Geithner’s Doomed Bailout Plan

March 23, 2009

Finally, the bank bailout plan has been released. There are still details to be filled in, especially as regards its second leg, the expansion of TALF. But the big-picture takeaway is simple: the government needs at least $1 trillion, and probably much more, just to make a dent in the problem of the banks’ toxic assets. (The term of art is now "legacy assets", actually.) But there’s no way in hell that Congress would agree to spend even $100,000 on a bank bailout right now. So the government has to come up with some way of taking the $350 billion in already-approved TARP money and multiplying it.

This plan is the government’s preferred solution. It decrees the TARP money to be "equity", and then goes off to the FDIC to provide "debt". Both of these sources of funds are US government risk capital which will be used to buy up toxic legacy assets. There’s no economic reason to make the debt/equity distinction. But there is a political reason: Congress would have to approve any more equity spending, but FDIC guarantees can be issued to an unlimited degree without Congressional approval.

The problem with this approach is that it’s needlessly expensive. What kind of yields will investors demand on FDIC-insured debt from a Public-Private Investment Fund? My guess is that they’ll be at least 100bp and possibly much more than that more than the yields on Treasury bonds. But because of all the political sillybuggery involved here, the government can’t just issue debt to fund this program, and needs to come up with a way of pretending that it’s in fact Public-Private Investment Fund debt being issued with no more than an FDIC guarantee. (I think that the FDIC will not charge any money for this guarantee, but that’s unclear.)

Why is the FDIC being dragged into this? You might well ask: I always thought that the job of the FDIC was deposit insurance, not guaranteeing loans to Public-Private Investment Funds. But I suppose that the government can’t be too picky right now about where it’s getting the necessary billions.

What’s more, there’s no indication whatsoever that this whole scheme will, you know, actually work. Private-sector investors want to pay as little as possible for these "legacy assets", in order to maximize their returns. But the banks will not sell any of their legacy assets unless they can do so at a price close to the level to which they’ve already been marked down. Is there any reason to believe that there’s a private-sector bid out there for legacy assets at their current marks? Not really. But if there isn’t, the banks will simply refuse to sell, and there won’t be any money or assets changing hands at all.

So color me highly disappointed in the whole thing. Here’s Tim Geithner himself:

The depth of public anger and the gravity of this crisis require that every policy we take be held to the most serious test: whether it gets our financial system back to the business of providing credit to working families and viable businesses, and helps prevent future crises.

Does the plan as presented today pass this test? In a word, no. Sadly.

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