Tim Geithner will finally roll out his banking fix on Monday. The plan still appears to be a public-private hodge-podge that most likely either won’t work or will result in a huge giveaway to banks and hedge funds (or both).
A brief review:
The plan is designed to help banks get rid of assets that are worth less than the banks say they are worth (e.g., “bad assets.”). The banks can’t sell the bad assets for market prices, because then they’d have to take more massive writedowns, and taxpayers would have to fork over tens or hundreds of billions more to keep the banks on life support. The banks can’t keep the bad assets, meanwhile, because then they’d stay zombie banks and have to hoard their capital to offset future writedowns.
The Geithner plan consists of three parts:
- A “bad bank” that the government will dump bad assets into (at taxpayer expense)
- An expansion of the Fed’s asset purchasing facility to include legacy crap assets
- A public-private partnership in which the government will lend money to hedge funds and other private investors to buy crap assets.
So what’s wrong with the plan?
The same thing that has been wrong with every plan the Geithner-Paulson-Bernanke regime has rolled out since last September: The price the government is going to pay for the bad assets.
Banks like Citigroup still insist that assets are worth, say, 80 cents on the dollar when the market will only pay, say, 20 cents for them. To induce Citigroup to sell the assets, therefore, the government has to pay something close to Citigroup’s fantasy value of 80 cents. And to induce hedge funds to buy the assets, the government has to deliver the assets at the hedge funds’ desired firesale value of 20 cents.
In short, the government has to bridge the gap between bid and ask, which is wide enough to fly a 747 through.
How will it do that?
In the Geithner plan, by subsidizing hedge-funds’ purchases of the bad assets with cheap loans (allowing the hedge funds to pay more and get the same return) and, thereby, secretly bailing out the banks by paying more for the assets than they are worth.
If Geithner is actually able to accomplish get crap assets off the banks’ books (not a given, now that anti-Wall Street rage has hit a new peak–see Thursday’s Populist Rage Tax), this will be another big bailout of banks or hedge funds or both. Depending on how big the giveaway is, the plan might succeed in removing a significant percentage of the bad assets without bankrupting the banks in the process. And this, in turn, might help accelerate the return of normal bank lending and, thus, help fix the economy. But only at huge additional expense to the taxpayer.
What would be a better plan? Seize the insolvent banks, write down the assets to market levels, and make the banks’ bondholders pay for most of the losses by converting a percentage of the bonds to equity. Then sell off and/or re-privatize the banks, which will now be well-capitalised.
This latter plan would wipe out shareholders and hurt bondholders–which is what the Treasury is trying desperately to avoid. It would also hurt the same taxpayers who are getting hosed in the Geithner plan–because bank bondholders are generally insurance companies, pension funds, and other companies that taxpapers have a stake in.
It’s still a better solution, though. It will fix the problem once and for all, it will likely cost taxpayers less, and it’s the morally fair thing to do. And the bank equity and credit markets should recover quickly, once they see that the newly recapitalized banks are actually worth owning and lending money to.