Friday, 3 July 2009

Isn't Revisionism Fun? The Geithner Plan Revisited

The New Republic's Noam Scheiber catches up with a "Deep Throat" from the Treasury Department as the Geithner plan, or PPIP, begins to spiral downwards faster, heading toward a near-certain death. You'll see a flurry of reasons tossed about for its demise, but if you get right down to brass tacks, there's only one that really matters: the banks don't want to play. They don't want to accept low auction prices for their bad assets. They want to pretend those holdings are worth more, for as long as possible, and postpone the day of financial reckoning.

As we all know, success has many fathers, but failure is an orphan. So does that mean the Geithner plan, which would have paired public and private investment to buy toxic assets, is an about-to-be orphaned failure? Au contraire, Mr. Nameless Insider insists:
If you had asked--I don’t want to speak for the secretary--what’s problem number one? I think he (Geithner) would say capital. Problem two? Capital. Problem three? Capital. Everything was in the service of that view. The legacy loans program was meant to help clean balance sheets. It was not an independent good in itself. It was seen as friendly to equity raising. Now people say the legacy loans thing is not gaining as much traction, so is that a failure? But because we had a good outcome in terms of raising equity, they [the banks] were able to raise equity without shedding assets ... you should be okay with that.
Ah. So PPIP was really all about the ability of banks to raise capital, and now that they seem to have solved that on their own, PPIP becomes expendable. Hmmm. Very interesting. But it does leave some unanswered questions.

1. If PPIP was all about (1) capital, (2) capital and (3) capital, why wasn't it sold to us that way?

Here's the Treasury Department's own summary paragraph on the Geithner plan from March 23:
Despite these efforts, the financial system is still working against economic recovery. One major reason is the problem of "legacy assets" – both real estate loans held directly on the books of banks ("legacy loans") and securities backed by loan portfolios ("legacy securities"). These assets create uncertainty around the balance sheets of these financial institutions, compromising their ability to raise capital and their willingness to increase lending.
Okay, Treasury does mention capital, but it also mentions lending, and look at the larger context. These assets create uncertainty around the balance sheets. And that has changed how? The assets are still creating unwanted uncertainty around balance sheets. Further, the Treasury had this to add at the time about its plan:
This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly. Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience.
Now the Treasury wants to pretend that the pile of dreck in the back room doesn't really matter after all.

2. If PPIP assumed capital was the problem, why was it structured in such a way that assumed liquidity was the problem?

PPIP is an awfully queer way to solve a capital problem. PPIP essentially would have pumped in a lot of cheap money to give private investors enough funds to buy the banks' toxic assets. PPIP made sense in a world where liquidity is scarce and investors need a little help from their friends (the U.S. government) because of the onerous cost of borrowing on the open market.

PPIP basically bought into the bankers' mythology: They couldn't sell their impaired assets at a fair price because of tight credit; no one could get money because the lending markets had seized up. Of course this was a lie, but Treasury went ahead and diligently built a whole plan (PPIP) around the lie. Now if PPIP had worked, then Treasury and the banks would have been correct: it was just a liquidity crisis. But now that PPIP is floundering badly, instead of admitting defeat, Treasury decides it's time for revisionist theater.

3. What happens to those banks that supposedly no longer need PPIP when the government jerks away the various crutches for the financial markets?

The major banks are still sitting on tens of billions of dollars of bad "legacy" assets. They are able to raise capital, but not because they're any healthier or smarter. Consider: (1) The banks were handed billions of dollars under TARP. (2) The government has made cheap funds available to them through an alphabet soup of lending facilities. (3) The government has said none of the 19 stress-tested banks would be allowed to fail. (4) The banks were allowed to twist accounting rules to their advantage, starting in April, to enable them to look healthier even if they're not.

Is it any surprise then that they are capable of raising capital? Investments don't get much juicier than this. The government will backstop losses, while the banks keep the profits. Hey, I'd lend ten bucks to a junkie who was getting $1,000 weekly welfare checks. But what happens when the government tries to fold up the Bailout Nation Tent? Also, Mark Thoma makes an interesting point: what if investments were made in the banks on the assumption that they would be getting rid of their toxic assets when they're not? Does that constitute a federally sanctioned double cross?

A few things to ponder. I think the summer will be full of PPIP revisionism as the Geithner Team tries to make excuses for the plan's failure.