Geithner Plan Surfaces

The long wait for the Obama administration to act on the banking crisis ended Monday when Treasury Secretary Tim Geithner’s plan to solve the banking crisis surfaced. Geithner’s plan is a highly complex version of what then-Treasury Secretary Hank Paulson proposed (and then abandoned) last fall. And it comes just a week after the Federal Reserve acted in apparent frustration at the Obama administration’s inaction.

Geithner’s plan creates a layered market for the toxic mortgage-backed securities that have clogged the credit markets since last summer.

The layering comes about because the Federal Reserve’s purchase of the otherwise unmarketable securities is just that: a purchase by the government without any contribution from other purchasers.

Geithner’s plan requires private capital to be invested in the purchase of up to another $500 billion to $1 trillion in the mortgage-backed paper. The Geithner plan — which the Washington Post called “long awaited but risky” — provides for the Federal Deposit Insurance Corporation to sell the securities and guarantee loans for the majority of the purchase price, the balance being comprised of the private investment capital and federal funds.

The government’s artificially-created market for toxic securities is layered, then, presumably separating the most risky securities which the Federal Reserve would buy under its plan from the less risky securities that could be marketed to private investors.

But there’s a problem: there seems to be no difference in risk among the many kinds of securities that anyone has yet to discern. They’re all unmarketable because no one can find a fair market value for them.

The Federal Reserve’s action is essentially the “bad bank” concept — one of the two possible solutions to the crisis — that was supposed to be the plan for the “Toxic Asset Recovery Plan” put in place and then abandoned too quickly by the Bush administration last fall. The idea was to have the government buy up the securities, freeing banks and other financial institutions to lend again. Because they have to carry the unmarketable — and possibly valueless — securities on their books as debt, they lack sufficient other assets on which to base lending. Buying up the toxic assets would free up the credit markets.

The Geithner plan is something else: it tries to attract private capital into the morass by promising government loans and the government assuming some — but not all — of the risk.
By the end of trading on Wall Street the day of the Geithner announcement, it appeared that the market had bought the idea: the Dow Jones Industrial Average was up almost 500 points to 7775, its highest level in many weeks. But will it last?

Before the Geithner plan was announced, there was nothing the administration had done that builds the markets’ confidence in the economy. Obama’s team is spending too much too fast, and Geithner’s plan will spend much more, even faster. Will the plan earn the markets’ confidence and lead to a sustained market recovery?

We’ll know after private investors have bought the first few hundred billions of the toxic assets. If they don’t do it quickly, they may not do it at all.