The Geithner plan vs the Brady plan

By Felix Salmon
April 9, 2009

Mohamed El-Erian is interviewed over at FT.com, and at the beginning of the first interview, at about 1:45, he says this:

I think you’re going to need a little bit of moral suasion. This is very similar to what we saw with the Brady plan at the end of the 80s. You had the overhang of the developing country debt, and you had a mechanism to lift it, but at the end of the day, you also need some moral suasion to get the banks to participate, and to clean up their balance sheet.

It’s an interesting analogy. But in one important respect there’s a huge difference. In the Brady plan, the banks had illiquid loans on their balance sheet which they swore up and down they were holding to maturity (because if they sold them they’d take a loss they couldn’t afford). The solution was to turn those illiquid loans into liquid bonds, add a few sweeteners in the form of zero-coupon Treasuries, and create a mechanism for allowing the banks to slowly let those toxic assets trickle off their balance sheets by selling them in the liquid secondary market as and when they could afford to.

The PPIP, by contrast — or at least the Legacy Securities Program — works the other way around. The banks have liquid bonds on their balance sheet, which they can sell in the secondary market if they want, but only at very low prices. Under the Geithner plan, those liquid bonds will be transformed into highly-illiquid public-private investment funds, with both the ability and the intention to hold the bonds to maturity.

And, of course, the fiscal cost of the Brady plan was wholly transparent and up-front. Under the Geithner plan, no one has a clue what the cost to the government is going to end up being.

But El-Erian is right that both plans involve Treasury twisting the banks’ arms to force them to do what is ultimately in their own best interest. But in one way the Geithner plan can’t ever be as successful as the Brady plan. Under the Brady plan, the main indicator of success was that the developing-country governments in question regained access to private-sector capital. Under the Geithner plan, the plight of the borrowers is not really part of the problem, since most of the debts in question were issued by some kind of special-purpose vehicle. Maybe the resuscitation of the securitization market as a whole is one of the objectives of the plan. But it’s not at the top of the list.

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Comments
4 comments so far

What would be the proof that the Geithner plan actually worked? And if it failed, what would be the proof?
When will the US taxpayers know what they actually got for their dollars?

Posted by YR | Report as abusive

I feel like I’m getting mugged by men in black suits.

“with both the ability and the intention to hold the bonds to maturity.”

Yes, and that’s a part of the plan. The point is to have the TAs be seen as investments. If hedge fund buyers, Pimco,etc., do buy these TAs, since they’re well know investors, it will help the government transform the TAs into long term investments in the eyes of the public. It’s a forward looking plan, showing confidence in our future, intended to attack the fear and aversion to risk. In that sense, it’s like infrastructure investment in the stimulus. It shows confidence in the future, and helps attack the notion of toxicity. That’s also why it’s going to be offered to average investors through mutual funds. By the way, if John Paulson is buying them, then they are investments. It’s simply a question of whether they are good or bad investments.

Also, the subsidy part of the PPIP, which is inherent in any hybrid plan, is inflationary, and will also help with QE, since the government will be perceived as having to print money if this all goes sideways.

Since I’m saying a lot of crap to most people, and partly to myself as well, I think that the FDIC is saying that the banks are going to have to pay for the PPIP in the end. They’ll raise their fees, and seize them, just to piss of Hempton, proactively, if they have to going forward. Since the PPIP is intended to save the banking system, as Caballero seems to believe, then they banks are going to have to pay for the plan in the end. It’s starting to sound damned clever.

“The PPIP, by contrast — or at least the Legacy Securities Program — works the other way around. The banks have liquid bonds on their balance sheet, which they can sell in the secondary market if they want, but only at very low prices.”

Ummm, the bonds aren’t “liquid” if the bid/ask spread is so wide that buyers and sellers are at an impasse.

Imagine that a bank is carrying a AA-rated senior CDO tranche at 30 cents on the dollar, but there are still no buyers to be found. If I offer to buy the tranche for 1 cent on the dollar, that doesn’t make the tranche “liquid.”

Posted by Nick | Report as abusive
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