Is Tim Geithner's toxic asset plan toxic?

Markets reacted quickly -- and positively -- to U.S. Treasury Secretary Tim Geithner's announcement detailing a public-private investment program to absorb toxic assets, once and for all, from financial institutions' books. "I am very confident this scheme dominates all the alternatives for trying to find that balance," Geithner said about the plan.

Not everyone is so optimistic. To be sure, there is a long, difficult road ahead. Throughout the day, Foreign Policy gathered the reactions of economists and practitioners as they come to terms with the plan. Stay tuned for updates and further contributions tonight and tomorrow.

Dean Baker:

The Geithner plan is yet another effort to avoid acknowledging the obvious: the major banks are insolvent. The hope is that expensive government subsidies can raise the selling price for these assets to a level that will be high enough that Citigroup, Bank of America and other major holders of bad assets can be kept insolvent.

This plan will allow for some large windfalls for investors who would have purchased some of these assets anyhow but were waiting for a big government subsidy. It will also lead to some large losses for the government as the lender to investors who bet and lose. There will also be incidents of fraud since there is not sufficient oversight capacity.

However, at the end of the day, this plan is not likely to buy up enough bad assets to maintain the solvency of the banks, so we will need yet another bailout package or the banks will have to finally be pushed into receivership.”

-- Dean Baker is co-director of the Center for Economic and Policy Research in Washington

Mark Thoma:

There were three plans to choose from: the original Paulson plan in which the government buys bad paper directly, the Geithner plan in which the government gives investors loans and absorbs some of the downside risk in order to induce private sector participation, and outright nationalization.

So which plan is best? Any plan that does two things -- removes toxic assets from balance sheets and recapitalizes banks in a politically acceptable manner -- has a chance of working. The Paulson plan does this if the government overpays for the assets, but the politics of that are horrible (as they should be). The Geithner plan also has the two necessary features, though it has a "lead the (private sector) horse to water and hope it will drink" element to it that infuses uncertainty into the plan. This option also comes with its own set of political problems -- problems that will worsen if the loans to private sector "partners" turn out to be as bad as some fear. Finally, the plan for nationalization also includes these two features, but it suffers from the political handicap of appearing (to some) to be "socialist," and there are arguments that the Geithner plan provides better economic incentives (though not everyone agrees with this assertion).

I am not wedded to a particular plan. Each has its good and bad points. Sure, some seem better than others, but none is so off the mark that I am filled with despair because we are following a particular course of action.

Thus, 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 trying to change the plan now would delay the rescue for too long, and more delay is not something we dare risk at this point.

-- Mark Thoma is professor of economics at the University of Oregon. He blogs at Economist's View.

Phil Levy:

With today’s announcement of Public-Private Investment Funds, the Obama Administration finally begins to grapple with the core issue of the economic crisis -- a deeply-troubled financial sector. The new program is not the best that we can do. It may be the best that we can do conditional on: not going to Congress and seeking more funds and not allowing any major financial institution to fail.

The underlying premise seems to be that we are in a Sleeping Beauty crisis. An evil spell has been cast on the financial markets. Now we just need the kiss of a handsome prince and the markets will spring back to life. The kiss comes in the form of private investor incentives to partner with the government and bid for troubled bank assets. The bidding is supposed to relieve bank balance sheets of bad assets and bring in enough money to restore banks' health.

There are potential problems with the plan itself. For example, it is not clear that buyers and sellers will even agree on prices for the assets.

More fundamentally, though, what if our problems are more deep-seated than just a temporary market funk? What if many of these loans really have gone bad and the assets are toxic? Then we're squandering scarce funds in a scattershot way and may still end up with an undercapitalized financial sector dragging down the economy.

-- Phil Levy is resident scholar at the American Enterprise Institute.

Michael Pomerleano:

In a Mar. 4, 2009 article, "Promising signs of progress in the ‘Bad Bank' Plan," I wrote that the approach sketched by the U.S. Secretary of the Treasury deserves consideration and support from the policy making and financial communities for the following reasons:

1) This design ensures that troubled assets are worked out in the private sector. The government bureaucracy does not have the expertise or the motivation to make decisive decisions in the resolution of troubled assets.

2) The proposed approach secures private equity capital, while providing government working capital. The program further ensures that the incentives of the managers are aligned with the public interest since the managers' own money is at risk.

3) The program creates capacity and competition in the private sector to deal with the mammoth impaired assets problem.

However, that program presented by the Treasury today is exceedingly generous to the private sector. The Treasury is acting as a rock bottom "discount" hedge fund; it offers assets to the private sector for a minimal amount of equity capital (5-7 percent), and non-recourse financing at subsidized government interest rates. The program will end up as a massive wealth transfer to Wall Street. It would have been desirable to see a far more robust risk sharing program.

A final observation is that the program is not a "magic bullet" -- it will take time to implement.

-- Michael Pomerleano is advisor on financial stability at the Bank of Israel. He is on external service from the World Bank.

David Rothkopf:

I want the Obama rescue packages to work. I'm delighted the stock market loves the Toxic Asset plan. But at best it is only a (very expensive) partial solution and, as a consequence, I'm growing increasingly worried.

This latest plan, like many other components of the Obama economic program, does not represent the kind of transformation once promised or that which might seem appropriate in a crisis of this magnitude. To date, the policies of the Obama administration have not done anything to reverse or even patch over the systemic flaws that put the entire global economy in peril... Washington was too close to Wall Street in the run up to the crisis and deeply mismanaged and financially reckless itself, neither shortcoming seems to be on the list of things for which the administration is seeking a fix.

...Now, with Geithner's address today, [the Obama administration is] introducing a toxic asset disposal program that seems to be based on the belief that the best way to restart a market suffering from the disease of untrammeled, unregulated greed is to subsidize the greediest. Having stumbled already in the midst of a crisis that they have known for six months would be their number one concern... this new plan lets us down on several levels. First, as noted by Paul Krugman, an economist with whom I often disagree, it is essentially a rehash of the Paulson plans. Next, it seeks to free up banks to lend again by taking bad assets off their books but without doing anything to ensure that once their balance sheets are cleared up that the banks will start lending at the pace the economy needs... Further, this fix replays the bigger error of the AIG bailout...not the distraction about bonuses, but the one in which we passed tens of billions through the failed insurance giant straight through, no strings attached to big financial institutions, many foreign. Here, the United States will take away massive amounts of risk from the purchase of the so-called toxic assets enabling the banks and hedge funds who played such a big role in getting us into this mess to get a free-ride at the tax-payer's expense. If the bets win, the private investors get a big payday...and the subsidy they are receiving as incentive to buy the bad assets comes again with no strings. They feast on the upside. And while taxpayers get some of the upside, they'll be the ones who have to swallow hard on the downside.