as I can tell, the only real strength to Geithner’s plan is that Eric Cantor hates it. The minority whip is quoted in a Huff Post article saying:
As described, the plan seems to offer little incentive for private investors to participate unless the subsidy is made so rich that it comes at the expense of the taxpayer
It is probably the most coherent sentence he has ever uttered, and I can only agree. The banks wouldn’t be in such hot water if these securities were actually worth anything so paying people to buy them doesn’t make a lot of sense to me.
To recap: investment bankers ruined our economy by buying worthless securities with borrowed money. To fix the situation, the government is... encouraging people to buy the same securities with borrowed money. The irony is thick enough to cut with a chainsaw.
10/31 update: Nobel Prize Winner totally agrees with me
