Tim Geithner's "toxic assets" Plan

As the US economy continues to fall into the harshest recession since the Great Depression, Congress is developing new plans for a turn-around on the investing frontier. Many are finding it hard to trust the government's intervention in such times, especially after the perhaps unethical actions taken by AIG after bailout moneys were dispersed several weeks ago. Even though President Obama has declared himself personally responsible for some of the 'lesser opportunistic' decisions made by companies after receiving bail-out money, assuming that risk does absolutely nothing to rectify the current economic challenges faced by America today. One may argue either way as to the foreseeable probability of the actions taken by AIG prior to its lending, however that particular mistake should not be an end-all to support of Obama's diligence in working to repair the economy. After initial bailout plans such as the Recovery and Reinvestment Program had been released to the public, US Secretary of Treasury and previous president of the Federal Reserve Bank of NY Tim Geithner has begun to finalize a plan that will attempt to buy up toxic assets to help propel the country into economic stability.

Geithner's toxic assets plan (The Public-Private Investment Program) is an attempt to "set up funds to provide a market for the legacy loans and securities that currently burden the financial system." In a nutshell, the program involves pools of loans that will be sold by banks in order to relieve their books of toxic assets. In turn investors will have the ability to compete for these funds, being enticed by the fact that they are government financed. Initially the FDIC and Federal Reserve will offer backing of $500 billion with the possibility of expanding to $1 trillion in terms financing.

Let's diagnose the current clutter in the United Stated economy, and take a look at the possible outcomes of what I like to call the toxic assets plan. First off, as most know, or least most reading this, the current financial struggle has come at the hands of the credit crisis and the fall of the real-estate market. Point blank, as Americans we are in our current financial predicament due to our ill-advised investing mistakes. As mortgages were introduced to the American public (1934) as a means of pursuing a trait of the 'American Dream,' individuals and families found themselves at ease when purchasing their own home. This created a boom in the real-estate market that in turn resulted prosperity nationwide... THEN came refinancing. Many Americans began using false documents and records in order to obtain their mortgages with plans of refinancing within a year of receiving their loans. In a Dateline special that aired on March 22, many banks had shown individuals claiming yearly incomes of $105,000+ for jobs like 'carpenter' or 'professional cleaner.' It would take an idiot to accept such false information - OR a bank who could care less about fraudulent information as refinancing would make it 'all better.' Americans were borrowing more than they could afford, refinancing to a lower percentage with an even higher risk loan, then defaulting on the new mortgage. Initially, the primary lenders were paid with the loans that resulted from a refinance, so they hadn't a care - but foreclosures continued to rise to an all-time high leaving the economy in its current recessive state. We have no one to blame but ourselves and the banks flawed ratings system together.

My opinion is concurrent with that of University of Texas economics professor Dr. James Galbraith, just a little less 'harsh' in refutation. As Galbraith states, the Geithner plan assumes that the bad assets that will be dumped by banks will increase in value over time. However, if these assets "realize massive losses," the government's financing will result in the those losses being charged to the FDIC. The plan will most likely work for one partner and one partner only, THE BANKS. Geithner's plan is that of an economic fairytale for investors. The problem is that as competition begins to heat up for these assets, banks may bid-up the price giving investors the perception that the bad assets are worth more than they truly are - this is what I like to call the "used car salesman effect." I.E., give a used car salesman a salvage-titled car worth $500, and he'll sell it for $5,000 - the bottom line is it's still only worth $500, and will continue to depreciate. While the banks understand that there is a bidding process for assets that would otherwise fall into larger debt on their own hands, pricing up the market value of such assets leaves risk solely on the taxpayer. Once those assets are off the banks' books, if the value decreases the burden is on the shoulders of the investors. Why is there reason to believe such an outcome? Because at this time the recovery rate on sub prime mortgages is extremely low. Another danger as Galbraith states is that the plan will not shrink the current financial system. Banks will be able to remain in business by dumping the bad assets, however there is no credit relief as there will be no increased ability to lend. On top of not being able to lend, there is no alleviation or help for the current borrower, leaving a surplus of unsaleable houses throughout the country.

I have a somewhat neoclassical view on how to fix such a problem. At some point, the banks are going to have to realize these losses - which have a combined residential real-estate and total peak market value of housing in the ballpark range of $20 trillion. The economy cannot recover until banks can lend. Banks cannot lend with large debts on their books, and even after some of the pools have been sold will not lend due to fear of losing their equity and being shut down. AMERICANS MUST INCREASE LONG-TERM SAVINGS. This will increase the solvency of the banks that can remain open. The public must be made aware as to the assets of these banks in order to reestablish confidence in the borrowing-lending system as Galbraith states. The system must be cleaned up, as it has been flawed and fraudulent for years. The banks that are too big to be managed will need to be taken over by the regulatory organization in this country, the FDIC. As savings increases and lending is stabelized, the economy will begin a recovery. One of the major oppositions to such a plan stated by Galbraith and annotated by myself (and many others) is that it is much more time consuming and extremely long term in comparison to the Public-Private Investment Program.

Calulated Risk Blog
Geithner - WSJ
Part I: Geithner's Plan "Extremely Dangerous," Economist Galbraith Says
Part II: Geithner, Obama Kowtowing to "Massively Corrupted" Banks, Galbraith Says
Private Options for Mortgage Recovery Offered