The Obama administration’s plan to buy up to $2 trillion in toxic assets, unveiled in the midst of roiling populist outrage over AIG’s executive bonuses, has put Treasury Secretary Timothy Geithner at the dead center of a political bull’s-eye. Calls for his resignation have come from opportunistic Republicans–who have no recipe for economic recovery except more tax cuts for the wealthy–but also from many progressives, rightly appalled at how the Treasury’s bailout enriches Wall Street at the expense of taxpayers. For now Geithner may weather the storm, especially if the media continue to mistake the stock market euphoria over this latest giveaway for a sign of widespread public support. But in the end, his fate is less important than the fate of the economic principles he has championed. Sure, Geithner must go–and he should take Geithnerism with him.
So far Obama’s economic advisers have been single-mindedly wedded to the goal of restoring the financial system to the way it was before the crash and stubbornly averse to any proposal that approaches nationalization (or conservatorship or receivership or whatever you label it). “We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system,” Geithner recently said. Locked into this logic, Geithner has produced a plan that relies too heavily on the “expertise of the market,” gives enormous subsidies to investors, socializes the banks’ bad debt and contains huge risks for taxpayers. And even on these rotten terms, it is uncertain to succeed in its putative goal–getting credit flowing again.
Indeed, Geithner’s plan strongly resembles Henry Paulson’s aborted proposal that the Treasury buy $700 billion of toxic assets, except that it ropes in a wisp of private capital in exchange for overly generous terms and promises that it won’t limit the executive pay of investors. Under Geithner’s plan, private investors and the government would buy, at auction, pools of mortgages that are souring the books of major banks. Hedge funds and private equity firms would put in 7.5 percent of the price, which the Treasury would match dollar-for-dollar using as much as $100 billion from TARP. The remaining 85 percent would be guaranteed in FDIC “nonrecourse” loans. If the asset values fall, the loans will not be repaid by investors, and the collateral (the real estate underlying the loans) is all the government can recoup. Private investors walk away with a minimal hit, and taxpayers end up holding the bag.
Besides the obvious raw deal here, Geithner’s plan takes a gigantic leap of faith by relying on the efficiency of a market system that has so far been unable to set a price for these toxic assets. So his jury-rigged market creates an artificial price. But what are these toxic assets really worth now? Finding out would require taking a hard look at mortgages and the banks’ books, raising the specter of large-scale insolvency. And even if banks are relieved of these toxic assets, what guarantees that they will actually begin lending? To date, Obama has merely asserted that they would do so, but the Treasury plan omits any lending requirement.
Instead of providing answers to these questions, Geithner’s plan expects those who got us into this mess to get us out. By gambling huge amounts of taxpayer money and the president’s political capital, it threatens to endanger the administration’s budget, which, unlike Geithner’s plan, represents a smart, long-term bet on this country’s future.