The latest program to try to stabilize the ailing financial industry, announced Monday by Treasury Secretary Tim Geithner, is still fundamentally wrong-headed.
If the problem was years of overly loose credit offered to marginal borrowers, then the way you get out of it is by taking a rest from overheated and overleveraged credit until various commodities reach more realistic prices, and people and companies work their way out of debt — not by pumping more funny money into the credit system.
But this plan isn’t quite as misguided as previous improvisations, and it just might get some of those toxic assets — the Treasury Department avoids that word and even the word “troubled,” going to new heights in Newspeak with “legacy assets” — so the stock market welcomed it, at least for a day.
The latest plan is to offer guarantees and other sweeteners to persuade private investors to participate alongside government in buying up the legacy assets in the form of securitized mortgage packages and other exotic financial instruments, some (but not all) of which have gone so bad there is no effective market for them.
The hope is that private investors using their own money will be in a better position than bureaucrats using the taxpayers’ money (and, therefore, having no personal stake) to determine what really are appropriate prices for these securities cluttering up various bank balance sheets.
Once those troubled — er, legacy — securities are off bank balance sheets, the banks will start lending prodigiously once again, and that will pull the country out of recession.
There are several problems with this approach, which become apparent if you understand, as Alan Reynolds, senior fellow in economics at the libertarian Cato Institute does, that the financial crisis and the recession are separate phenomena. The recession began more than a year ago, but the financial crisis started in earnest last September and was exacerbated by the panicked response of the government, which decided that certain firms that had made bad investment decisions were “too big to fail.”
The way out of the financial crisis is to stop “helping” the banks, let those in the most trouble fail and let healthier institutions gobble up their assets. The forecasters who were most accurate about when the recession began projected that recovery will begin toward the end of this year, with or without more trillion-dollar heroics from government, but that it will be a slow, rather than a swift, recovery.
Involving the private sector rather than simply having the taxpayers buy up toxic assets, as former Treasury Secretary Henry Paulsen had originally suggested in September, could make the prices paid more realistic. Federal Reserve Chairman Ben Bernanke’s reassurance that the administration did not desire to nationalize banks probably did more to bolster the financial industry than Geithner’s plan, but the Geithner plan at least doesn’t look as if it will do much harm.
Given the evidence of last week that Congress could change the rules in midstream, it might not be easy to get private investors to participate this time. If Congress doesn’t try to micromanage, however, this latest plan just might help to restore confidence in the financial sector.