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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