The Geithner-Summers Plan is Even Worse Than We Thought
Two weeks ago, I posted an article showing how the Geithner-Summers banking plan could potentially and unnecessarily transfer hundreds of billions of dollars of wealth from taxpayers to banks. The same basic arithmetic was later described by Joseph Stiglitz in the New York Times (April 1) and by Peyton Young in the Financial Times (April 1). In fact, the situation is even potentially more disastrous than we wrote. Insiders can easily game the system created by Geithner and Summers to cost up to a trillion dollars or more to the taxpayers.
Here's how. Consider a toxic asset held by Citibank with a face value of $1 million, but with zero probability of any payout and therefore with a zero market value. An outside bidder would not pay anything for such an asset. All of the previous articles consider the case of true outside bidders.
Suppose, however, that Citibank itself sets up a Citibank Public-Private Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bid the full face value of $1 million for the worthless asset, because it can borrow $850K from the FDIC, and get $75K from the Treasury, to make the purchase! Citibank will only have to put in $75K of the total.
Citibank thereby receives $1 million for the worthless asset, while the CPPIF ends up with an utterly worthless asset against $850K in debt to the FDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walks away with a cool $1 million. Citibank's net profit on the transaction is $925K (remember that the bank invested $75K in the CPPIF) and the taxpayers lose $925K. Since the total of toxic assets in the banking system exceeds $1 trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-off in the Geithner-Summers plan is unconscionably large.
The earlier criticisms of the Geithner-Summers plan showed that even outside bidders generally have the incentive to bid far too much for the toxic assets, since they too get a free ride from the government loans. But once we acknowledge the insider-bidding route, the potential to game the plan at the cost of the taxpayers becomes extraordinary. And the gaming of the system doesn't have to be as crude as Citibank setting up its own CPPIF. There are lots of ways that it can do this indirectly, for example, buying assets of other banks which in turn buy Citi's assets. Or other stakeholders in Citi, such as groups of bondholders and shareholders, could do the same.
Several news stories suggest some grounding for these fears. Both Business Week and the Financial Times report that the banks themselves might be invited to bid for the toxic assets, which would seem to set up just the scam outline above. What is incredible is that lack of the most minimal transparency so far about the rules, risks, and procedures of this trillion-dollar plan. Also incredible is the apparent lack of any oversight by Congress, reinforcing the sense that the fix is in or that at best we are all sitting ducks.
The sad part of all this is that there are now several much better ideas circulating among experts, but none of these seems to get the time of day from the Treasury. The best ideas are forms of corporate reorganization, in which a bank weighed down with toxic assets is divided into two banks -- a "good bank" and a "bad bank" -- with the bad bank left holding the toxic assets and the long-term debts, while owning the equity of the good bank. If the bad assets pay off better than is now feared, the bondholders get repaid and the current bank shares keep their value. If the bad assets in fact default heavily as is now expected, the bondholders and shareholders lose their investments. The key point of the good bank -- bad bank plans is an orderly process to restore healthy banking functions (in the good bank) while divvying up the losses in a fair way among the banks' existing claimants. The taxpayer is not needed for that, except to cover the insured part of the banks' existing liabilities, specifically the banks' deposits and perhaps other short-term liabilities that are key to financial market liquidity.
Cynics believe that the Geithner-Summers Plan is exactly what it seems: a naked grab of taxpayer money for Wall Street interests. Geithner and Summers argue that it's the least bad approach to a messy situation, in which we need to restore banking functions but don't have any perfect ways to do that. If they are serious about their justification, let them come forward to confront their critics and to explain to the American people why the other proposals are not being pursued.
Let them explain the hidden and not-so-hidden risks to the American taxpayer of the plan that they have put forward. Let them explain why they are so intent on saving the banks' bondholders, even the long-term unsecured creditors who clearly knew they were taking market risks in buying Citibank bonds. Let them work with their critics to fashion a less risky and less costly plan. So far Geithner and Summers tell us that their plan is the only option, but without a word of further explanation as to why.
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I have real concerns about the Obama adiministration's economic stimulus plans, but I notice that all of the critics state their objections as if there were some alternative that had no significant risks or downside & that guaranteed success (Sachs, Krugman, et al). That's obviously not true. Give me the real cost/benefit analysis of the various options and I'll choose a side.
Now I know what it means to be second guessed every step of the way.
Some folks pontificate, some quote their mama's, others their daddy's as having the most sound solution for the economy.
Sachs & co have the luxury of suggesting solutions without taking into account political realities. We all know what will happen if the government becomes the "re-organizer" of banks and arbiter of "fairness".
Sad as it sounds, there'll always be a loser.
"Sauve Qui Peut!"
I'll stick with Barack.
More than 70 years ago, when the Great Depression began and FDR was elected, FDR said that he would try something and if it didn't work he would try something else until he found ideas that actually did work.
This is what is happening today.
Now my father, who was a successful manager of Department Stores, a man who majored in Economics told me once that if you got 10 Economists into a room and asked them the same question they would have 10 different answers.
Given what I've seen from economists, I tend to believe him .
And I believe that President Obama is doing the best he can and wil eventually succeed
in pulling us out of this Depression
If you, Professor Sachs, have some ideas that you think are better...
WHY DON'T YOU RUN FOR OFFICE?
My mother is an economist. I have been following this financial news everyday with great interest. If you got 10 economists in a room, you would not get 10 different answers on this particular problem. There is actually quite a consensus that this Geithner-Sumners plan it a total zero. Other plans have been proposed but the Administration won't even consider them. Strange-since Obama largely won the election AFTER Lehman Brothers collapsed and former Treasury Secretary proposed his TARP plan.You might recall in most polls, before September 15 that McCain was leading by a slim 2-5 points. Clearly, Americans voted for Obama because they wanted change-in a time of great financial disaster. We are not getting it. In fact, I think it a sick joke that people like former IL governor Blagovich is impeached and indicted, but people like Timothy Geithner get promoted to US Treasury Secretary, and Larry Sumners who made millions directly from the big zombie banks, is now the leading economic advisor in the White House? The fix is definitely in.
Geithner Plan is close to unraveling. As soon as we stop pleasing our main TBill buyer, the dollar will drop lke a rock. The resulting inflation will virtually eliminate all sectors of our economy dependent on discretionary spending.
Note the Chinese government is already flexing their financial "Nuclear Option" muscle as a negotiating tactic. They sold a net billions in TBills in Jan and Feb. Then they bought TBills in March. No wonder Geithner was buying our own TBills in Jan and Feb.
Chinese reserves fell a record $32.6 billion in January and another $1.4 billion in February before rising $41.7 billion in March, according to figures that were released by the People’s Bank for the first time over the weekend. Resumed growth in China’s reserves during March suggests that confidence in the country may be reviving, and capital flight could be slowing.
watchTVgetsSTUPID -
I don't know you but you make more sense than Obama's insiders.
In fact many of the posts here make more sense than Obama's insiders.
Maybe honest people don't have to make it complicated.
Jeffery Sachs I appreciate the fact that you've seen the error of your ways but you too were a true believer in free market capitalism just ask some of the peripheral countries you helped "developed". I think our biggest problem is that we're relying on people who have enjoyed the benefits of free market capitalism to help fix this economic situation. I'm a graduating senior at CSULB and let me say it doesn't take someone from wall street to understand how we got here and what needs to be done to turn things around. First of all we need to stop following a failed theory, we need to stop being scared of the word socialism. Democratic socialism is good, its not a scary thing, now we just need for all of you older such wiser people to get the hell out of our way so we can fix the problems that you have left us with. We're tired of watching the baby boomers destroy our world. We have serious problems to fix and you guys are only in our way so please do the world a favor and don't give us anymore suggestions.
There are five big banks on Wall Street that own 81% to 96% of all the bad assets and debts. Our most lauded economists and the majority of the American people do not want to give trillions (more) dollars to these banks. If Geithner and Summers refuse to make a sound(er) argument as to why we should continue bailing out these five banks with taxpayer dollars, then they and the Adminstration they represent must be involved in some kind of conspiracy to steal taxpayer dollars on behalf of the owners of these five banks. it also needs to be known, who are the Owners of these five banks and what is their financial and historical relationship to the Federal Reserve? If that is made common knowledge, the general population may finally learn of the massive historical, finanical criminal conspiracy that has been going on for decades, the veritable looting the United States by a financial aristocracy.
Great comment! I may want to add that:
The concept that we can somehow support our broke and failed system with tax payer’s money is insane.
Summers and co thinks that our current financial system is healthy and it is just suffering a confidential crisis because of the subprime mortgage debacle.
And all we need to do is throw money at it.
This theory is fundamentally false.
Our current financial system is fundamentally broke and backing it up with tax payer’s money is criminal and unconstitutional – period.
Obama’s Presidency, the faith of the Democratic Party and the future of our entire Country is depending on putting an end to those Hedge Funds and Derivatives, the things that got us into this mess in the first place.
We need severe oversight over our banks; they are not the center of the Universe. We need to put an end to those frivolous speculations.
Wall Street and Corporate America will and need to play a much smaller role in the future. A healthy economy is backed by healthy small and medium sized companies, the backbone of our economy.
This is our last straw and if Obama screws this up he will be doomed and the riots we are just witnessing in Bangkok are nothing to what the people are going to do to our Establishment once we go down. Obama you better get your ego straighten up and do the right things!
And the right wingnuts will pick up the pieces?
Oh I just love nutcase conservati
They break their backs to screw us up and then they scream bloody murder
when the rest of us finally kick them out of office...
And they don't stop screaming either...
heartily agree with your post
If this isn't a good reason to participate in the upcoming tea parties, nothing is. People need to get out there and let Obama and Geitner know that though they might have a soft spot in their heart when it comes to family shots of the Obama's with their cute new puppy, those feelings will not override the rage provoked by Obama and Geitner's big steal of tax payer money.
Conservatives in America these days must think that they are petty Gods and Goddesses with the power of omnipotenc
They are always right and never wrong...an
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For anyone interested in the bailout and a credible opinion of the Geithner toxic asset plan go to the following link.
http://www
It is a conversation with William K Black who was a central figure in the cleanup of the S&L crisis. The clarity and conviction of his disagreement with the approach taken by Geithner/S
Thanks for this - it's a great interview - and a real eye opener. There's also another recent interview with Black by Bill Moyers here: http://www
If Black is right, then this crisis is not just an unfortunate accident that nobody saw coming, it is the result of criminal behavior at the banks ("control fraud"), and criminal negligence within the regulatory agencies (violating the "prompt corrective action" law). I think we should only pursue recovery plans that will "catch the bad guys". This should be our highest priority because maintaining the rule of law should be government and society's highest priority. Take the banks under managed receivership, do the audits, and find out the truth (even if it hurts economically! ... which it won't - it will most likely help).
William Black was interviewed on Friday (4/10/09) by Alex Jones:
http://www
Each day, I become more and more disenchanted with the President's approach to resolving the financial crisis, and more and more concerned about the President's motives. Someone out there with the relevant experience and sufficient brain power, please, help us out.
I just read on HP that Wells Fargo, the recipient of a 25 billion dollar bailout, has posted its largest profit ever. WTF is happening, here?
Is there any way that President Obama's approach to the so called banking and financial crisis may be explained as a rational and reasonable program, calculated to be in the best long term interests of the nation and us average Americans?
Thanks, in advance, for the help.
Sadly, lack of experience and brain power is not the problem. Summers and Geithner are plenty smart. Really, nobody knows for sure how to fix things. Therein lies the problem.
That said, I too am getting worried about the financial plans...
"Summers and Geithner are plenty smart."
No, they are not. That's a myth. Not says I - says history.
In fact, they fail at most everything they attempt. Miserably so.
They do ONE thing good. Real good. They separate average folk from their money and magically transfer it into their own back pocket, no work involved - only smoke and mirrors. In other words, they are con artists SUPREME
If you think I'm shooting blanks, you have not done your homework
Lovin that 'change'
"That said, I too am getting worried about the financial plans..."
If you had done your homework, you would have been plenty worried from the get go. Now is almost too late. These are really crooked, corrupt, STUPID people Mr O has guiding his economic policy.
You wrote: "If they are serious about their justification, let them come forward to confront their critics and to explain to the American people why the other proposals are not being pursued."
This is the kind of pressure we need to put on the Obama admin.
Apparently, the big campaign contriubtions to the Obama campaign from the big banking/investment houses has paid off big time.
Why isn't there more outrage over the fact that Summers made millions last year in 'speaking fees' to Wall Street corporations? summers needs to be thrown under the bus.
i'm extremely disappointed in Obama's performance over the handling of this whole 'bailout/stimulus' thing. if he really wanted to bring change to Washington, then why didn't he bring Paul Krugman along for Treasury? these guys are maintaining the status quo.
Thomas Jefferson said banking institutions are the greatest threat to our nation. he said the power of the banks and corporations must be returned to the people, or our children would wake up "homeless on the continent their fathers conquered.
Jefferson was a modern day political prophet, and its about time certain people started reading his thoughts on government.
Exactly why should Summers be betrayed? And by whom?
(In reference to: "summers needs to be thrown under the bus.")
The simplest way to avert much of this is to use the fictitious personhood of corporations, established in 1887 by the absurd use of the 14th Amendment, against them. We need to revive and enforce the 'no interlocking directorates' rule first. That prevented competitors in the same business from sharing seats on each other's boards - collusion and trusts were thus largely avoided. So let's enforce it such that no spin off, considered a separate entity, can have an interlocking relationship. Sure - big corporations can set up new addresses and new executives and boards, but they'd have to have contracts (which would have to be public and thus stop it) between the new company and the old, and would have to have new accounts, also public. All their swaps would have to be open and visible so we can trace where our money has gone. This is not infallible but would definitely make it more difficult and would make it sufficiently more costly to be a real brake on this greed. It would take time for them to set up the webs of 'hand holding' interlocks - you Banker A sit on Company B and Company C and do B and C's bidding - so this also would slow 'em down. Laws can make or break deals. Let's get Congress to revive the things that used to prevent this sort of slimy business rake off. It might not be enough in and of itself. It's a very good start.
We need to fire Geithner and Summers, declare a "bank holiday", close all banks until they separate the banks from the gamblers, and don't let them open without strong regulation. We need to put very very high taxes on any income of any kind that is greater then 25 time the minimum wage. We need to stop the exploitation of workers world wide. Until we bring us all up together we are on a race to the bottom. Until then a fewer and fewer people will accumulate more and more of the worlds wealth letting more and more people get poorer and poorer. We need to make it easier to unionize. We need to then make sure the unions don't become corrupt. We need to stop the buying of our government officials. We need to all get involved and demand justice.
I like the concept of indexing tax brackets to multiples of the minimum wage (in several steps, as now, with 25 times as the steep increase point). Wealth concentration is deadly to the robustness of an economy. Theoretically, it allows efficiency of scale in commercial projects, but in practice it is mostly just hoarded.
If this can be done, though, the need for unions decreases dramatically. Strip away the complexly inefficient layers of labor mechanism negotiations, and their basic purpose is simply to increase the return of commercial rewards to the workers.
NATIONAL PROTEST APRIL 11: Push the banks out of Congress!
35 cities across the country organizing to break the power of the financial industry and the bankers who caused the current economic crisis. A web organizing platform, http://www
The website proposes three key principles for economic reform:
NATIONALIZE: Insolvent banks that are too big to fail must incur a FDIC intervention -- no more taxpayer handouts.
REORGANIZE: Current CEOs and board members must be removed and bonuses wiped out. The financial elite must share in the cost of what they have caused.
DECENTRALIZE: Banks must be broken up and sold back to the private market with new antitrust rules in place-- new banks managed by new people.
The public good is served by new bank executives operating within stricter regulations. We need a clean slate to restore confidence. Now "toxic assets" question are being bungled. Taxpayers are buying back toxic assets, without any say in the matter. Where is the Resolution Trust Fund? The RTF recaptured 40-50 percent 20 years ago with the S & L Bailout.
"Too big to fail"? Simon Johnson experienced bank recapitalizations as IMF chief economist. It took just months for those transitions to occur. But Citigroup/Bank of America behemoths require literally 100(s) of times as many FDIC personnel. But can't we offer recently laid-off accountants, bookkeepers, etc. be hired to get the job done?
Jeffrey Sachs, are you serious. This is the same guy that helped ruin the Solidarity movement in Poland, as well as their economy, and also adviced Boris Yeltsin and had a hand in their economic problems. Where the heck were these economist when the ship was beginning to sink, lets say about a year ago. If these guys are so smart and know all the right answers (Sachs, Krugman, Reich, and others) this whole mess would have been prevented if they had only spoken up. Once again, give me a break.
You're assuming they would have been listened to. The guys in charge now are doing exactly what they want to, which is steal all the money. They like societies with a few rich and a lot of poor-or-scraping-by folks. Keeps the hoi polloi out of the business of the Masters of the Universe if they (we) are having to fight over the crumbs to survive.
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