Three Scenarios for the Geithner Plan

Three scenarios are possible for the new Geithner plan:

1. The toxic assets will attract only few bidders, while most investors decide they are not a good investment at any price, even with Treasury's inducements, since those asset are not just illiquid but actually hopeless.

2. The Geithner plan will attract only few banks, because they fear their assets will receive only very low bids, forcing banks to take further write downs and thus eroding their capital even more. This will tear the mask from the banks' balance sheets and spell their doom. Because of that risk, many banks may choose not to participate. This scenario also renders the plan ineffective.

3. The plan's participants buy most assets from the banks at prices that leave the banks solvent. In this case, the plan works well but would amount to effectively subsidizing the failing banks, transferring their losses and risk to the taxpayers via the Fed's balance sheet.

None of the above scenarios is very promising; none leads to a good denouement. And what bothers me most is that we bet our financial system and the economic recovery on this plan, hailed as a panacea. It is never a good idea to bet the house on any grand scheme. Any system as complex and reflexive as the US economy is by definition unpredictable, and nobody could be confident this plan will work. If it fails, shattering the high hopes of so many, the price of disappointment will be immense. We will be with our back to the wall, facing another wave of panic.

The very premise behind the plan is flawed. We insist on saving the banks, and refuse to admit most of them are impaired beyond hope. We prefer to sweep their problems under the carpet, but the day of reckoning is here and it is always better to deal with our problems than pretend they are not there. We can handle the truth, although we may not be able to postpone it much longer.

What we should do instead is have the Treasury offer to match the capital of new community banks to be formed by the private sector. Entrepreneurs will have strong incentive to launch these new banks because of the federal matching, which will double their capital overnight. These new banks, unburdened by past mistakes, will have clean balance sheets and will be eager to lend, replacing the old failing banks and rejuvenating the credit system. Because most banks operate with loans at least ten times their equity capital, the amount of new credit will be at least 20 times the capital allocated by the government, so the multiplier effect will be very substantial.

And the banks that engaged in wretched excess and can't survive without federal funding do not deserve our help.

Comments

[notajesusgigolo]

Call me a cockeyed optimist, but I beg to differ:
(1) Investing in toxic assests will attract buyers because a majority of American people trust Obama and have the good sense to know that true remedies take time - lots of time. They're willing to wait it out before proffering harsh judgment.
(2) Banks wrote their own scenario of doom, which reached its crescendo with the Bush II administration being cognizant of the dastardly maneuvers. Now it's a new game, and the bankers will simply need to follow the rules and regs that were arrogantly swept under the rug, especially during the last eight years, along with a few new ones that are sorely needed.
(3) Yes, the American public will absorb this debt to save the global economy from totally imploding - there are no alternatives on the table, just incoherent mumbling from the self-imposed GOP peanut gallery
Patience is the key. Something the American public seem to have plenty of, along with good will toward men. The pols and MSM could learn an important lesson from us, instead of treating us like fools.

[bighat]

Just who are these investor that have ended up with all these subprime loans or whatever is causing congress to believe that some companies are too big too fail. Are they foreign countries. The wealthy. People who give large campaign contributions. Would I as an average american be any worse off than if congress did nothing. Let these big companies fail. Let the shareholders who hired these high risk takers lose their money.

Just how does bailing out AIG or Citi help me or any average American. Yes some would lose money but I think most of us would be better off. Other banks and insurers would step up and hire the midlevel and under people and busines would continue on.

If Citi once again becomes the world largest most trusted bank would that help me or any other average american

[andyg]

Who going to start a new bank, if the goverment plans to take most of the profits.

[Charlie M]

Mr Schram seems to forget there are thousands of innocent people ,tax payers, that will loose their assess if what he espouses is done? I agree we need to deal with these inslovent banks. I say nationalize them ,nationalize all the banks for that matter , until the government figures a way to make things right again . There will be plenty wanting to start new banks or restart the old ones .

[stevendedalus3]

The most important action the government can take to ease the economic crisis is to bypass the middle-fiddle manipulators of Wall Street and deal with the thousands of solvent local and regional banks that still exercise sound lending and investment practices. Moreover, there are countless ways to put people to work without having to wait for new technology such as wind turbine grids and high speed rails. Decaying malls and housing are in need of immediate clean up and repair. Many malls in decline should be open to walk in clinics, start up businesses, daycare centers, and schools of all sorts; low-income housing in distress are in need of not only energy efficiency but painting to basic plumbing. Unemployment insurance beneficiaries should be urged if only temporary to become security guards in shopping centers and in schools, not to mention the great need for teacher aides. And for the countless young men and women there is a great need, especially now, for Mexican border control.

[writerroz]

Listen, People. The fact that Scram Schram got his article posted does not imply that he has the whole answer. There is NOT just one solution, since the causes of this crisis are MANY sided just as the effects are MANY sided and the suggestions are Many sided. For God's sake, let's be patient and give these people who are working at solving this hurculean crisis some necessary time. Bush & Republicans were allowed to create this almost Depression over a period of eight years , and with the support of people who are doing the squacking now.

[grateful4thedead]

schram is not disclosing his positions

[Paul Christopherson]

The latest iteration of TARP is complex, which means it is corrupt. An honest plan would be simple and direct. This one suggests that A lend to B, who will transact with C, who might then lend to D. It is like the Rube Goldberg machine, where a ball rolls down an incline, drops into a shovel, which tips it into a spiral, where it goes around and around, etc., etc. The analogy breaks down, though, because in Rube Goldberg’s creations, causation was inviolate. They were elaborate but functional. In TARP world, the causation breaks down before it reaches the stated objective of inducing new lending.

We have seen this kind of policy by indirection before. It was not important to catch Osama, who actually did 9/11; he was marginal. Instead, we had to invade Iraq, which had nothing to do with 9/11, because that would cause a change in the region, which would induce a behavior change elsewhere. Likewise with trickle-down:-- if we cut taxes on rich people, it will induce them to behaviors that will have the effect of creating jobs. Neither of these cons, we now know, had any merit or honesty. Rube Goldberg would have scoffed at them. But they were vigorously put forward, very forcefully asserted, and America went along. This time we should just say no. The program has nothing to do with stimulating lending.

[hgovernick]

[QUOTE] "We insist on saving the banks, and refuse to admit most of them are impaired beyond hope." [/QUOTE]

The above statement raises some questions for this reader:

1. *Exactly* how many banks is the author including under the numerical proxy-umbrella "most"?

2. Could we see evidence which is more substantive than the author's statement that "most" of them are impaired beyond hope?

[Hansharriet]

Let's stop playing around and nationalize the whole banking system. To buy the toxic assets only leaves us holding the bag.

[SimonLeigh]

Let's really stop playing around and face the fact that restoring the unsustainable, high-polluting borrow-and­-keep-borr­owing lifestyle means disaster--and quite soon. Couldn't we just let those who've borrowed hugely lose their money, and start again? My parents had a fine life without ever borrowing a cent. It can be done and, facing monstrous climate change, we should at least consider whether reduction, not growth of population and pollution, is the right way to go?

[hgovernick]

Right on. I second that motion.

[tailgateshirts]

Look,

That would be a good plan too. But it CANNOT be the only plan.

Its a great idea and I think its worthy of consideration.

BUT You do realize that these "NEW" banks you create will be with the same guys that ran these big ones, that either quit or got fired.

They will be the ones with the capitalization to back the loans from the gvt. Not the 2 story townhome owner that you dream of.

Keep the sharks on wall st and provide support for community banks to give people options of banks that are not hedge funds

[davecol]

Wake up America !

The biggest lie ever, ever told is that banks are losing money on mortgages!

Do the math yourself but it is simple! Banks loan at 5% or more and borrow at 1% or less. So as long as over 50% pay there mortgage is does not matter how many millions get foreclosed on. The bank makes a forture.

The math 2 people borrow a million, one pays one goes into foreclosure and burns the house to the ground never paying a dime! The first person pays 50K INTEREST 10k principle total 60k. The bank pays for 2 million 20k interest, 20k principle. Bank gets paid 60K and has to pay 40k for a 20k profit!

The numbers are rounded but you could use a calculator.

So it is all a great big lie!

The banks lost money giving the rich corporations trillions in loans to steal all the jobs and take them to third world countries with the bulk going to India and China . Now these corporations have defaulted on all of these loans!

The answer is jobs!

The answer is domestic content!

The answer is technology and keeping technology in the US!

The answer is not printing more money and letting the idiots who got us in this mess steal more money! The money will soon be worthless!

[tailgateshirts]

Yes but banks play a role in creating leverage to push the limits, and the strings got a little too lose this time around.

The world couldnt support that level of credit floating around

All the money still gets paid to someone, and reselling that asset, the staff, etc.

Its a big circle

[GrahamInCanada]

Um, don't quit your day job, whatever it is...

For example, one more step to your illogical progression: That bank borrowed two million, you said, lent it to two individuals, a million each, one of who paid nary a dime, and one of who paid as required.

You say, the one loan that paid totaled fifty thousand interest and put put in ten thousand in capital, for sixty thousand dollars.

The bank paid twenty thousand interest, and twenty thousand principle, for a forty thousand outlay, you say.

Therefore, the bank made twenty thousand dollars, you say.

Bullocks. The next day, the loan was due, the one guy paid back nine hundred ninety thousand dollars (one million less ten thousand), the other, nada.

The bank has to pay back one million, nine hundred and eighty thousand dollars (two million less twenty thousand).

The bank has lost nine hundred ninety thousand dollars, you ninny!

[thriftyone]

Almost, but you neglected to add in the derivitives that were sold (and resold and resold...) based on mortgages which were faulty assets to begin with. The asset value in these mortgage loans was under 30% of the home value by the time everyone had dipped into the pie. These "finance" companies don't have a clue as to what is actually on their balance sheets and have stated that they cannot "unwind" the derivitives based on mortgages.

I would say, send a couple of bank investigators into these institutions, pull these derivitives off the balance sheets, write the losses off to the shareholders and make the depositors whole. Start over with new staff and new rules. Go back to the Glass Steagal Act and require US Banks &&& Financial Institutions to follow the Basel Accord.

[noesis]

This showed up in my mailbox today.

Why central banks are making the mistake of treating this as a global liquidity problem, rather than a global solvency crisis.

"Contrary to what political leaders and their central bankers seem to believe worldwide, the problem of liquidity that they are striving to solve by means of historic interest rate drops and unlimited money creation, is not a cause but a consequence of the current crisis. It is in fact a problem of solvency which is digging " black holes " where liquidities disappear, whether we call these holes bank balance sheets (1), household debt (2), corporate bankruptcies or public deficits. In consideration of the fact that a conservative estimation of these "ghost-assets" reaches already USD 30,000-billion (3), our team considers that the world is now facing a situation of general insolvency affecting in the first place the most indebted countries and organizations (public or private) and/or those depending most on financial services."

http://www.globalresearch.ca/index.php?context=va&aid=11848

[Ironquill]

One might argue with Alan's logic, but his essential point is to provide funds to the smaller banks who will lever it up and lend it.

The problem with throwing money at the large banks is that there is still no guarantee that they will lend it in a timely way and shorten this recession. And should the plan languish, we will have shot our bolt, making other solutions even more remote.

It seems in Geithner's plan the thing that has been sacrified, at least for this Presidency, is the creative energy to downsize the financial industry in a way that is more responsive to the needs of everyday folks and small businesses.

Wall Street loves this plan and I admit I have benefitted from the market gains the past several weeks. But I am very uneasy about enabling the large banks with new financial engineering schemes that smack of the schemes which got us here in the first place. It seems as if another shoe will drop, and my instinct is to hunker down again, not branch out.

I would not want to be in the stock market a year from now if it turns out that this plan is a bust.

[MikeZarin]

Secretary Geithner’s New Vulture Investors Picnic Route is Not the Way to Go – What is?

See. www.endfin­ancial crisis.com. It says that using Section 102 TARP Guarantees of bank impacterd debt assets, we can guarantee principal and an interest rate of, say 2.6%, and establish a value of those bank debt assets at 75 cents on the dollar, end the credit crunch, value impacted assets on the banks’ books, and even enable the sale of those assets in the open market at 75 cents on the dollar. The banks to receive 75 cents on the dollar of each principal payment and the U.S. 25 cents of each payment of principal on the outstanding debt assets in exchange for the guarantee -- providing enough money to the U.S. to take care of any defaults.

Also enabling a reduction of interest on impacted debt mortgages to 5%, the differential of interest between 5% from the homeowner mortgagors and 2.6% to the bank mortgagees go to the U.S. providing for more insurance, in addition to the 25 cents on each dollar of principal payments, against any cost to the Federal government for this program, including lower interest rates and subsidies to keep homeowners in their homes.

Using TARP Section 102 guarantees thus results in a no cost program for the U.S. and savesour financial system promptly.

Fully discussed at www.endfinancialcrisis.com.

[websmith]

Alan Schram is the one who should be Secretary of the Treasury.

The other scenario is that private investment refuses to buy worthless paper without some sort of back door exit plan and the taxpayers end up eating the entire $1.2 trillion. The idea that we would want to risk available private investment funds in this when they will be needed when we start to recover is destructive.

Instead of printing more money and devaluing the dollar more, we should use the deposits from the failed banks to fund the new community banks. Instead of selling good assets for pennies on the dollar, we should just forgive the loans that the failed banks are holding. People who suddenly find themselves without home, car, or credit card payments will deposit their new found money in the new banks as they buy cars, homes, furniture, clothes, etc. While we all won't be so fortunate to suddenly have a car or home without a payment. We all will end up benefiting and this time it will be us instead of them even though the banks will also benefit from new deposits and loan worthy customers. We don't have to print, borrow, and spend a dime to stimulate the economy.

http://ewebsmith.com/finance/betterstimulus.html

[Donnie4488]

Schram's last sentence says it all.