Change we can believe in? Though they'll try to convince us otherwise, the new Geithner/Obama bailout plan is just a more complicated version of the original Paulson/Bush TARP proposal released last September.
While the administration intends to formally announce the plan tomorrow, the details of the Geithner/Obama bailout plan were leaked to the New York Times last Friday. The plan is rather complicated and I won't pretend to understand all the details. Nonetheless, Yves Smith at Naked Capitalism has provided a more or less understandable analysis of the plan. From what I can tell from the Times article and the Smith analysis, the Geithner plan includes three main parts. Firstly, the FDIC will provide loans to private investors like hedge funds and private equity firms to encourage them to purchase "toxic" assets. The loans will be equal to 85% of the value of said assets and backed "only by the value of mortgage assets being bought," according to the Times. I believe these loans are basically, in the words of Paul Krugman, "heads I win, tails you lose" propositions. In other words, if the prices of these assets go up, private investors will reap profits. If they fall, the taxpayer will pick up the tab. In part two of the plan, the treasury department, drawing on the remaining $350 billion in taxpayer dollars allocated for TARP, in conjunction with private investors, will cover the remaining 15% of the value of these assets. According to the New York Times piece, treasury will likely contribute 80% of the remaining 15% share and private investors will contribute about 20%. All told, private investors will contribute about 3% of the cash under this plan and the taxpayer will be on the hook for the remaining 97%. In the third and final piece of the plan, the Treasury "plans to expand lending through the Term Asset-Backed Secure Lending Facility, a joint venture with the Federal Reserve". This program is intended to make it easier for consumers to get loans. The administration assures us that the taxpayer will be protected from overpaying for toxic assets because the banks will "bid in auctions against each other for the assets". As a result of this process, they contend that the government will pay far below the original market value for these assets.
Without a doubt, this plan is just plain awful. In proposing this plan, Obama and his economic team have revealed themselves to be one of two things: utterly incompetent or a bunch of duplicitous liars trying to pull a fast one on the American people. Unfortunately, most of the evidence points towards the latter, but let's start with the incompetence of the plan.
To begin with, the Obama economic team has fundamentally misdiagnosed the problems facing the financial system. According to Paul Krugman's most recent blog post, the administration remains captive to the idea that over the past year or so, we've been experiencing a run on basically sound banks. This bank run has drove down the price of assets and got the banks in trouble, but in the view of Obama's economic team, there's nothing fundamentally wrong with the bank's balance sheets. In the minds of Geithner, Summers, Bernake etc, "there are no bad assets. Only misunderstood ones". As such, intervening in the markets to stabilize and correct the price of the banks' "misunderstood assets" will solve the problem. Unfortunately, as ought to be evident to pretty much anyone, the banks are not fine and their troubled assets, which are largely mortgage-related securities, are not misunderstood, they're just plain bad. As Dean Baker frequently points out, we are and have been experiencing the collapse of an $8 trillion housing bubble. Due to the collapse of housing prices, the related rise in foreclosures, and the epidemic of negative equity facing millions of Americans, the market regards mortgage-backed securitites as basically worthless and of course, they're right. Further, housing prices in many areas of the country still need to fall an additional 20% or so to reach historic trend levels, so the actual value of these assets will inevitably continue to fall. As such, the FDIC and Treasury will end up overpaying for assets, the real value of which will continue to slide downwards, costing the taxpayer billions of dollars. Yet, even after we've propped up the banks with more subsidies, many of them will still be insolvent. They've just made too many bad bets.
As for the duplicitousness of this plan, the examples are myriad. Firstly, as Yves Smith points out, the billing of this plan as a public private partnership is maddeningly Orwellian. In her own words, "Since when is someone who puts 3% of total funds and gets 20% of the equity a "partner"?". There is very little private and very little partnership in this plan but there's an awful lot of public money and public risk.
The unnecessary complexity of this plan is also disturbing. By developing a Rube-Goldberg machine-like bailout plan with lots of moving parts, the administration seems to trying to hide an essential fact: that it's really just a repackaged version of the original Henry Paulson bailout plan proposed last September. The goals are the same: get the bad/toxic/troubled/misunderstood assets off the banks' balance sheets, as are the means: use public dollars to pay above market prices for these assets. The central component of the plan, the "heads you win, tails you lose" loans to hedge funds worth 85% of the value of these assets, is the functional equivalent of just buying the assets outright from the banks. Geithner et all are just adding another step to the process, by routing the money through private equity funds and hedge funds rather than just buying the assets outright. Although they totally missed the housing bubble and have demonstrated monumental incompetence elsewhere, we can be pretty sure that Geithner, Summers, and everyone else involved are well aware of this fact. These folks only tend to be incompetent when competence threatens the profits of America's bloated financial sector.
Finally, the administration's argument that competitive bidding will keep the taxpayer from overpaying for bad assets is probably the most despicable and bald-faced lie of all. According to Yves Smith, the reality of these auctions is the exact opposite. Banks simply won't agree to sell these assets unless they get what they think they are worth, which is by definition an above-market price (if this were not the case, they would've already been able to get ride of them). Thus,
the point of a competitive process (assuming enough parties show up to produce that result at any particular auction) is to elicit a high enough price that it might reach the bank's reserve, which would be the value on the bank's books now.A plan which the administration claims will protect the taxpayer but in fact does the exact opposite! This sounds a lot like the Clear Skies Act and other Bush administration antics to me. Rational observers have long known that Obama is no radical and not even especially progressive, but I honestly never expected such open deceit would emanate from his office as president.
And notice the utter dishonesty: a competitive bidding process will protect taxpayers. Huh? A competitive bidding process will elicit a higher price which is BAD for taxpayers!
On top of revealing that the Obama economic team (which includes President Obama of course) is a midly incompetent and highly duplicitous bunch with a disturbingly low opinion of the American people, the new bailout plan also rewards all the wrong people and creates some pretty perverse incentives. Unlike nationalization, which is the only sensible solution to the financial crisis, this plan leaves the criminal management of the banks in place. Apparently, the Obama administration would like to continue rewarding the same folks who got us into this mess with even more cash. The "heads I win, tails you lose" loans to hedge funds also encourage them to make risky bets without bearing any of the consequences. And do we really want to funnel any more money into private equity firms and hedge funds, which, as Juan Gonzalez often points out on Democracy Now, are even less transparent and more dangerous than investment banks? I certainly don't think so.
More than anything, this plan reveals that the Obama administration cares more about the banks and their executives than the American people. We should all do everything we can to voice our opposition to it. In electing President Obama, the American people thought they were voting for change, not 4 more years of Bush-era, failed policies. Yet, when it comes to financial policy, team Obama has done absolutely nothing to distinguish itself from team Bush. In fact, in some ways the Obama administration has been worse. At least when Paulson released his plan for bailing out failed banks with taxpayer dollars back in September, he was basically upfront about it. Instead, the Obama team has developed an excessively complex plan to mask their true intentions. I know it's a little dramatic to say so, but this is a sad day for American democracy.