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Monday, March 23, 2009

Some Positive Comments on the Geithner Toxic Plan

by Calculated Risk on 3/23/2009 05:27:00 PM

From Mark Thoma at Economist's View: Which Bailout Plan is Best?

... I prefer nationalization because it provides a certainty in terms of what will happen that the other plans do not provide, the Geithner plan in particular, but it also appears to suffer from the political handicap of appearing (to some) to be "socialist," and there are arguments that the Geithner plan provides better economic incentives than nationalization (though not everyone agrees with this assertion). The Geithner plan also has its political problems, problems that will get much worse if the loans that are part of the proposal turn out to be bad as some, but not all, fear.
I am willing to get behind this plan and to try to make it work. It wasn't my first choice, I still think nationalization is better overall, but I am not one who believes the Geithner plan cannot possibly work. Trying to change it now would delay the plan for too long and more delay is absolutely the wrong step to take. There's still time for minor changes to improve the program as we go along, and it will be important to implement mid course corrections, but like it or not this is the plan we are going with and the important thing now is to do the best that we can to try and make it work.
I tend to agree with Mark on this. The Geithner plan is suboptimal, but it is probably the best we can get in the current environment. I'd add a caveat: this plan is easy for the banks to game or arb - and if a bank is caught gaming this plan, the AIG bonus flap will seem like a light Summer breeze.

From Matt Padilla: Economists mostly bullish on $500 billion toxic asset plan

An excerpt:
“My gut reaction is that this is an excellent plan. This plan will go a long way toward getting banks in better position to lend more aggressively and break the deleveraging feedback loop that is now in place."
Scott Anderson, senior economist, Wells Fargo
I think this is a myth that banks will lend "more aggressively" once the toxic assets are off their balance sheets. To whom? Perhaps Anderson is making the moral hazard argument here - maybe he is saying since the banks (and their investors) are being bailed out with above market prices for toxic assets that they will once again engage in risky lending. I hope that isn't his argument.

The key problem with the Geithner plan is that it incentivizes investors to pay more than market value for toxic assets by providing a non-recourse loan and with below market interest rates. (See Krugman on the price impact of a non-recourse loan). The investors do not receive this incentive, the banks do. And the taxpayers pay it, so this is a transfer of wealth from taxpayers to the shareholders of the banks.

This can be thought of as a European style put option - it can only be exercised at expiration. The taxpayers will pay the price of the option in the future, the investors receive any future benefit, and the banks receive the current value of the option in cash. Geithner apparently believes the future value will be zero, and that is a possibility. If so, this is a great plan - if not, the taxpayers will pay that future value (and it could be significant).

Still I agree with Mark Thoma:
[T]his is the plan we are going with and the important thing now is to do the best that we can to try and make it work.
Oh well, Paul Kedrosky quotes T. Boone Pickens today:
My dad said a fool with a plan can beat a genius with no plan.