Geithner's Plan Will Tax Main Street to Make Wall Street Richer

The new consensus among the experts who missed the housing bubble (EMHB) is that Treasury Secretary Tim Geithner's plan to subsidize the purchase of junk mortgages and their derivatives will help alleviate the stress on the banking system. That's good news.

These geniuses have devised a plan that for $1 trillion (approximately equal to 300 million kid-years of SCHIP, the State Child Health Insurance Program) can alleviate the stress on the banking system. Note that no one claims that $1 trillion spent on the Geithner plan will actually clean up the banking system - that would be asking too much. The EMHB only assure us that this $1 trillion (more than enough to have energy conserving retrofits for every building in the country) will make things better. Isn't that enough?

Oh, by the way, some people will get very rich off the Geithner plan. Some hedge and equity fund managers could make hundreds of millions or even billions off the Geithner plan. And, under current law, they will pay a lower tax rate on this money than a schoolteacher or firefighter. Are you sold yet?

One other outcome of the Geithner plan is that the folks who bankrupted their banks and wrecked the economy will be able to continue to earn multi-million dollar salaries. Of course this is necessary, because who else has the skills to run these banks, other than the people who drove them into bankruptcy?

For some reason, every plan the EMHB have developed so far involves using taxpayer dollars to subsidize the bankrupt banks and keep them breathing a little bit longer, while offering opportunities for other Wall Street actors to get hugely wealthy. Some people say that the EMHB keep coming up with plans that enrich the Wall Street crew because they are so closely tied to the Wall Street financial interests.

It is, of course, possible that the EMHB are too closely tied to the financial industry, but it's also possible that they just lack the creativity and imagination to think of a plan that doesn't enrich the Wall Street crew. After all, these people lacked the ability to see an $8 trillion housing bubble, the largest financial bubble in the history of the world. So, let's see if we can help them out.

The core problem is that many of the largest banks are bankrupt. They are currently concealing this bankruptcy by listing assets on their books at prices that are far above their market value. In principle, they can do this for a long time, unless the government forces them to write-down the value of these assets. As long as the banks are bankrupt, they will not make new loans, limiting the ability of many businesses to get capital.

Instead of Geithner's plan to allow banks to sell these assets at a subsidized price, we can go the other way. Geithner could have announced a plan to clean up the banks, following a standard FDIC-type takeover.

This approach could harness the power of existing bondholders to help the government clean up the banks quickly. Geithner could, for example, promise to honor the banks' commitments to bondholders in full, if the banks recognized their losses immediately. Bondholders, however, would be offered a lower payback rate for each month that the banks waited.

So, if a bank waited one month, the bondholders would only get a guarantee for 90 percent of the value of their assets. If the bank waited two months, the payback would fall to 85 percent and so on. (Note the issue here is bank bonds that the government has no legal or moral obligation to pay off. The government will, of course, pay off the banks' FDIC-insured deposits.)

Under this kind of a plan, bondholders would place enormous pressure on the banks to recognize their losses. Bank executives that refused to own up to the bank's bad assets might even face personal liability. In other words, executives who lie about their bank's assets might not just lose the bonuses that came out of TARP money, they also might lose the tens or hundreds of millions of dollars they "earned" during the housing bubble.

If President Obama's advisers, all of whom are leading members of the EMHB camp, had more imagination, they might have devised a plan like this for dealing with the banking crisis. Instead, they came up with a plan that will enrich Wall Street and further punish Main Street.

Congress can try to bring enough pressure to make President Obama reverse course. At the very least, Congress should insist that when this plan fails, Secretary Geithner and others involved in drafting the plan are sent packing. We cannot continue to have a system that always ignores the mistakes by those on top and only holds those at the bottom accountable. The EMHB already wrecked the economy once; how many more times will they get the opportunity?

Comments

[ArchAngel]

Wall Street has a very long history of creating larcenous schemes to con investors and steal their money.

Not too long ago it was junk bonds. Some of the responsible criminals were caught and sent to jail.

The same exact thing has happened again. Only this time we are giving the criminals more money.

[dsws]

"The core problem is that many of the largest banks are bankrupt."

Insolvent. Bankrupt is when they're in a legal process to not pay their creditors full value.

"They are currently concealing this bankruptcy by listing assets on their books at prices that are far above their market value."

Again, it's insolvency not bankruptcy, but yes.

"In principle, they can do this for a long time, unless the government forces them to write-down the value of these assets."

But forcing a write-down would involve picking an arbitrary value to write the assets down to. This provides a somewhat inflated but reasonable market value for them to mark down to.

"So, if a bank waited one month, the bondholders would only get a guarantee for 90 percent of the value of their assets."

So instead of making 100% a one-trillion-dollar loan, we would be giving Wall Street only 90% of an eight-tril­lion-dolla­r gift. What a bargain.

[marthainmaine]

Welcome to the Clinton/Fascist administration. Govt. by the ones who gave US 3 strikes and you are out...NAFT­A...welfar­e reform with no jobs for the welfare moms to go to....Deregulation of banks and Energy. The rolling black outs in California were under Clinton. We will not vote for Hillary in 2012. Go get a life Bill and leave US alone.

[emcslead]

so if Clinton is solely responsible for the rolling blackouts in California (which, btw, persisted into the 2000's), does that make Bush the bad guy when all of the Northeast lost power for almost a day in 2003? And how does fascism lead to DE-regulation? I thought deregulation was a part of a laissez-faire economic plan, not a fascist plan.

And if Clinton's the fascist, wouldn't HE be in power as the dictator?

Just curious....

[Carolab]

First, find out who the bondholders are and what their contractual rights are.

Second, send these guys packing now before they can do us more harm and further enrich themselves.

Thirds, investigate and prosecute for financial fraud.

Fourth, end the interest-based, debt-based fractional reserve banking system.

[Carolab]

Sorry for the repost and typos -- tired tonight

[Carolab]

First, find out who the bondholders are and what their contractual rights are.

Second, second these guys packing now before they can do us more harm and further enrich themselves.

Thirds, investigate and prosecute for financial fraud.

Fourth, end the interest-based, debt-based fractional reserve banking system.

[Carolab]

*send*

[Carolab]

*thirds*

[ArchAngel]

In the eighties, Wall Street Criminals created "Junk Bonds". These were financial instruments worth much less than hyped for. They were ultimately banned and some went to jail and were banned ffrom working in finance.

Now we again have exactly the same situation; Wall Street Criminals create "Derivatives". These were financial instruments worth much less than hyped for. They will ultimately be paid for by US Taxpayers and some will be greatly paid and continue working in finance.

[sunny123]

Thank you for the alternatives you suggested. For the first time someone has ideas rather than just criticism. Hopefully, our President will listen and learn. I believe you are right. We have set the foxes in the henhouse and expect a different ending. Not rational. Utter lunacy states that doing the same old things will have different outcomes.

Please keep up the good work and the comments.

[rj1340]

The core problem is that Geithner's plan does not extinguish the CDOs, nor is there any structure for the bought up paper. Besides the fact that the "investors" are getting 50% of the profit for 7% of the risk, they can sit on the paper until its worthless and we'll absorb the brunt of the losses. Another huge hole in the plan is that the banks may shy away from vulture bids or have to take excessive write-downs if they sell at bargain basement prices. The Main Street Solution (Derivatives Bridge) affords a broader range of fixes and minimal taxpayer exposure. They suggest having the gov buy the mortgages at realistic prices, then offer them to the mortgagees at the same price, thereby reducing their debt and monthly expenses and reimbusing the gov. The banks can extinguish the CDOs with the proceeds and everyone goes home happy and more solvent. Any questions?

[sophistwatch]

It's a decent theory, but house priced just fell another 30%. If unemployment keeps rising and house prices keep falling who is going to sign up for a reduced mortgage when it might be even lower tomorrow or your job is shaky?

Geithner's plan and the plan you outline both rely heavily on a robust recovery. In the event we have a nice recovery, "everyone goes home happy and more solvent". However, if we slide backwards by a significant amount after the initial investment is made, under both plans, investors have a great deal of incentive to walk away from their losses.

[Realization]

One thing not being discussed is the need to eliminate the trade deficit and get out from under excessive foreign borrowing and the power that gives our international creditors, like China. Should be a top priority and it won't happen by itself. Our competition will make sure of that.

[NickfromCali]

Obama's been listening too much to the Clinton/Feinstein wing of the Democratic party.

Art Torres must go!

[sophistwatch]

Mr. Baker and Mr. Krugman are missing important points. There are actual nation states involved in the ownership of these larger institutions and large chunks or our foreign debt.

The size of the problem limits our options. Dr. Matin D. Weiss states that the top 5 US banks ALONE have $200 trillion in exposure to derivative activity. Only 7.8% of that amount is Credit Default Swaps. 82% of the exposure is in a derivative product many of you have never heard of. http://www.moneyandmarkets.com/alarming-news-bank-losses-spreading-32910

Receivership of AIG, Citi et al, is complicated by massive foreign holdings in those institutions. They have real power and influence over how this is being handled. The average investor is expected to take losses, not nation states.

David Masters of Insurance Daily writes on November 24th of 2008.

"China Investment Corp (CIC), the wealth fund engaged in merger talks with AIG, believes that if China and other developing countries help to rescue the world’s financial system, they should be given more of a say in how the world’s economy functions".

If we didn't owe so much to entities who hold real leverage over us in trade and finance, we actually could and should do what Baker and krugman advocate. However, there are real world political and strategic consequences for playing casino with huge amounts of borrowed foreign money, losing the bet and asking for more money.

[blindhog]

You're so right. This is going to take time.

We are going to have to back out of this ever so slowly, like a MAN who wondered into the lions' den (problem is this MAN dragged U.S. in with him).

[noesis]

But instead of deleveraging, the Treasury/Fed plan to use more leverage (provided by the government) to solve the excesses created by leverage. That is insanity.

[noesis]

But I do agree with you that the political/strategic consequences are indeed real. When one looks at our total debt to GDP and sees it at ~359% and rising, the writing on the wall becomes clear. To get this under control, we can either pay down the debt (re-negotiating with our foreign creditors), default (increasingly likely), or inflate it away.

[GnomeDigest]

I was ready for Obama governing moderately, and was not surprised when he went half-ass ending illegal renditions and continues to obstruct any significant attempts to bring the former administration to justice. I could accept these sorts of things, and still maintain faith that overall, Obama was still out to make things better for the middleclass.

This plan to get rid of the "toxic assetts" ended that faith. We just finished a huge round of the financial industry taking irresponsible risks and the taxpayer had to subsidize the losses (the bailouts).

And now Obama backs a plan that allows the financial industry again to take irresponsible risks with promise of the taxpayer again coverring the loses.

I will not continue to support a President that follows the same old trickledown BS ideology that has been proven a complete farce. This version of trickledown is more dressed up, but it still ammounts to we have to help the richests get even richer for the benefit of all. The idea that the financial industry gets to make tons of money as they sink us into a recession, and then get to turn around and make all the money supposedly getting us out of the recession they sponsored, is ABSURD.

Its time to force the banks to show us their real balance sheets, and go belly up if thats what the books show. WAMU already went bankrupt and into receivership and the US or world economy didnt collapse or ripple.

[noesis]

No economic faux-science here:

We cannot have both debt leverage and a hyper-efficient system"the volatility is just too great. What Taleb explains"which no one else does"is that efficiency is already a form of leverage. A highly efficient system removes slack and magnifies small changes. Think of the efficient system as a high-performance aircraft. Each minute of steering input creates a rapid and violent shift of course, speed, or altitude. The system itself is souped up even before you add the debt. Once you do, the pilot is equally jacked up and twitchy, creating an explosive combination. Now imagine that fighter jet trying to fly in a 1,000-plane formation, and you get an idea of the world financial system in the 21st century.

A deleveraged financial system is a stable one, especially if we increase the redundancy within the system. That's an idea Taleb has taken from biology. But in finance, redundancy means two things: not having players in the game who are "too big to fail" and not allowing anyone"from the individual to the institution"to play with too much money. Redundancy means have cash on the side, not risking it all, and not becoming dependent upon financial assets for your economic well-being.

http://www.reuters.com/article/nourielRoubini/idUS277797009120090326?pageNumber=1&virtualBrandChannel=10452

[JimRinX]

I was under the impression that the culprits had all skeedadled off to 'undisclosed location-ville'; and I know that Geithner was one of the few who were crying foul about the whole thing from the beginning.
While I give you credit, Mr. Baker, for offering up some viable alternatives to the current strategy; it's always been a 'damned if we do, damned if we don't' - or a 'chose the lesser of evils' - type situation.
As far as I'm concerned, the maintaining Bond Liquidity Issue, that was raised by Mr. Blodget in Daily Brief Item #1 has value. I'm not sure how your "FDIC Takeover-type" plan would affect that issue; but I do understand that the Pension Funds, etc., that would go under if too many Bond based equities become insolvent, would 'hurt Mainstreet' every bit as much as giving Wall Street the necessary capital that it needs to maintain their liquidity.
Besides, the real problem here is that we rely too much on usurous methods of doing business (firms that take out short term loans to fill their petty cash drawers. UGH!), when eliminating these modes of operation would do all of us so much good!
There's plenty of HONEST ways to make a buck, Mr. Baker; how come we never hear about plans that address these kinds of issues? Fixing the Machine - rather than jury rigging things every time it goes sproing!, would seem to me to be the REAL solution to these kinds of problems.

[populistdemocrat]

Congress may have other ideas the ones suggested here by Dean Baker. According to this article on Bloomberg news "Mark-To-Market Lobby Buoys Bank Profits 20% as FASB May Say Yes," (at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=awSxPMGzDW38 ) Congress wants to make accounting definition changes to ease the losses of the banks. The pressure to do so put on by Congress, in public, to the Financial Accounting Standards Board Chairman Robert Herz shows they are very serious.

I wonder whether the Chair of the Subcommitte, Democrat Paul Kanjorski, of PA, would consider a similar tactic, based on hard economic times, so that consumers could cut their credit card debts by 30% Just an accounting change here, Mr. Chairman. Talk about changing the rules in the middle of - well, unfortunately, not a game...It looks like the Wall Street banks, despite all the trouble they have wrought, still are calling the tune in DC. I'm disappointed in Rep. Janjorski.