I am going to try to keep this as absolutely simple as possible. I will try to keep to the KISS principles that I learned from teaching Intro to Business courses at University years ago, and years before that teaching ESL.
Here goes.
We will start with - THE PROBLEM - which surprisingly perhaps is not that clear.
Then we will look at what Geithner is trying to do and why it may or may not work.
The PROBLEM:
If you are thinking - the problem is that the banks are in trouble, you are right but there is more to it.
Geithner, and many economists insist that the problem is the banks can't lend money (or are too scared) because they have too many bad loans already. If this is the case the obvious solution would be to help them get rid of the bad loans, so that they could get back to lending again.
Other economists contend that the real problem is that the whole economy has been living on too much debt for too long. Now that the bubble has popped, everyone is busy trying to pay down debt. No one wants to take on new debt. If this is the case, then cleaning up the banks won't automatically help because no one is ready to borrow yet.
Here is a simple reality check from Galbraith - 5 misconceptions
* The trouble with the economy is that the banks aren't lending. The reality: The economy is in trouble because American consumers and businesses took on way too much debt and are now collapsing under the weight of it.
* The banks aren't lending because their balance sheets are loaded with "bad assets" that the market has temporarily mispriced. The reality: The banks aren't lending (much) because they have decided to stop making loans to people and companies who can't pay them back.
* Bad assets are "bad" because the market doesn't understand how much they are really worth. The reality: The bad assets are bad because they are worth less than the banks say they are.
* Once we get the "bad assets" off bank balance sheets, the banks will start lending again. The reality: The banks will remain cautious about lending, because the housing market and economy are still deteriorating. So they'll sit there and say they are lending while waiting for the economy to bottom.
* Once the banks start lending, the economy will recover. The reality: American consumers still have debt coming out of their ears, and they'll be working it off for years.
What are we trying to save again?
So far Citibank, BofA, AIG and a number of other banks have been at least temporarily "saved". Lehman was not.
Geithner's plan, like the plans that came before it are designed to save banks (and the financial system?).
There are however a few lonely voices out there that ask " Should it not be banking we are trying to save, not banks?" The idea being that as long as we have a financial system with banks, it does not really matter which banks these are.
This is a very important point.
What are we trying to fix?
There are three broad groups of things that need to be looked at: Two are in the past, one is in the future. It is important to separate these.
- All that toxic crap (bad loans packaged together and derivatives and....) that no one knows (or can agree on) the value of.
- Normal loans. A lot of plain vanilla loans (mortgages, etc) that were not packaged up have also gone bad. But these we can value quite easily. Unfortunately as the economy continues to weaken more and more of these loans may go bad.
- The ability to make future loans. We need to be able to make credit available to those that need it and can afford it. Somehow we need to have banks that are ready and able to make NEW loans, when they are needed. To this end there are a lot of healthy banks out there that did not get involved in the toxic crap. Unfortunately these banks are not benefiting as much as they should from the stupidity of their competitors (those whom the government is helping to keep afloat).
How do we "fix" toxic crap?
The hardest one to fix is the toxic crap because we still don't know what it is worth and until we do we can't know how big the hole is in the bank balance sheets. The banks understandably don't want to take a hit on something that might not be that bad. They claim that the values in the marketplace are far too low. The people that think the banks are bankrupt argue that the toxic crap is just that, crap, and that if the banks wrote the values down to what they should be they would be "insolvent"
Geithner's plan, is at least in part, a way for banks and holders of this toxic crap to try to find a "market" price for these assets. By getting investors to bid on them, we at least get a chance at seeing what people will pay for them.
Who pays to clean this up?
This is a really interesting point that keeps getting swept under the rug (and camouflaged by bonus uproars). This is where I have a huge problem with Paulson, Geithner, and Summers.
Let's face it...money has been lost. Loans were made that will not be paid back. Okay...so who eats the losses? Well the banks do, until they run out of money (which they did very quickly). Then the banks ran to the government for "help". The government has stepped in and provided capital and a number of programs designed to "help" the banks.
Here is my problem. Banks have shareholders and bondholders. So far the shareholders have lost quite a bit, but the bondholders have NOT. Even though bondholders were making nice returns on bank debt before the crisis (much better than if they had held AAA US government Treasuries), they are now getting a 100% "guarantee" on their debt. Nowhere in any documentation does it say that bank debt is 100% backed by the federal government. I am not saying that government should not help, only that government should only help after bondholders have been asked to ante up first (perhaps by converting their debt to equity).
Both administrations have bent over backwards to make sure that bank bondholders do not have to take a haircut. This is NOT fair to taxpayers.
Once again Geithner's plan asks nothing of the bondholders and instead puts almost all the risk (and all the losses) on the taxpayers account.
When you hear people arguing for nationalization or a good bank/ bad bank solution, what you are really hearing is people saying that the bondholders of these institutions need to take a haircut first; that they need to take their losses before the Treasury or the Fed steps in. Unfortunately, the staffs of both administrations have seemed unable to even contemplate this.
Will Geithner's plan work?
Possibly. It should help to figure out if there is a way to value the toxic crap. If no one bids, or if the bids are too low and the banks don't bite, then it is back to the drawing board (except Geithner said today that there is no Plan B? - which is worrisome).
BUT: If we go back to the original discussion of the problem, you will see that having the banks rid their balance sheets of toxic crap may not put the economy back on track because banks stuck with dodgy assets may not be the real problem!
If the real problem is that the economy is overloaded on debt then it will instead take time and saving to set it right. Even healthy banks will not help if no one wants (is confident and qualified enough) to borrow.
What next?
More waiting and hoping I guess. Reading many comments on the Geithner plan, from economists that I respect, the consensus seems to be that it is not perfect, and may not work, but it is worth a try. Many however feel that eventually the government will have to step in and nationalize some of the banks. This plan puts off that day, and if it fails, will actually provide support for the next step...nationalization.
My View:
If you go back and read diaries I posted a long time ago (when I first signed up), you'll see that I have been concerned about the debt bubble for some time. I'm afraid that the problem that Geithner is trying to address is not the real problem and so the prescription is also not correct. (The former Prime Minister of Australia faulted Geithner for his handling of the Asian crisis for not addressing the correct problem, so it can happen).
I fear that taxpayer money is being needlessly squandered when it is most needed. I fear that the real culprits in this mess are still in charge. I fear that those who should be paying for this are not paying, and will not pay.
I for one would be more comfortable saving banking while letting the bad banks go under.
Final thoughts:
I would not want to be involved in trying to sort out this mess, for any money. It is a thankless job that only a masochist could enjoy. The sums involved are staggering, the time pressures insane, and the danger of a wrong move enormous. Right or wrong I do respect those that are trying to fix it.
Note: One of the pieces I relied on for writing this was The new toxic and bad legacy assets programs of the US Treasury: surreptiously squeezing the tax payer and the Fed until the PPIPs squeak, a long title for an excellent piece by William Buiter of the Financial Times. If you want a more detailed discussion that article is a good one to read.