Free Markets, Free People

Brad DeLong

The “Geithner Plan”, Front And Center – Will It Work?

The Geithner Plan for “Bad Bank Assets” has been published in the WSJ under Geithner’s name. It is pretty much that which was leaked and critiqued by Dale here.

James Joyner wonders:

To my non-economist mind, that sounds eerily remniscient of the Troubled Assets Relief Program (TARP), the $700 billion plan passed last October to prop up the frozen financial system by buying, well, troubled assets. Granting, arguendo, that the Bush administration, which ran the first part of TARP, was evil and incompetent and the Obama administration is all sweetness, light, and omniscience, why would this work any better the second time around?

Paul Krugman, as we noted last week, is not impressed by this plan at all:

This is more than disappointing. In fact, it fills me with a sense of despair.

After all, we’ve just been through the firestorm over the A.I.G. bonuses, during which administration officials claimed that they knew nothing, couldn’t do anything, and anyway it was someone else’s fault. Meanwhile, the administration has failed to quell the public’s doubts about what banks are doing with taxpayer money.

And now Mr. Obama has apparently settled on a financial plan that, in essence, assumes that banks are fundamentally sound and that bankers know what they’re doing.

It’s as if the president were determined to confirm the growing perception that he and his economic team are out of touch, that their economic vision is clouded by excessively close ties to Wall Street. And by the time Mr. Obama realizes that he needs to change course, his political capital may be gone.

Krugman goes on to discuss the economics of the situation and a relatively easy way to solve the banking problem. Probably one of the more striking lines in his discussion is:

But the Obama administration, like the Bush administration, apparently wants an easier way out.

This speaks to a theory we’ve all discussed about certain aspects of the job of president in which Barack Obama displays very little interest. From his chuckling though his “punch drunk” interview with Steve Frost yesterday on “60 Minutes” (an invitation to view him as unserious about the crisis) to his seeking an easy and fast solution to the banking crisis, it seems that this is one of those areas which holds little interest for him. He wants it dealt with as quickly as possible (or at least seemingly dealt with so it is at least off of the front pages) so he can move on to his real interest – his costly social agenda.

Anyway, read all of the Krugman critique.

Brad DeLong thinks Krugman may be wrong and lists 3 reasons why:

1. The half empty-half full factor: I see the Geithner Plan as a positive step from where we are. Paul seed it as an embarrassingly inadequate bandaid.

2. Politics: I think Obama has to demonstrate that he has exhausted all other options before he has a prayer of getting Voinovich to vote to close debate on a bank nationalization bill. Paul thinks that the longer Obama delays proposing bank nationalization the lower it’s chances become.

3. I think the private-sector players in financial markets right now are highly risk averse–hence assets are undervalued from the perspective of a society or a government that is less risk averse. Paul judges that assets have low values beceuse they are unlikely to pay out much cash.

While it is nice to be optimistic, it is also important to be realistic. Frankly I think DeLong’s optimism isn’t realistic in the face of this particular crisis and I’m inclined to believe the Krugman critique to be more “spot on”. I have no confidence that this plan will solve the problem.

One of the problems the administration faces which is above and beyond the “workability” of the plan itself is related to the AIG bonus blowup in Congress. Private investors are gunshy about participating – for good reason:

The backlash on Capitol Hill means private firms may think twice about taking part in Geithner’s public-private partnership, even though government financing will limit their risk and increase the potential of earning profits, said David Kotok, chairman and chief investment officer of Cumberland Advisors Inc., in Vineland, New Jersey.

“We expect that the participation in the program to be announced this coming week will be tepid at best” because of “fear that any action which puts them into the federal assistance plan will subject them to the chance of retroactive punishment and taxation,” Kotok said.

A real “chilling effect” given Congressional and adminstration overreaction to the bonus situation. Reports are Obama is cooling to the idea of retroactive taxation, but, right or wrong, there is still going to be a demand for some sort of action. We’ll see what sort of leadership Obama tries to exert concerning those bonuses if any.

~McQ