Book of the Month

Deadman's picture

The dagbuzz for 3/23/09: (The Geithner Bank Stability Plan)

See video

Details of the Geithner bank stability plan came out today, and Wall Street for one loved it. And why not,  for the plan basically allows financial institutions to take the worse of the toxic assets rotting away on their balance sheets and pawn off the vast majority of the risks of nonpayment onto the U.S. government (and ultimately the U.S. taxpayer).

I will give credit to Geithner for creativity in crafting the plan given our limited options. Without the use of private money and leverage, we would never be able to afford absorbing all the problematic assets without jeopardizing the health of the U.S. balance sheet and sending our foreign investors fleeing for the exits. And even if we could afford it, Congress would never step up with the money now that the public's appetite for these Wall Street bailouts has totally disappeared, so Geithner cleverly bypassed that particular concern by giving extraordinary powers to agencies like the Federal Reserve and the FDIC.

It is quite apparent from reading the fact sheet the U.S. Treasury released today regarding the plan (which I encourage everyone to read since it actually provides a concise, rather easy-to-understand summary) that Geithner's core assumption is that current market prices for these toxic assets are not reflective of their underlying value.

If Geithner is right, and prices of these assets are artificially low, then his plan could very well work. If he's wrong and, as many experts believe asset prices fall further, then we are throwing good money after bad, and the leverage we are employing will cause even more damage.

Geithner says new plan is best option

Geithner's core assumption is that current market prices for these toxic assets are not reflective of their underlying value

Isn't there a feedback mechanism here? Value is not static. Part of the reason the assets have so little value right now is that investors are bearish on the economy. They're not necessarily irrational; they just expect the worst. And indeed, if the country plunges deeper into an extended recession or worse, those assets will never recover any value. But if the economy rebounds, the assets will very likely become worth more than their current market value. So doing nothing is a self-fulfilling prophecy. The question is whether government action is capable of spurring an economic recovery which would de-toxify many of the troubled assets.

PS Good post

interesting question. and yeah, the value of these assets is somewhat dependent on the health of the overall economy, and if people feel that these efforts will revive the economy they may bring the value of the assets along as well. obviously, i've expressed my skepticism of that notion repeatedly.

moreover, there are certainly people who feel that the value of the assets underlying these assets (ie housing) became so far extended beyond any realistic justification that they have farther to fall no matter what the overall economy does. that said, much of the value of these assets is predicated only somewhat on the underlying collateral, but mostly on the ability for the people to pay off their debts in timely fashion. (ie a buyer of a toxic subprime MBS doesn't care a whit if the price of the underlying collateral falls another 20% if the person who owns the mortgages keeps paying off their debt on a timely basis)

Latest Comments