Just a month or so ago, the stock market plunged because investors did not like Treasury Secretary Timothy Geithner's outline of a plan for removing toxic assets from bank balance sheets. This week, Geithner announced the details and — what do you know? — the market shot up. Obviously, the market's mood swings are not the best indicator of Geithner's merits or of his plan's. But what's new as of Monday is that we have a fuller basis for evaluating his program. And the best judgment is: It's worth a try, but hardly guaranteed to succeed …
If all goes according to plan, the market know-how of the private firms will lead to maximally efficient deployment of government resources, and taxpayer losses will be relatively modest. Indeed, Geithner expects the initial federally backed purchases to help establish market prices for previously illiquid assets, which will then bring in more and more private buyers with no need for federal support.
This cleverly avoids having to ask Congress for more Wall Street bailout money. One problem, though, is that the banks that now own the toxic assets think they're worth a lot more than would-be buyers do. It's unclear whether Geithner's incentives will bridge the gap. The trick is to make the government's private partners put up some of their own money so that they have an incentive not to overpay the banks — while subsidizing them enough that they don't haggle endlessly and defeat the purpose of the program.
Los Angeles Times
We won't know for months whether the plan will work, because much depends on the owners' willingness to accept the prices offered. Yet we welcome the effort to have those prices set by the market, not the government. And we hope the program's launch will shift lawmakers' attention from the symbolic fight over Wall Street bonuses to more substantive issues, including the foreclosures that are undermining the assets the government is about to acquire.
Under the new Public-Private Investment Program, the government will try to buy distressed pools of loans or securities in partnership with investors. Because the government will also provide loans or guarantees to the investors, taxpayers will shoulder most of the risk. To mitigate the potential cost to the government, investors will negotiate the prices paid for the assets, and they'll absorb the first losses.
Geithner said the government would not subject its partners to new limits on pay or bonuses. That's as it should be. These firms, after all, are joining the team of rescuers, not grasping for a lifeline. Yet it remains to be seen whether investors are willing to take Geithner at his word or to believe that the rules won't change after the program launches. They have a right to be skeptical …
Geithner has to stay true to the real goal of the program, which isn't to protect banks — it's to help the market see which firms are healthy and which aren't. The sludge on their balance sheets is making it hard for banks to raise capital, causing them to hoard and make fewer loans. That's why it makes sense for Washington to help create a market for those assets. The sooner the financial system rebounds, the faster the economy will too.
New York Times
President Barack Obama's long-awaited plan to revive the banks could work if certain assumptions about the future are right. But there is not much, beyond faith, to believe those assumptions will pan out — and even if there were, it is hard to see how the plan is the best way to go.
In the near term, the plan would provide financing to buy $500 billion of banks' bad assets — and possibly up to $1 trillion over time. Most of the financing would be in the form of low-cost government loans and loan guarantees for private investors who buy the troubled assets.
The first assumption is that those battered assets will recover handsomely, thus allowing the government loans to be repaid with interest. There has, however, been no independent assessment of the assets or their underlying collateral, so there's no way to know that they will recover by much, if at all from their beaten-down state …
Even if we assume that the assets do increase in value, allowing the government to be repaid, there are still unsolved problems.
Successful sales will rid banks of some of their toxic assets, but not necessarily all or even most of them. To restore the banks to health, the sums expended would have to be enough to balance the banks' assets and liabilities, and provide a cushion to resume lending and absorb future losses. No one knows how much that is, though some estimates put it north of $2 trillion, much more than what the administration is contemplating …
A better way would be to base the rescue on current reality, not assumptions about the future. What would an examination of the banks' assets reveal about their value? What is the size of the hole in the banking system? In the absence of good-faith measurement, taxpayer-financed purchases of bad assets could court huge, unnecessary risks.
In other banking crises, resolution has sooner or later involved separating solvent banks from insolvent banks. In the end, there is no getting around firing the executives at failing banks, acknowledging the losses, wiping out the shareholders and then deciding how the government can best restructure the institutions. The Obama administration has yet to explain why its approach is better than that.