ARE BANKS STILL SO SICK THEY NEED THE HOSPITAL, EVEN AFTER ALL WE'VE DONE SO FAR?
I read this, today. Paul Krugman's take is the most evocative (although I don't agree about a 'subsidy'). His contrast is perhaps too stark, without a gray area.
...if you think that there are some key (large) institutions who need some backfilling, mostly, then the Geithner plan is like an out-patient procedure, rather than an overblown, full hospitalization.
If you really think that the *current* bad asset problem is so bad that only nationalization can fix it, then, of course Paul is right, by definition: the Geithner plan is just whistling past the graveyard. Also, if you think that Geithner's put is already deep-in-the-money, then taxpayers get a better price (zero) on the same assets via nationalization / bankruptcy. At the same time, nationalization is fraught with problems, leaving equally compelling reasons to try a public-private partnership, if one can be fashioned, sufficient to the day.Bottomline? They *must* get the banks to stop making losses, by this time next year. No small task, because the banking management has considerable discretion over when they realize their losses.
Also, they need to have a 'nationalization' plan or receivership plan ready. The military would plan for all contingencies, and so must they.
On the other hand, if you think that there are some key (large) institutions who need some backfilling, mostly, then the Geithner plan is like an out-patient procedure, rather than an overblown, full hospitalization.
Let's start with the premise that the goal is to stop the cycle in which deterioration in the bank asset quality leads to deterioration in the real-economy which leads to further deterioration in bank asset quality.
Suppose, to halt the cycle, we put in place a plan that (1) temporarily stops deterioration in the real economy (fiscal stimulus) (2) facilitates the sensible clearing of what bad assets there are (mostly stopping 'corrosive' foreclosure irrationality) and (3) increases bank asset quality enough to allow 'the system' to function again, without props.
Add to the mix the observation that the government has few second chances. Resources, even for the USA, are limited.
Can the recent Geithner plan work (for number three)? (We already know their lack of boldness with #1 and #2).
Suppose that Citibank and Bank of America have $300 billion in bad commercial real-estate. They won't mark this down, rapidly. Instead, it will bleed into their profitability over a long time. Possibly, they will have more giant, negative quarters. This will be bad for the economy, overall. Slim chance there will be a robust recovery, without the banks.
Suppose, under the Geithner plan, they could get that sludge off their balance sheet, into risk-bearing hands, sufficiently capitalized and long-term, that a serious worry about the negative cycle of deteriorating asset quality and real economic activity are greatly mitigated.
Let's say that both organizations are willing to sell half. Let's say the government's stress test says they should sell three quarters. In back-and-forth, they decide to sell two-thirds, or $200.
They are going to take a $30 billion dollar hit, to do so. This is a short-term negative, but very much a long-term positive. The 'transition' is to be accelerated, pushed. That's the point of policy.
There isn't $200 billion in private capital to scare up, for distressed assets. But there might well be $35 billion. Therefore, the Geither financing plan gets the job done. It provides a mechanism for banks to manage large chunks of risk, to get them off the balance sheet, to add transparency, to build confidence ... confidence in their debt and equity, once again.
Yes, it requires a put from the Government, but so what? If the put ends up deep in the money, taxpayers would own the assets anyway. Would they own them at a better price? Probably, yes.
So, it does come down to how big you think the problem is (and will become, over the near term). If the problem is large-enough, then a significant source of the wealth that 'fixes' it has to come from bond-holders in individual institutions, not just taxpayers (not that they are wholly separate). Otherwise, Geithner is on track.
