Last month Treasury Secretary Timothy Geithner went to Capitol Hill in an attempt to calm the fears of Congress, investors, and banks. His mission… to give a broad outline of his plan so that an impatient audience would understand that a plan was forthcoming. Normally we would excuse a career finance geek who's used to operating behind the veil of secrecy of the Federal Reserve System for not being the most impressive of public speakers. Nor did anyone expect details of the plan given he had not yet begun to the skeleton crew left at the Treasury. But unfortunately his performance was so poor; his inability to answer questions so frustrating, and the plan so vague that it had the opposite effect. Not that I will ever have a chance to be Treasury Secretary, but I'm also confident that I'll ever be so bad at my job that I cause a small stock market crash.
A month later we are now starting to see details of the plan leak out and there are some things I and others find troubling. Here's the plan:
- FDIC will set up partnerships with private investors to supply enough capital that it removes the risk from purchasing $2 Trillion or so in "toxic assets" that are weighing down banks. The theory here is that nobody will buy them because they can't figure out what they're worth. Once they are initially cleared this will then have the effect of restarting a market which is desperately needed to make this work. Even a dangerous investment has some terminal value, but it won't unless the investor is sure they can unload it later on.
- Firms that invest in these assets will then be hired to manage them creating a secondary incentive to climb into the "bad asset" business.
- Expansion of the TALF program which I'd call the "rest of us" part of the plan. Essentially it backs asset-backed securities (ABS) like student, auto, credit card and other consumer loans.
So what's the beef? Geithner was bashed mostly for his inability to explain how a fair market value would be determined that is fair to taxpayers but still is enough to have a positive effect on the banks. In addition, there was no indication how risk and profit would be distributed in this public/private partnership. Now we're seeing the reason he was reluctant to say, it appears the downside is all on the government side of the ledger and the upside to the investors.
To me and others the most troubling aspect of this plan is that it presumes that the assets are as Tim Duy puts it "there are no bad assets. Only misunderstood assets." They seem to be convinced that the market is wrong and that these assets have some intrinsic value higher than where they are. There's a problem with that theory… it's wrong. Homes are only worth what people can afford, no more, and typically no less. The problem with the last decade or so is that creative dishonest lending practices inflated buying power by 40% in some cases. Take away the interest only, no money down, hybrid adjustable rate mortgages and that phony buying power disappears. It doesn't take an economist to figure out what happens when the buying power of potential homeowners is dramatically reduced.
So apparently our grand plan is to close our eyes and pretend that these assets are still worth more than they are, a nod to a philosophy Republicans have been falling all over themselves to end known as Mark to Market or Fair Value accounting. It used to be that if an asset appreciated or depreciated, the bank simply held it at the same value until the gain or loss was realized… reality be damned. You'd think that they would value honesty and integrity in financial reporting. By the way, I would not suggest trying this strategy at home. It could have disastrous consequences.
Husband: "Honey how much is in the bank account?"
Wife: "Let's say… A MILLION!"
Husband: "Ok I'm buying a boat."
Needless to say this story ends in a messy divorce. The problem being that when the government tries the same thing there is no court we can run to try to dump our spouse and boat on. I suppose if there are no more losses to book on these assets it won't be a problem and we'll in fact see a gain. But if there were no more losses, why would we need the government inducing investment?
