Is the Geithner Plan the Least-Worst Option?

March 25, 2009

Matthew Richardson and Nouriel Roubini have a good and concise view of all the problems with the Geithner bank bailout plan:

Let’s not have any illusions. The government bears the risk if and when the investors take a bath on the taxpayer-provided loans. If the economy gets worse, it could get very ugly, very quickly…
There is something a little worrying about circumventing the legislative process on such a huge investment…
No one knows what the loans or securities are worth. Competing investors will help solve this by promoting price discovery. But be careful what you wish for. We might not like the answers…
We have to anticipate the likelihood that some banks will resist selling their loans and securities…
We may then have to start asking, "Why keep insolvent banks afloat?" And having asked that, we will have to search for ways to manage the ensuing systemic risk.
Either way, once the plan is fully implemented, we will be entering a new phase of the financial crisis. The water is choppy. Let’s hope we are strong swimmers.

The amazing thing is that this laundry list of problems appears under the headline "Give credit to Timothy Geithner’s new toxic asset plan": Richardson and Roubini actually consider themselves supporters of the scheme. Essentially, they say, we have to bite the bullet: it might be unpleasant, but it’s necessary.

I’m beginning to detect something of a pattern here: there are no really full-throated supporters of this plan outside the Administration; there’s no one who thinks it likely that nothing will go wrong. Instead, there is a group of people who have reasonably concluded that this is the least-worst option, in light of political constraints: essentially, it’s better than nothing, which is the only realistic alternative given that Congress is in no mood to pass anything bailing out banks right now.

I am though worried about the banks’ participation in this scheme — especially the Big Four. In order for this to have a chance of succeeding, they all need to participate, but they can’t overtly or covertly cooperate. I hope that Treasury is hiring some serious auction-design and game theory experts right now, because there does seem to be a large number of ways in which this plan can be gamed, especially when the banks have shown no particular enthusiasm for participating.

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