The Geithner plan to improve the balance sheets of banks may work.
It is, nevertheless, a bad idea and shouldn’t be necessary.
This plan by the Treasury secretary, and much of the frenzied monetary expansion being conducted by the Fed, is based upon a dubious premise: that the credit markets are frozen and need to be unclogged.
This assumes that there is a significant excessive of demand for credit compared to its supply. While there are undoubtedly companies that want credit that are having difficulty obtaining it, if this were generally true, interest rates would be rising sharply.
They aren’t. In fact, they are at historically low levels.
The economic slowdown has reduced the demand for credit. Nevertheless, business debt increased 4.8 percent last year, indicating that credit markets are not truly frozen.
The Geithner plan involves the federal government creating joint ventures with private companies to buy bank loans and collateralized debt obligations, mostly mortgage-backed securities.
Private investors will put up some capital, the government will put up some capital, and the government will provide additional capital through subsidized loans. The joint ventures will then buy loans and securities the banks want to sell.
These are favorable enough terms that some private investors will probably be willing to play.
But step back a minute and consider this: The only reason they will be willing to play is if they have a high degree of confidence that they will be buying bank assets that are worth more than they will pay. And on the other side of the transaction, the banks will be giving up something worth more than they are getting.
The banks may be willing to do so, because what they will be getting will be of more certain value than what they are giving, and that may be advantageous to meet their regulatory requirements.
But a regulatory scheme that assumes that banks are healthier when they give up something everyone assumes is of more value for something that everyone assumes is of lesser value is self-evidently perverse.
There is, of course, nothing that legally prevents these loans and securities from being traded today. This, however, is a market that has been frozen because of uncertainty about what the federal government would do. No one wants to go into competition with the big gorilla that sets the rules.
On the securities side, the Geithner plan limits competition for bank CDOs, which will further depress their value.
The government will choose a limited number of private partners to create joint ventures to purchase these securities. Treasury’s white paper suggests probably around five.
These favored partners will then get access to government capital and favorable financing not available to other potential purchasers.
The Treasury will provide capital for both the loan and securities purchase programs. For the loan purchase program, FDIC will provide financing guarantees. For the securities program, private partners will be able to borrow from the Fed.
Of course, none of these governmental entities actually have any money. So, all the money the federal government is throwing in will either be borrowed or, in the case of the Fed, created out of thin air.
A better approach would be for the federal government to create a better environment for recapitalizing banks with purely private funds.
Banks are a bargain right now. If the federal government provided more certainty to the value of bank-owned CDOs, either through more realistic regulatory treatment or a direct guarantee of a portion of their worth, and exempted new bank investments from the capital gains tax for a while, private capital could probably do the job.
But the Obama administration, like the Bush administration before it, apparently thinks markets are incapable of sorting through these things without the guidance and extensive participation of the government.
The Geithner plan, while far from optimal, is less ham-fisted than the efforts that have preceded it.
Robert Robb, an Arizona Republic columnist, writes about public policy and politics in Arizona. E-mail: robert.robb@arizonarepublic.com