Free Markets, Free People

Stiglitz Calls Geithner Plan “Ersatz Capitalism”

A number of economists, including Paul Krugman, have panned Timothy Geithner’s plan to recapitalize banks by buying toxic assets in a complex and highly leveraged way that puts the taxpayer’s dollars at risk.

Joseph Stiglitz, a Nobel economist, has piled on. In fact, his is probably the most damning opinion I’ve seen. Stiglitz says that first of all, Geithner has analyzed the problem incorrectly. Geithner keeps telling us it is a “liquidity” problem. Stiglitz says “poppycock”:

The main problem is not a lack of liquidity. If it were, then a far simpler program would work: just provide the funds without loan guarantees. The real issue is that the banks made bad loans in a bubble and were highly leveraged. They have lost their capital, and this capital has to be replaced.

What he means is their “capital”, or assets are in worthless loans. Yes that’s right – worthless. So, as he points out, paying “fair market value” for these assets won’t work, will it? They’re worthless.

So what does Geithner propose?

Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time.

Stiglitz explains the proposed process very well, demonstrating it fairly simple and straightforward examples how the taxpayer takes the majority of the risk, and, given the nature off the “assets”, will absorb the majority of the losses.

But Americans are likely to lose even more than these calculations suggest, because of an effect called adverse selection. The banks get to choose the loans and securities that they want to sell. They will want to sell the worst assets, and especially the assets that they think the market overestimates (and thus is willing to pay too much for).

But the market is likely to recognize this, which will drive down the price that it is willing to pay. Only the government’s picking up enough of the losses overcomes this “adverse selection” effect. With the government absorbing the losses, the market doesn’t care if the banks are “cheating” them by selling their lousiest assets, because the government bears the cost.

That is a process driven problem. The Geithner process guarantees the outcome because that is the most likely outcome, banks not being stupid and with the government bearing the cost.

Bottom line – taxpayers are going to get hosed and hosed good.

Stiglitz provides an interesting alternative which gives you an idea of how poorly he regards Geithner’s plan:

Some Americans are afraid that the government might temporarily “nationalize” the banks, but that option would be preferable to the Geithner plan. After all, the F.D.I.C. has taken control of failing banks before, and done it well.

Given only those two option, I’d say Stiglitz has a point.

Of course, the argument we’ve made since day one is we ought to let them go bust, get it over with and begin the recovery. That’s the same argument we made concerning GM and Chrysler.

Instead we’ve gotten these insane plans driven by the administration which has thrown literally trillions of good dollars after bad – and to no apparent avail.

This madness has got to stop.


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16 Responses to Stiglitz Calls Geithner Plan “Ersatz Capitalism”

  • “Instead we’ve gotten these insane plans driven by the administration which has thrown literally trillions of good dollars after bad – and to no apparent avail.”

    The apparant avail is that Obama and his administration gets control over more pieces of the financial pie (instead of bankruptcy courts) and as such can pay back and curry favors with people (IE IAW).  Does anyone think that if the govt has a say in GM going bankrupt that the UAW will have to concede anything.  Look for the govt to pick up the costs for the benefits of UAW workers.

  • IAW should read UAW

  • I expect the decision to allow the banks to mark to “significant judgment” will reduce the pressure on the banks to enter into these Geithner agreements.  So, maybe the damage from the Geithner plan will be far less.


  • The madness won’t stop so long as Obamaco is generating propaganda through its ancilliary organizations that confuses people.

  • And Erb calls this ‘leadership’

  • I was hoping that with Paulson was gone, the Treasury Secretary would stop acting like an investment banker focused on closing a deal. 

    I made a similar point to Stiglitz on another post, namely (i) there is seemingly little thought given to the distinction between the liquidity and the solvency issues, and (ii) that the process Geithner has devised cannot possibly “protect taxpayers” without underpaying for the assets, which would not do anything to deal with the banks’ first problem.  Not to mention the fact that the criteria for participating in this “market based” solution is so narrow that only a few institutions qualify.   [cue all of the other arguments about how this procedure seems to have been created to do the exact opposite of what is purported to do . . . ] 

    Does anyone have any confidence at all that any of these current plans will work to do anything other than cause massive inflation, economic dislocation and skewing of incentives of everyone in the economic system?

  • Hi all,

    I haven’t commented here in years until recently. Mr. Erb drew me back in so I might as well comment some more.

    I’ve been having trouble following all the details of this plan and one thing has been bothering me more than the rest. Will it be possible to track what happens to this tax money in the future?  

    If not, maybe this complex plan isn’t a misguided attempt to protect taxpayers. Maybe it’s a guided attempt to protect the administration while it appears to be “doing something” about the issue, taxpayers be damned. Once the plan is executed – regardless of amounts paid, true values, and taxpayer protection – the banks won’t have the “toxic assests” any more. If no one will ever know how well the taxpayers were protected, or won’t know for years, the administration can claim victory such as in this fake example: 

    “Our plan has successfully removed toxic assests from banks, an important step in our economic recovery, freeing them to begin lending again. We have achieved this victory with private investors, avoiding the undesired nationalization of our banking system. Our multi-pronged approach has successfully protected taxpayers by minimizing losses. We have used $X billion in our partnerships with private investors, with projected recovery of $Y billion from the assets in the future.”

    If Y is never known, how could political opponents ever credibly claim it was a bad deal? And if Y won’t be known until the administration is out of office, why worry about it, assuming you don’t really care how much taxpayers are taxed? This is a real question I have, and if anyone sees where I’ve misunderstood the plan I’d be grateful for a correction. Thanks!

  • We should be very frightened when both left and right leaning economists don’t like this plan.

    Also, isn’t this the same error Geithner supposedly made in the East Asian crisis in ’97 according to Paul Keating’s article?

    Like Zozo, I think the administration simply wants to be seen by the public as “doing something” but they also know that they are gaining useful power for their future political efforts by controlling the funds, the zombie jobs, etc.  Plus they can play populist at the same time, knowing the bankers are terrified of them and will keep the campaign dollars flowing no matter what. “Kill the chicken to scare the monkey” or “pour encrouager les autres” whichever analogy floats your boat.

  • There are reasons I read your blog, and this post is one — thanks for the link to a very persuasive and well argued opinion by Stiglitz.   I think he’s right.  I am not sure, though, if allowing all these banks and businesses to fail would be the best option — it’s just as risky in the other direction, it could spiral into a depression with no natural way out.  But yeah, the more I read, the more I agree Geithner’s plan is dangerous.

    • Scott, its good to see you coming around on this issue. 

      We can’t mistake movement for progress.  Action does not necessarily get results. 

      How many dollars will you spend to save one dollar?  What are the consequences to the system going forward?  Incentives will be skewed and behavior changed for every actor in the economy because of this plan.  I cannot imagine that Geithner and Co. have given any thought to this issue.  Consider whether the regulatory reactions to the S&L crisis caused or contributed to this crisis.  Consider whether the regulatory reactions to housing issues caused or contributed to this crisis.  Then consider whether another grand regulatory scheme will help or harm.  Whatever respect you may have for those in Congress and the admininistration, they are just people.  They are not necessarily capable of devising an appropriate response to this situation and will more likely make things worse.  The economy, and even the financial sector, is too complicated to be controlled by the delicate maneuvers of Geithner or Bernanke or, God forbid, Pelosi, Reid, Frank, Dodd, Obama, Waters, etc…  They can direct certain actions but they cannot dictate outcomes, and when the plan is as large, complicated and poorly constructed as this one, the consequences can be severe even if they are not immediate or immediately noticed.

  • Stiglitz’ trenchant analysis is right on target.  Geithner is all generalities/platitudes.  The administration (which I strongly supported prior to the election) that touted “transparency” to the taxpayers is anything but that.  These are some questions that remain unanswered: 

    1 Did some banks receiving TARP funds at 0% interest “park” some/all of it in government bonds @ 3% interest (at the taxpayers’ expense), as rumored — while failing to use funds for their intended purposes? Were banks required to segregate TARP funds on their balance sheets? Aren’t taxpayers entitled to accounting of original TARP funds before the admin doles out/subsidizes more funds? 

    2 Does Geithner’s plan favor the private sector, from which he emanates (plus, Wall Street, I believe, was among the largest contributor to Obama?) Taxpayers bear largest downside risk (@90%?) while the private investors bear smallest? Also, can “toxic assets” truly be valued? And aren’t banks now being allowed to inflate their prices, as reported, so that the “toxic assets” can now be valued at more(!) than investors would pay for them  — creating even more illusory money and throwing the stock market into further distortions in pricing?

    3 Relatedly, why no after-the-fact taxpayer transparency to ensure no favoritism/self-dealing/greater access to information in bank/company hand-overs? Why the widely differing bid prices? (1st bank — $2.16 billion, or about $1 a share, with FDIC assuming potential losses; 5 days later, 2nd– $15 billion without FDIC assistance: investment bank — $2/share, increased to $10/share within less than a week). Is such unprecedented government action legal/will it continue? 4 Bank account credit card/deposit account fees increased exponentially post-TARP, as have APRs, further hurting already hard-hit Americans. A form of double taxation? Should increased banking fees be prohibited/eliminated in any new bail-out/stimulus plan?

    4 Even the largest banks apparently made loans at 100% LTV and ignored longstanding underwriting standards; uninitiated borrowers encouraged to enter into high-APR ARMS on representation that home values would increase, etc. Will regulation limit such practices? Mortgage broker colleagues report that only a few borrowers actually can benefit from the lower rates — if loan amount is 1/2 the home value, etc.? Moreover, many “re-financed” loans by banks apparently don’t really have lower rates, but only longer terms/balloon payments at the end?

    5 Isn’t slashing jobs, salaries, benefits, bonuses, outsourcing — perhaps a model initiated by the highly touted Jack Welch, who has been revered/followed by many, many American corporate executives  on the part of corporations, – including financial institutions — what initially caused/are adding to the problem?  (I.e., focus on short-term, not long-term profits/sell divisions with the least profitability, ever over a short period of time, even though they may be mainstays in an economic downturn/ don’t fund any R&D project unless it can show a profit in 2/3 years, etc.)?  Meanwhile, CEOs/executives are rewarded, through increased pay, by shareholders for increasing short-term profits using these tactics?

    6 CEO pay @ 344:1 average workers’ pay? — much of it non-taxable business expense/deferred compensation, resulting in @$20 billion/yr at the taxpayer’s expense?  (see internet articles).

    7 Most disturbing is the proposed, massive increase in the federal debt. Does the massive increase in national debt (at least 9.3 trillion over the next decade) make us more vulnerable to our enemies, who may seize on our relative financial weakness as an opportunity? Will we have the financial resources to defend ourselves against a threat/attack? (other countries aren’t exactly stepping up to the plate)?

    8 Isn’t the answer more regulation instead of more (and more and more) federal hand-outs/subsidies/etc. (again, at least $9.3 trillion over the next decade), as many European governments have urged? I fear from my children and grandchildren, who will incur enormous taxes necessary to pay back this outsized debt, and whose future standard of living is very much in doubt. We saw the demise of communism in the 1980s; are we now seeing the demise of unregulated capitalism in the first decade of 2000? Are we now irretrievably forsaking our number one superpower status?

  • “CEO pay @ 344:1 average workers’ pay? — much of it non-taxable business expense/deferred compensation, resulting in @$20 billion/yr at the taxpayer’s expense?  (see internet articles).”

    I don’t know what “internet articles” you’re referring to, but compensation is capped at $1 Million/employee that can be counted against revenue (i.e. non-taxed), and has been since the Clinton tax bill of ’93.

  • To Michael W: 

    I think you are mistaken.  See below.

    From what I have read, based on well-researched and document studies, CEO pay has increased from the ratio of CEO salaries compared to average worker salaries have increased from approximately 40:1 to 344:1 in the last 30 years.  In addition, much of CEO compensation is in performance, etc. bonuses, which are deemed a business expense and hence exempt from taxation, deferred compensation, which is not taxed until years later (and is unlimited, unlike the average citizens’ 401(ks)), etc.  As the article, below, notes, The Wall Street Journal, in 2006 determined that, by comparison, the CEO to average worker pay ratio was 11 to 1 in Japan, 15 to 1 in France, 20 to 1 in Canada, 21 to 1 in South Africa, and 22 to 1 in Britain. See:
    For CEO compensation in 2006, see:
    For CEO compensation in 2007, wait and watch the number and photos change in the following article:
    See also:
    Note also that the five The top 50 hedge and private equity fund managers averaged $588 million each, more than 19,000 times as much as typical U.S. workers earned. .
    I think what you’re referring to with respect to Clinton is the following information relating to a failed Clinton initiative:  “Another major LOOPHOLE is the UNLIMITED TAX DEDUCTABILITY of executive compensation, which allows companies to deduct executive compensation from their income taxes as a business expense so long as the pay is ‘reasonable’. The IRS has failed to define reasonable, and a 1993 attempt by then President Clinton to cap executive compensation DEDUCTIONS at US$ 1 million FAILED.”  (emphases added).  See:
    For the $20 billion in taxpayer subsidies, see: . Then click on the paragraph at the bottom of the page that states “The full IPS report is available from the IPS by clicking here.” Click on the “here,” and then click on the title of the article that appears, entitled: Executive Excess 2008: How Average Taxpayers Subsidize Runaway Pay, and the full article will then download onto your computer. This is one of only many, many articles on the issues, above, that appear on the internet.
    Since the CEO paychecks essentially are subsidized by the American taxpayer, given that they don’t pay taxes on a substantial portion of them, the ratio of CEO to average worker compensation is likely even higher.
    The Income Equity Act of 2007, which was intended to address these inequities, was never passed.

    • No, I’m exactly right:

      IRC sec. 162(m) — Certain excessive employee remuneration

      (1) In general

      In the case of any publicly held corporation, no deduction shall be allowed under this chapter for applicable employee remuneration with respect to any covered employee to the extent that the amount of such remuneration for the taxable year with respect to such employee exceeds $1,000,000.

      In short, any pay above $1 Million cannot be expensed by the company (i.e. counted against income to lower the company’s amount of taxable income, and thus the amount of tax it owes).  There are some performance based pay exemptions, but they are limited.  After that provision went into operation, executive pay soared because (a) they were being paid in stocks/options/warrants, etc., and (b) the executives were directly incentivized to push stock price up regardless of the sustainability of that price.

      As for your contention that “CEO paychecks essentially are subsidized by the American taxpayer” that is patently ridiculous. The CEO’s do pay taxes on their incomes (at the top rate), the corporation pays extra taxes on its income (since it can’t expense all the salary it pays), and other taxpayers have nothing to do with it. Just because the government doesn’t take every last cent that one makes does not mean that one is being subsidized.

      • I don’t think you read any of the articles, written after the passage of the cited statute.  The lead-in to the main, lengthy and well-documented report states as follows:

        “Executive Excess 2008: How Average Taxpayers Subsidize Runaway Pay
        By Global Economy
        Author(s): Sarah Anderson, John Cavanagh, Chuck Collins, Mike Lapham, Sam Pizzigati
        The U.S. tax code is riddled with loopholes that allow top corporate and financial leaders to avoid paying their fair share of taxes. Ordinary taxpayers wind up picking up the bill – to the tune of more than $20 billion per year. All five executive-friendly tax loopholes highlighted in the report are the targets of Congressional reforms. However, these efforts have stalled in the face of fierce opposition from corporate lobby groups. The report also finds that S&P 500 CEOs averaged $10.5 million in pay in 2007, 344 times the pay of typical American workers. Compensation levels for private investment fund managers soared even further. The top 50 hedge and private equity fund managers averaged $588 million each, more than 19,000 times as much as typical U.S. workers earned.”
        Also, Warren Buffett himself recently has complained about the inequality in taxes between rich and poor: (and recent articles citing his statements)

        You’ll find many more articles on the internet supporting the proposition.

        • I don’t think you read any of the articles, written after the passage of the cited statute.

          I didn’t need to since I already knew that the ’93 tax provision was still good law, contrary to your assertion:

          CEO pay @ 344:1 average workers’ pay? — much of it non-taxable business expense/deferred compensation, resulting in @$20 billion/yr at the taxpayer’s expense?

          As I showed above, the statute says exactly what I claimed. Your assertion that such compensation is not taxed is simply wrong. The company that pays the compensation can only write off $1 Million. The employee who earns the compensation must pay taxes on every last red cent. Even when it’s deferred, or paid as a bonus. It is true that companies can write off some performance based pay (e.g. commissions) against their tax liabilities, but the employee still pays income taxes, and the company still pays income taxes.   The idea that any of this compensation is tax-exempt is absurd.

          I’ve also read many iterations of the same argument you regurgitated in the progressive/socialist/collectivist claptrap masquerading as “independent” research that you provided. I am quite familiar with the ideas presented there. Every single one of them assumes: (i) wealth is a fixed, zero-sum game; (ii) any tax savings employed by “the rich” are automatically “subsidies”; (iii) there is a limit on how much anyone person “deserves” to be paid; (iv) all pay scales should favor those at the bottom regardless of output or productivity; among many other similar lines of thought. These concepts are categorically wrong and I reject the collectivist principles underlying them. 

          In short, just because a CEO doesn’t pay all, or even most, of his or her salary in taxes, does not mean the he/she is getting a taxpayer subsidy.  Logically the point makes no sense anyway since, assuming that the CEO is one of the highest paid people in the country, and therefore in the top 1% of taxpayers (who pay about 28% of all taxes), your argument is that the CEO is subsidizing himself.  Of course, that makes absolutely no sense.