The Geithner plan is part of a much broader financial program that the US Treasury and Federal Reserve have embarked on to stabilize the financial system. It is now well recognized that the financial system should be repaired first for the stimulus package to work and the economy to recover.  This financial plan aims at helping banks purge troubled assets off their balance sheets, as those assets have been considered a hindrance to lending by banks and borrowing by businesses and consumers.

            The plan calls for the establishment of public-private funds that will be operated by private investment managers of hedge and pensions funds and the like and be financed mostly by the US Treasury and FDIC. Those funds will purchase the troubled real estate loans from banks and toxic securities from the markets and keep them until maturity or until they make profit. The purchases will be financed by up to $1 trillion that will come from three sources: $150 billion from the TARP in the form of equity, $820 in the form of debit and $30 billion from the investment mangers who will be hired to buy and run the funds.[1]

            The plan was received with open arms by the stock markets. The Dow Jones Industrial leaped by 7% on the same day the plan was announced. Why was this enthusiasm for this plan? First, the plan has fed the stock markets with details that the previous announcement of the plan lacked. The markets were hungry for details and found them in this plan. Moreover, the plan relied on the market as a viable mechanism in pricing and managing the troubled assets, negating the idea of nationalization. This mechanism gives a venue of how to value the assets, and reduces the possibility of the government undervaluing them in the stock markets’ mind. However, competitive bidding by the private managers may end up making the government pay 30-60 cent on the dollar for assets that have probably a probability of 5 percent of being paid.

            Passing the euphoria of the first day, the plan is now looked at more carefully. The plan is not a rose garden as it has dangerous weeds in it. First, it is a massive subsidy to the banks who own the toxic assets and the managers who will manage them.  The $30 billion in private money will be leveraged with up to $1 trillion of government money. The plan transfers most of the risk to FDIC who will allocate the majority of the funds. But since FDIC is insured by the taxpayer money, the ultimate recipient of burden of the risk is the taxpayer itself.  Furthermore, there are those like the 2008 Noble prize economist Paul Krugman, whose opinion is now influencing member of Congress, who believe that the plan is too small to be effective. The size of the troubled assets exceeds $2 trillion but the plan pledges $500 billion with the possibility of expanding the money to $1 trillion.   But we should remind those economists that this financial plan is part of a broader program to deal with the crisis. We should remind them that Federal Reserve is buying an additional $1 trillion of bad debt off the private sector's books and replacing it with cash through its non-traditional policy of quantitative easing. These economists also believe that the market is not the right mechanism to deal with those insolvent banks, and therefore they advocate the Swedish solution which requires nationalizing insolvent banks and keeping them until portability.

            I can add that the US government and the Federal Reserve officials are pursuing a trial-and-error approach that have moved them up the learning curve to deal with this extraordinary and multifaceted evolving crisis. Their approach is also gradual and multifaceted. They have learned from their mistakes and they have enlarged their financial stabilization program in scope and financing. Although some time and money have been wasted, it seems that the financial pieces are complementing each other and in the aggregate are sowing the seeds of success. In the meantime, we should pay close attention to how the competitive bidding in the marketplace will shape up.  There will be big discrepancies on the values of the toxic assets between the banks that hold them and the private investors who contemplate buying them.  Currently, it seems that the banks are less willing to sell than the private managers are willing to buy. The Public Private Program should classify the assets in three or more groups, depending on their degrees of liquidity and tradability. Then they should start with the most liquid and most tradable assets until a full "toxic" market is created. This process will be slow and can take months to move into full gear. The market should eventually bring together those who are willing and those who are made able by government money to agree on a fair price.  

         But the recent announcements from the Treasury will complete the plan. and further slow the markets.  Placing strong restrictions on the participation and qualification of the applying funds managers, as the Treasury revealed, will hinder the market from doing its job of bringing the buyers and the seller to transact at a fair price. The Treasury aims at restricting participation to those investment firms that already have a minimum of $10 billion of toxic assets on their balance sheets, and the assets should be  first-tiered such as mortgage-back loans and not backed by other securities such as CDOs squared. The rescue process needs more participants and not less to create a liquid market. Moreover, relaxing the mark-to-market accounting rule by FASB at this time is a bad timing for the plan. Valuing assets based on cash flows is a good idea but it should come after the rescue succeeds. Changing accounting principles now will make banks want to hold on to their toxic assets instead of departing with them. The change will make the toxic assets be valued at a higher price than what they would be priced at by the market.

            The trial and error approach seems to try and err more again iin the middle of the gaime. Therefor, more time will be wasted. But the plan will take traction, but less efficiently than was hoped for before.  We will  be able to focus our vision on the stimulus package and the real economy. The stock market seems to have given us six months from now to see the real economy start to wake up.

[1] See Brad De Long’s blog: http://delong.typepad.com/sdj/2009/03/the-geithner-plan-faq.html