To improvise when there are no obvious solutions available is called resourcefulness. To improvise instead of adopting an obvious but unpleasant solution to an unpleasant problem is called stalling.Some people believe that Treasury Secretary Timothy Geithner's plan to help private investors buy toxic assets is an example of the first kind of improvisation: unusual circumstances call for unusual measures, they say -- this may work, and if it doesn't, we can always try something else. Others worry that the Obama administration is stalling because it is afraid that a more straightforward solution, the temporary nationalization of broken banks, would be politically toxic.Geithner's plan, the Public-Private Investment Program, is really a variation on an old theme. Like Henry Paulson's TARP, it is designed to prop up distressed banks until the economy rights itself and there is once again a normal market for their assets. The first version of the Paulson plan had the government buying up bad assets directly from the banks, but this didn't work because neither Paulson nor anyone elseknew how little these assets were worth. If the Treasury Department bought them at their market value, the banks would still have huge holes in their balance sheets; if it paid enough to plug the holes, it risked throwing hundreds of billions of tax dollars away on worthless mortgages and securities (hence the unofficial name for the program, "cash for trash").Paulson quickly changed his mind and, following the example of the British government, offered the troubled banks direct cash infusions instead. The Nobel Prize-winning economist Joseph Stiglitz has memorably compared this kind of bailout to "a massive transfusion to a patient suffering from internal bleeding." This policy failed partly because the government had no way of forcing the banks to start lending again with the money it had given them.Paulson had taken the banks at their word. The problem, they said, was not that they were insolvent; it was just that they lacked liquidity. It has since become clear that a few of the big banks are badly undercapitalized. (According to the government's "stress tests," Bank of America, Wells Fargo, and Citibank are all in fairly bad shape.) The Geithner proposal, which lets private investors buy toxic assets with a lot of public money and a little of their own, is unlikely to solve this problem. The only extra capital it would give the banks is the difference between what their bad assets are now worth on the market (not much) and whatever they can be sold for at a rigged auction where the bidders, thanks to government largesse, have little to lose. If the assets later turn out to be worth less than the "private partners" paid for them, the "public partners" -- that is, taxpayers -- will cover most of the losses. As Nick Paumgarten writes in this week's New Yorker ("The Death of Kings"): "These are assets that the banks have been unable or unwilling to unload on the market. In other words, for the plan to work, the government must allow itself to be gulled." But for the "private partners," there is almost no downside.
Geithner, then, is trying to rescue overleveraged financial institutions by offering new leverage to other financial institutions. The hope seems to be that more easy money will solve a problem that was caused in the first place by too much easy money. The alternative is to let the government take over the failed banks, strip them of their toxic assets, inject them with capital, and auction them off. Holders of the failed banks' shares and debts would be wiped out; the banks, under new management, would be lending money again to qualified borrowers; and the government could simply bury the bad assets until they were worth selling. Those who advocate this policy are not moon-eyed socialists; they include Stiglitz, Paul Krugman (another Nobel Prize winner), and Yale president Richard Levin, who is no one's idea of a radical. Levin recently told the Yale Alumni Magazine:
I would think about declaring some of our largest banks insolvent and seizing them. Then I would split them along the lines required by the 1933 Glass-Steagall Act, separating the commercial banking function from the riskier investment banking and securities underwriting functions that these institutions have assumed since the Glass-Steagall Act was repealed in 1999. As quickly as possible, I would sell the commercial bank back to the public through an IPO [public stock offering]. Hopefully, within weeks we would have viable commercial banks that could start making loans -- because they would now be adequately capitalized.
Of course, it is possible that Geithner's plan could succeed where Bernanke's failed -- and if it did, who would begrudge a few speculators who got rich off a national emergency? But if the Geithner plan is at best a fair bet (and one that underwrites unfair betting), there is no doubt that nationalization would succeed in quarantining the bad assets. It would be complicated, but surely no more complicated than the bizarre contraption Geithner has invented. It might also be expensive (again, no one knows what those bad assets will turn out to be worth in a year or two), but it would also be direct and transparent. And if the Geithner plan fails, as it may -- or if it succeeds only partially -- the government may have to nationalize insolvent banks anyway. So why not just do it now?The answer is politics. Nationalization, we are told, would aggravate fears of creeping socialism that are already being exploited by the Administration's opponents; after the massive stimulus package, and in the midst of an ambitious health-care initiative, the public would not tolerate an attempt by the federal government to take control of another part of the private sector.This fear seems oddly disconnected from the national mood. Nowadays the fiercest public outrage is directed not against government overreach but against financiers who are profiting, at taxpayer expense, from an economic crisis that the financiers caused. If Obama were to present nationalization as the alternative to a program that uses taxpayer money to underwrite private speculation, it seems unlikely that the public, still seething from the AIG-bonus scandal, would reject a temporary government takeover. For the moment at least, voters may fear socialism less than they despise publicly financed profiteering.Nick Paumgarten's New Yorker article reports a joke told by a Wall Street insider: "Wall Street takes your money and their experience and turns it into their money and your experience." For "your money" and "your experience," now read "our money" and "our experience." Have we learned anything from it?