– James Pethokoukis is a Reuters columnist. The views expressed are his own –

For the populists who really, really want to make Wall Street pay by slashing their pay, Treasury Secretary Timothy Geithner certainly isn’t giving them what they want.

Yes, the top executives of the remaining TARP firms seem destined to be salary serfs to the “pay czar”, Kenneth Feinberg.

Of course, it’s hard for even the most die-hard free marketeer to feel sorry for financial firms that mismanaged their businesses terribly, took government bailout money and now find themselves under Uncle Sam’s thumb.

But as for everyone else? Well, here’s how Geithner put it: “We are not setting forth precise prescriptions for how companies should set compensation which can often be counterproductive. Instead, we will continue to work to develop standards that reward innovation and prudent risk-taking, without creating misaligned incentives.”

Even worse for those who wanted the Treasury secretary to bring down the hammer, he went on to highlight how the financial sector is already making changes on pay and how he looks forward to a “continuing conversation”. Yes, self regulation in action! Hardly what the torch-and-pitchfork crowd craved to hear.

That’s just too bad. To his credit,  Geithner seemingly understands his goal isn’t to punish, but to play a constructive role in nudging financial industry compensation in a direction that better connects risk and reward.

Ultimately, it is shareholders and management who should decide what executives make. Indeed, Geithner’s recommendations centered on empowering the Securities and Exchange Commission to give shareholders a stronger say over executive pay.

And changes are taking place. Firms like Credit Suisse, Morgan Stanley and Goldman Sachs have tried to rework pay systems by allowing bonus clawbacks, for instance.

Good thing, too. Government has a terrible record in rejiggering executive compensation. Example: Legislation back in 1993 intended to rein in corporate pay by eliminating the tax-deductibility of executive compensation above $1 million unless pay was linked to performance.

But one unintended effect of the law, academics James Wallace and Kenneth Ferris have found, “was that executives’ total compensation actually increased in the post-1993 period” thanks in big part to the use of stock options.

Not surprisingly, executive pay issues moved back into the spotlight earlier this decade after Enron and other corporate scandals. One part of the 2002 Sarbanes-Oxley Act prohibited executive loans. As with the 1993 law, corporations responded in ways perhaps not anticipated by legislators.

Signing bonuses and fatter severance packages became more popular — just the sorts of things now being frowned upon.

What sort of compensation might work better to align executive compensation with long-term shareholder interests? A group of academics — Alex Edmans of Wharton, Xavier Gabaix and Tomasz Sadzik of New York University and Yuliy Sannikov of Princeton — have devised an approach based on what they call “dynamic incentive accounts.”

Unlike bonus clawbacks, this system doesn’t try to recoup money already sent out the door.

Here is how it works, according to their new study: Executive pay is escrowed into an account, a fraction of which is invested in the firm’s stock and the remainder in cash. The account would be rebalanced each month according to company guidelines — rules would certainly also vary by industry — and by how close the executive is to retirement.

The gradual vesting of the account — cash from a sold stock cannot quickly withdrawn — even after retirement, “allows the CEO to consume while simultaneously deterring myopic actions.”

In other words, the goal is to promote long-term thinking over short-term manipulation.

For instance: If company’s stock soared, the executive could sell, though the proceeds would say in the account. If the stock then dropped, that money would have to be used to buy more stock. He couldn’t just take the money and run.

Is this the best system out there?. Maybe, maybe not. Or maybe for some firms or sectors and not for others. But that is why you don’t want a one-size-fits-all plan devised in Washington, particularly one with political rather than economic goals. That is a pothole that Barack Obama and Timothy Geithner have so far avoided.

– Christopher Swann is a Reuters columnist. The views expressed are his own –

Offer a U.S. Treasury secretary visiting Beijing one wish, and he will certainly opt for a revalued Chinese currency. Offer a second, and the probable choice would be a strengthened social safety net.

Timothy Geithner followed bipartisan tradition when he recently called on the Chinese to strengthen their social benefits. Indeed, it has become an article of faith that a solid welfare state will allow the Chinese to curb their abnormally high savings rate — which is at the heart of the global economic imbalance.

Luckily for Geithner, this consolation prize appears within reach. China’s spending on welfare rose 27 percent last year.

Particular excitement has surrounded China’s plan to provide near-universal healthcare by 2011. Free from the need to stockpile for a medical emergency, the Chinese people will be more able to splurge on consumer goods, it is thought.

Jim O’Neill, Goldman Sachs’ chief global economist and the doyen of China enthusiasts, argues that this is perhaps the most important public policy in the world at the moment.

Yet while welfare reform is almost certainly good for the Chinese, it may do precious little for the United States. Hopes for China on this front are based on half truths.

The first is that imbalances stem from the unnatural thrift of Chinese households. Levels of saving are certainly high — around 25 percent of disposable income — and did rise in the 1990s. But this has not increased noticeably since the turn of the century — the period over which the economy got most out of kilter. It is also less of an anomaly than is often assumed.

Citizens of India, in comparison, squirrel away even more, around 28 percent of income. Yet there is no clamor for Indians to curb their savings and enjoy themselves more. They run a current account deficit. So, household frugality is not always a worry.

Rather, the real increase in savings since 2000 in China has come from the nation’s companies, which are now bigger savers than the nation’s households. While encouraging Chinese people to set aside less may help, it has not been the main source of the problem.

Second, the lack of a social safety net may not be the principal reason that savings are relatively high. The traditional explanation for the surge of frugality in the 1990s is that China dismantled its welfare state.

A more powerful reason for the extra stockpiling, however, is that China hit a demographic “sweet spot”. The country’s ever-tightening family planning dictates from the 1970s left many couples with fewer mouths to feed and thus able to save more. This explains why savings rates rose even in rural areas.

If demographics are indeed the main driver, it is unrealistic to expect the rebuilding of social programs to return the households savings rate to the level of around 15 percent that prevailed in the mid 1980s.

The main reason the Chinese are such rotten shoppers is that workers are getting an ever-shrinking share of the economic pie.

Household consumption, at just 38 percent of gross domestic product, is indeed exceptional — and has fallen sharply in the past decade. In India, it is closer to 61 percent.

It is not that Chinese companies have been particularly stingy with workers. Even allowing for Chinese statistical window dressing, UBS believes that real wages have grown about 10 percent a year since 1999.

Instead the culprit is the unusually capital intensive strategy for economic growth. Heavy industry now accounts for close to 70 percent of value added in China.

This has been fostered by financially ambitious local officials whose pay is often linked to “industrial production and visible changes in the locality,” according to Tao Wang of UBS. The bias against the service sector and other labor-intensive companies has helped halve the pace of job growth since the 1980s.

Even profits from Chinese state companies are often locked up in a perpetual investment loop and never end up being spent on consumption, according to Richard Herd, the OECD’s top China economist. “It’s not like India where the portion of the income created by the companies is paid to the owners, boosting consumption,” he says.

To really bolster spending, China needs to stop pampering heavy industry and take its heel off the neck of the service sector.

– James Saft is a Reuters columnist. The opinions expressed are his own –

California’s fiscal train wreck should be watched warily by investors in U.S. Treasuries; as the start of a trend among states seeking bailouts, as a source of pressure on Federal funds and as a harbinger of hard choices at national level.

California voters last week rejected a finance bolstering proposal, setting the stage for billions of dollars worth of  cuts in services, layoffs and a shortened school year.

It also leaves the state with a budget shortfall of more than $21 billion, an exacerbated seasonal revenue shortfall and a fragile reputation in the bond market.

These are just about the last things a state needs when unemployment is high and recession is deep, but California is trapped between its own high cost base, bond investors unwilling to give it the benefit of the doubt and a Federal government that is loath to play Santa Claus. Of the three, the last is most likely to give way, and if the U.S. does widen the bailout it is already giving to states it will have potentially profound consequences.

Treasury Secretary Tim Geithner knocked back, equivocally, a request from California Treasurer Bill Lockyer to use TARP funds to backstop the issuance of bonds by California. Lockyer fears that investors and banks will impose punitive costs on new borrowings, costs that will only worsen its overall position.

Though Geithner was right to say California wouldn’t fit under the TARP, saying in essence that this was not the purpose of the vehicle, he was far from final on the whole issue.

Asked to rule out categorically a California bailout, Geithner told Congress:

“We will have to do exceptional things, as we have done already, to fix this mess … That’s not putting on the table or taking off the table any specific thing like that. But I just want you to know that there are things that we’ve had to do I would never have contemplated doing.”

Christopher Thornberg, of Los Angeles-based Beacon Economics, thinks the stakes for California and the U.S. economy will prove too high.

“I don’t think the Feds can afford to say no to California just now.”

AS THE BAILOUT ROLLS

The economic and social impact of California’s spending cuts are unpleasant. Also of concern is the health of the municipal bond market itself, the continued smooth functioning of which is systemically important and could force the government’s hand. To be clear, Californian 10-year debt is still yielding a fairly reasonable 4.4 percent, a lot higher than equivalent Treasuries at about 3.3 percent but not ruinous. There are well founded fears about what the price will be going forward.

Treasury and Federal Reserve officials are understandably reluctant; after all, look at the mortgage market which continues to be hooked up to a government sponsored ventilator. Clearly too if Federal assistance were given to help California  sell bonds, other states and localities would quickly get in line for their share.

And while California makes the headlines, the finances of other states are also dire.

Forty-seven of the 50 states face budget deficits in fiscal years 2010 and 2011 totalling a hefty $350 billion, according to the Center on Budget and Policy Priorities.

Much of that will be resolved through higher taxes and spending cuts, but a chunky part could end up being bankrolled in one way or another by the Federal coffers, which should give pause to Treasury investors already absorbing massive issuance.

California is in some ways a special case: it requires two thirds majorities to pass tax increases. But its political inability to get to grips with a set of unpleasant choices is perhaps a warning for the U.S. as a whole.

There is precious little consensus in Congress for more bailout money and even if another tranche of support for states on top of the $140 billion already offered makes economic sense, it may not be forthcoming. It’s not hard to see political paralysis in Washington if more money is needed, for whatever reason.

Secretary Geithner has been lucky or smart to the extent that markets have decided that his tools and bankroll are equal to the task as far as banks go. That consensus may or may not hold and may or may not continue to matter.

If states or municipalities mean he must go back to a refractory Congress, confidence could ebb as rapidly and dramatically as we have seen it grow.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. –

– James Saft is a Reuters columnist. The opinions expressed are his own –

The stress test of banks now underway in the U.S. is one exam in which failure will be the only true measure of success, at least in terms of speeding a recovery.

The U.S. will release some information about the methodology of the stress test of 19 major banks on Friday according to reports, with results slated for release in some form on May 4.

What is far from clear is if this will be some sort of self-deluding exam in which all of Treasury Secretary Tim Geithner’s children are judged to be above average or whether the U.S. will take this opportunity to take real and difficult remedial action with banks that are too insolvent to play their role in the economy.

Injections of equity for those which need it should be made at the common equity level — anything else at a severely undercapitalized bank just scares off other equity investors.

This is a good step for some banks, but sadly may not be enough for all, in which case the U.S. should simply take the time-honored route of taking the zombie bank into government conservatorship, wipe out shareholders and top management, and set the stage for a controlled dismemberment of what is left.

This is preferable to simply upping government support and stakes because it is clear and limits not just the benefits to those who’ve made bad decisions in the past but also the power of the state. In the current situation, no one really has any idea how or when the U.S. will increase, exit or manage its stakes in banks. It is all too easy for the government to become subject to special interest pressure in the current situation.

A conservatorship, along the lines of what has been done in the past for Continental Illinois, actually limits the potential for government abuse, such as politically motivated lending, even though it is a greater use of government power. Once that state admits that a bank has failed, it pretty much has to dispose of the assets, which is cleaner and easier to oversee and protect from abuse.

And even putting aside issues of government control, capital will not flow to banks in the current situation. Geithner, appearing before Congress on Tuesday, said that the “vast majority” of banks have more capital than then need, a statement that was; very likely true, greeted with joy by equity investors, and almost entirely beside the point.

It is not that most banks may fail, it’s that some very large ones quite possibly should.

VOICES IN THE WILDERNESS

Far more germane, and of more concern, was a report by the International Monetary Fund, which upped its estimate for global write-downs by banks and other financial institutions to $4.1 trillion.

Assuming that U.S. banks take their leverage ratio, in this case the relationship between tangible common equity and total assets, to 16-1 or so, as against 25-1 before the deluge, the IMF is forecasting that there is still a need for a half a trillion dollars of more capital.

“The current inability to attract private money suggests that the crisis has deepened to the point where governments need to take bolder steps and not shrink from capital injections in the form of common shares, even if it makes taking majority, or even complete, control of institutions,” the IMF said.

The IMF further said that bank earnings will only partially offset credit losses, so a policy of keeping the banks alive and allowing them to earn their way out of the hole is fraught. They forecast loan charge offs to peak at 4.2 percent in the U.S., about double the worst seen in the recession of the early 1990s but thankfully below the 5 percent plus levels seen during the Depression of the 1930s.

This could be a wrong analysis, but if it is not there is a disturbing chance of an extended downturn similar to Japan’s experience with its lost decade.

All told, when the risks, both of what amounts to corruption and economic damage, are compared to the difficulties of seizing the worst banks, it seems a fairly straightforward decision. But of course in reality it is not, and I can’t predict what the U.S. will do.

“These ‘too big to fail’ institutions are not only too big, they are too complex and too politically influential to supervise on a sustained basis without a clear set of rules constraining their actions,” Kansas City Fed President Thomas Hoenig told Congress earlier this week.

This is quite a statement for a sitting central banker to make in the current circumstances.

His point about the political influence of large institutions is well made and disturbing, and applies not just to future plans for regulation but to the current state of play.

It is not just the banks which will pass or fail this test.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. –

The weekend revelation National Economic Council chief Lawrence Summers received almost $5.2 million in salary and other compensation last year from hedge fund DE Shaw and Co, and hundreds of thousands more in speaking fees from other banks, has dealt another blow to the administration’s fast-waning credibility on financial reform.

Summers and protege Treasury Secretary Timothy Geithner have already attracted criticism for a strategy many commentators believe is unduly favorable to Wall Street.

For all the talk of beefed up supervision and stringent capital requirements in future, financial assistance to the banking system has come with few conditions. Anxious not to offend powerful Wall Street interests, Treasury staff have consistently pushed back against attempts to impose compensation restrictions or other penalties on recipients of public funds.

It all stands in marked contrast to the tough line being taken with General Motors and Chrysler. Bank chiefs were invited to discuss the industry’s future at the White House; GM CEO Richard Wagoner was summarily dismissed.

Wall Street’s special treatment is justified by citing the industry’s pivotal credit-creating role. But there is a widespread suspicion financial interests have captured the government agencies, legislators and senior officials meant to regulate them. It is the type of rent-seeking behavior common in emerging markets and associated in the past with militant industrial unions and President Dwight Eisenhower’s military-industrial complex.

In a thoughtful article in the latest edition of The Atlantic magazine, former IMF chief economist Simon Johnson argues U.S. policy has been controlled for the past two decades by a “financial oligarchy” which exercises influence through campaign contributions and the regular exchange of top personnel between Wall Street firms and the White House, Treasury and other institutions meant to regulate them. It promotes an identity of views between the regulators and the regulated.

The disclosure of Summers’ earnings simply fuels that impression, and the administration’s decision to publish the disclosure forms on a Friday afternoon shows awareness of the embarrassing appearance of business as usual for an administration that came to power promising “change we can believe in.”

No one is accusing Summers or other senior officials of impropriety. His deep involvement with Wall Street was known at the time of his appointment and the fees were all earned before he accepted a position. But with his highly quantitative approach, assumption the solution to most problems is a market-based one, plus instinctive hostility to most forms of regulation, Summers epitomizes the financial revolution that so visibly failed in 2008. He is a leading exponent of the ancien regime. It is hard to imagine he will really press for significant reform in the months and years ahead.

If the president wants more funding from Congress, and to demonstrate he is serious about changing the way Wall Street works, he needs to broaden his circle of advisers.

The president is not short of advice. But he needs to reach out beyond the tight circle of Summers-Geithner-Rubin-Gensler to consider alternative views, then have the courage to trust his reformist instincts rather than the status quo views of the Wall Street-Washington establishment.

– James Saft is a Reuters columnist. The opinions expressed are his own –

There is one law, it appears, for failing U.S. automakers but sadly quite another for similarly failing banks.

The Obama administration has decided to play hardball with auto firms; rejecting recovery plans from General Motors and Chrysler LLC (GM.N) and warning they could be thrown into bankruptcy. Chrysler, which is controlled by Cerberus Capital Management CBS.UL, has 30 days to complete an alliance with Italy’s Fiat SpA (FIA.MI) or face losing its government funding. GM chief executive Rick Wagoner is out at government request, as will be most of his board of directors in coming months.

This is painful and risky but probably for the best; the auto industry has far too much capacity and both firms have blundered repeatedly, avoiding making hard decisions to improve their competitiveness and products. In short, this is what is supposed to happen in capitalism when you fail.

It is also a huge contrast to what is being done for U.S. banks, where management has generally remained entrenched and where Treasury Secretary Geithner and his predecessor have thrown cheap money and other subsidies at doubtful banks in ever more complicated forms. Most recently, going as far as cutting hedge funds and other investors into the deal under the public private partnership in order to create the illusion of a return to market forces.

If the U.S. administration thinks the auto tough love will make them look like they are taking a hard line with highly compensated executives, they could not be more wrong. If anything it will increase the perception of the divide between how Main Street and Wall Street are treated when they come begging at the public trough.

To be fair, the case against the automakers is pretty airtight. Even given a recovery, which is by no means a sure thing, they may not be viable. The best counterargument, that bankruptcy causes rolling failures among suppliers and that consumers will shun automakers which are in bankruptcy. Those possibilities are hard to measure, and even if true, probably not enough to justify keeping the two on life support for what could be an indefinite period.

IT’S DIFFERENT FOR BIG BANKS IN TROUBLE

So what accounts for the difference in treatment, given that many banks, large and small, are both insolvent and dependent upon government support for their continued existence?

There are some legitimate reasons but they quickly bleed into special pleading and moral hazard. The entire economy is dependent in substantial part on the health of the financial system which intermediates capital, theoretically allocating it (insert ironical remark here) where it will make the best return.

That makes it harder for policy makers to simply allow banks to fail and for the industry to find its right size, the damage in the meantime would be too great. That gives large overleveraged banks a strong negotiating position with government, even in their weakness. That’s unacceptable and needs to be dealt with now, by treating them on their merits, rather than later through regulation to control the size and leverage of institutions.

There is a real risk that we get the worst of all worlds; the banks are kept alive and make it through with management in place and are able to use their obvious influence and might to deflect legislation. We then have a system with moral hazard at its heart and another larger crisis heading our way after the next bubble.

It is striking that the guy leading the enquiry into the viability of the automakers is former media investment banker, financier and private equity investor Steven Rattner rather than an auto person. Quite right too, someone who has lived and breathed this stuff is conflicted and won’t have the proper perspective.

But what a contrast with the number of once and future investment bankers (former Goldman Sachsite’s Neel Kashkari being exhibit A) involved in the government side of the banking bailout. After all, who else could understand this stuff? Don’t Trouble Your Pretty Little Head about that, as they used to say down south.

There is an alternative, after all. Rather than constructing a bank bailout which is essentially the Resolution Trust Corporation but missing out all that messy stuff about banks failing and executives getting canned, why not simply impose tough capital limits, fail the banks and executives that fail and come up with a reasonable timetable for selling on what you are left holding?

It has two great advantages; it has worked, both in the U.S. and around the world, and it is fair and easy to understand as fair.

Rescuing the economy and the banking system, as opposed to the banks, is going to require more government money. The favorable treatment of banking executives and shareholders may make that money very difficult politically for the administration to get.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –

– Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute. —

Republicans and Democrats in Congress, along with President Obama and Treasury Secretary Geithner, have been raking AIG over the coals in hearings and speeches for paying employees bonuses totaling $165 million. But today’s Los Angeles Times reports that the Treasury Department specifically agreed to the bonuses in a 586-page agreement signed on November 25. The deal allows AIG to pay out bonuses for the 2009 year that equal bonuses paid for 2007.

It stands to reason that the contracts to pay bonuses would have been known to Treasury officials a half-year ago, when they reviewed AIG’s financial position before funneling $85 billion into the firm to prevent its collapse. Basic due-diligence scrutiny of the firm’s books would have revealed the contractual obligations to make bonus payments to retain talented staff. What is puzzling is why the administration pretends not to know.

According to documents from AIG, the bonuses are compensation owed to employees under Connecticut law. Under the Connecticut Wage Act, the company said, if the bonuses are not paid, AIG becomes liable for legal costs of employees who try to collect, as well as penalties that could equal twice the bonuses owed. AIG might also leave itself liable to shareholder suits.

Despite the show trial in Congress and the sense of public outrage, it would be unwise for the government to go back on the contracts and sue to recover the money, especially when they agreed to it in November. This could make America resemble Russia, where trumped-up charges are used to prosecute companies that fall out of favor with the ruling elite.

Members of Congress are also discussing emergency legislation to tax away part or all of the bonus. This would set a precedent—corrupting if not unlawful—of using the IRS and the tax code as weapons of the state to go after individuals whom the administration and Congress want to punish. Such sanctions might amount to ex post facto punishment, legislation that makes unlawful behavior that was lawful when it occurred. The Constitution prohibits such legislation. Even President Nixon, who had an enemies list, never dreamed of this.

The wave of public sentiment against the AIG bonuses presents the government with a choice. It can try to run companies that receive bailout funding in a way calculated to win public approval, micromanaging every detail. This is impossible, because the government cannot even manage its own federal agencies efficiently, with episodes of wasted resources surfacing regularly.

Better, the government should get out of the business of rescuing ailing companies. The bailouts have won little support among Americans. In a CBS poll published on March 16, 53 percent of Americans disapprove of the government giving money to banks and financial institutions even as a way to help the economy and only 37 percent approve.

When TARP began in early October, it was supposed to resolve the problems of the financial sector and avert an economic slump. In late September, President Bush warned that if a bailout bill did not pass: “More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. “

Even though TARP passed, 28 more banks have failed, the stock market has dropped by almost one-third, and median home prices have declined by 9 percent. It’s natural that Americans have become disillusioned.

The attack on AIG is being used by the administration and Congress to bolster sinking approval ratings and hide the failures to date of the $700 billion TARP and the $787 billion stimulus package, as well as their lavish future spending plans: the $275 billion housing bailout plan, the $634 billion health fund, and higher individual and carbon tax increases. The outrage would be put to better use abandoning bailouts altogether.

– Diana Furchtgott-Roth is a senior fellow at the Hudson Institute and former chief economist at the U.S. Department of Labor. The views expressed are her own. –

This week Treasury Secretary Tim Geithner unveiled a financial stabilization plan that could cost $2 trillion, in addition to the $790 billion that Congress plans to spend on economic stabilization. All this without any consultation with Congress.

That’s financial stability?

The Dow Jones Industrial average fell almost 400 points Tuesday on the news, and the Asian equity markets followed. This steep decline is symptomatic of the unease that permeates financial markets.

It’s not just the amount of money that is troubling. The markets were also distressed by a lack of detail, especially on how to deal with so-called toxic assets - loans with diminished and uncertain value. The previous Treasury secretary, Henry Paulson, proposed to buy toxic assets, then discovered the difficulties of pricing and so switched to purchases of banks’ preferred stock to infuse capital into the banks.

Geithner promised “to consult closely with Congress” as he moved forward, but Congress has not held hearings on implementing the program, even though it would leverage $1 trillion of Federal Reserve funds and close to that in private-sector funds. The public fears that the $2 trillion dollar bank bailout fund would be just throwing good money after bad.

Last October Congress allocated $700 billion to the Troubled Asset Relief Program. But TARP, with roughly half the funding disbursed, has not yet delivered on its promises. Then, on February 10, it was déjà vu all over again. Geithner declared, “Our plan will help restart the flow of credit, clean up and strengthen our banks, and provide critical aid for homeowners and for small businesses.” He didn’t say how long it would take - because no one knows.

The Geithner plan is another version of TARP, but with more bells and whistles. Banks with assets over $100 billion would be subject to an intensive audit, to measure their capabilities. A Public-Private Investment Fund would purchase troubled assets, although how private money is to be mobilized was unclear.

Carnegie Mellon economics professor Allan Meltzer disagrees with Geithner’s approach. He proposes to allow banks access to government funds only if they can first raise an equivalent sum on their own. If not, it’s off to bankruptcy court they must go, with their competitors free to snap up any worthwhile assets at bargain prices.

The idea behind TARP was not new. Similar programs had successfully been put in place in the Asian banking crisis of the late 1990s. A government agency, a so-called “bad bank,” would buy the toxic assets, paying for them with fresh capital so that the banks could continue to function.

By definition, if the government is purchasing distressed assets it is paying more than the “market price,” more than a private buyer would pay.

Geithner might be better off admitting that these assets will have to be purchased by the Treasury at prices higher than market, and then going to Congress and the American people to make his case. He could say that this will be expensive, but will allow banks to clear underperforming assets off their balance sheet, enabling banks to start lending again. With revived credit markets, the economy can grow.

The implicit reason for going beyond Congress is: “Trust us, we know what we are doing.” Yet Geithner undermined that message by stating that all of this is uncharted territory and that mistakes would certainly be made. Neither the message nor the messenger reassures financial markets. Quite the opposite.

Indeed, Geithner and the Administration may have done what the Democratic leaders, Senator Harry Reid and Speaker Nancy Pelosi have consistently failed to do - make Congress appear to be the last best hope for responsible government in Washington.

Diana Furchtgott-Roth, dfr@hudson.org, is a senior fellow at the Hudson Institute and former chief economist at the U.S. Department of Labor.