"This scheme dominates all the alternatives." -- Treasury Secretary Tim Geithner, this morning.
Say what you will about Geithner, he's confident in his plan, or rather, how today's part of the plan -- the public-private market for what he calls "legacy loans and securities" -- fits into the overall financial recovery plan, which now includes capital assistance (TARP original), the housing plan, and the various Fed and Treasury asset-purchasing schemes. At this morning's briefing for reporters, Geithner tried to convince a skeptical audience that this new mechanism to fix the financial system is not just a good idea but better than the other options. In his view, those options are minimal public intervention into the markets -- not an option at all, really -- or direct purchase of assets by the government, which requires the government to assume all risk. Whether or not you agree with that frame probably determines how you feel about his plan. I tend to think Brad Delong has a better approach than Paul Krugman, but your results may vary.
Geithner said he sees a large problem of risk aversion right now; this plan is designed to create incentives for people to take risks and purchase these troubled assets. But make no mistake, private investors have some skin in the game -- though not as much as the government -- and will see their equity stakes wiped out in the case of a loss. But because most of these legacy assets are based on the mortgage markets, you have to see the plan as kind of a complicated bank shot. The government is betting that these assets are undervalued, both because the recession has driven down values more than the actual popping of the housing bubble, and because the new housing policy package, in stemming foreclosures and backstopping home values, will lead to gains in that sector, as will the forecast and much-hoped for return of economic growth in the fall of 2009. That is why Treasury is in particular encouraging long-term investors to participate in this program -- buying a pool of mortgages now could prove quite lucrative for taxpayers and investors down the road. Of course, if Krugman is right, and the bad assets continue losing value over time, then this is going to be a very expensive failure, but also the kind of failure that could create the political incentives for the kind of insolvent bank seizure he advocates.
Without some more detail about the financing structure and implementation, it's hard to assess the outcome of that failure, but government losses might not be much more (or less) than the upfront costs of more agressive forms of intervention. One reason I think this plan may be a good decision is that my recent reporting on the FDIC has made me increasing skeptical about the relative ease of temporary nationalization on the scale that would be needed to alleviate the crisis, and particularly what the outcome of a failure of that policy would look like. While we need to act quickly to turn around the financial sector, even if the government decided to pursue an aggressive bank seizure right now, Treasury officials simply do not know yet which banks merit seizing and which methods of temporary government control would be successful in that strategy; nor do they have the management capacity or legal authority (yet) to control the banks.
Remember that the overall goal is to get credit moving again to fuel recovery. When asked how to tell if the plan is working, Geithner urged people to track statistics for the price of credit, the value of the assets in question, and the issuance of new securities, suggesting that participation rates in the program may not be indicative of broader dynamics the plan influences in the market.
-- Tim Fernholz
