Timothy Geithner Proposes A “Cure” For Toxic Assets: Take A Poison Pill
March 24th, 2009
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In scientific terms, toxins are regarded as compounds that, if ingested in small quantities, can cause severe organic damage and even death. There are in the natural world, however, compounds which in small quantities are harmless; taken in large doses the same compounds can prove lethal. Such is the case with financial toxicity.
Our modern financial system is the creation of fallible human being, meaning there will be encountered in any modern economy a certain degree of mischievous speculation, outright fraud and chicanery. Often these activities lead to the creation of asset bubbles. If the proportion of inflated or fraudulent assets is a trivial proportion of the gross aggregate assets held by the major institutions in the financial system, the damage can be contained. However, when asset bubbles constitute a significant proportion of the paper wealth of a major economy and then deflate, they become toxic in the truest sense of the term. With our current Global Economic Crisis, it is the size of these deflating assets that contributes to their toxicity. However, their impact on the global credit system is virtually identical to that of chemical toxins on biological mechanisms; they are the penultimate monkey wrench that jams up the whole works. The toxic assets sitting on the balance sheets of financial institutions throughout the world have paralyzed the economic heart of the global economy, starving it of the blood and oxygen of normal flows of credit. The result has been economic paralysis more severe than anything experienced since the Great Depression. However, instead of an antidote, or at least a well conceived therapeutic response, U.S. Treasury Secretary Timothy Geithner has offered up more toxicity.
Perhaps toxicology is too clinical for the Wall Street clique that has dominated policy making in Washington as it applies to the economy. By training and experience Geithner is a creature of Wall Street, and has proposed a solution to the disease of toxic assets that is nothing more than the original brainchild of former Treasury Secretary Hank Paulson. Yet, even Paulson retreated from his original idea of buying up the toxic assets on the balance sheets of U.S. banks, choosing instead to purchase equity in these institutions, an approach that was just as ill conceived.
There are many weaknesses to the Geithner plan, not the least being that it is simply Paulson redux. It pretends that U.S. banks are essentially healthy except for the fact these toxic assets are not really toxic but are in fact “under-valued” by the market. Accordingly, Geithner wants to use taxpayer money to re-inflate the value of these assets, by encouraging private investors to buy them through auctions, thus bidding up their price. This will be accomplished by Treasury using the balance of the TARP money, $75-100 billion, to match private investors direct stake in the purchase of such assets, and then provide cheap loans to the private investors through the Federal Reserve and FDIC to buy up to $1 trillion of the toxic assets. The private investors will only risk the small proportion of their own capital being utilized in the transactions, as the U.S. taxpayer loans will be “secured” by these same toxic assets, which will be the collateral.
Rather than toxicology, Geithner is resorting to folktales and alchemy in providing this witches brew of a curative. The Geithner plan is not only bad in terms of its philosophy; have the taxpayers take almost all the risks, with the private investors subsidized to the tune of nearly a trillion dollars, while these same investors are assured of the great bulk of any upside. There is an even more fundamental problem. Most of the U.S. banking system, and much of Europe’s, is effectively insolvent. Other than radical surgery, which recognizes that maintaining on life support zombie banks can only prolong the Global Economic Crisis, any other solution is doomed to failure.
Geithner is proposing to place U.S. taxpayers at severe risk, by in effect borrowing money to purchase these toxic assets on behalf of hedge funds and other private investors. Yet, as massive a sum as Geithner’s plan envisions, it is not nearly adequate towards addressing the full dimensions of the problem. NYU economics professor Nouriel Roubini has estimated that the U.S. financial system is sitting on $3.6 trillion of bad assets. A leaked document from the European Commission assesses that banks across Europe hold up to $24 trillion in bad assets, suggesting that even Roubini’s gloomy analysis may be unduly optimistic. It is already clear that the banking system in the United Kingdom is comatose. Yet, Geithner asks that we suspend disbelief, accept that the U.S. financial system’s toxic asset exposure is limited to $1 trillion, and we should allow the private sector to do its thing, subsidized by the American taxpayers. Far from being thoughtful, insightful and analytical, Timothy Geithner offers a dish of warmed-over free market cliches and Hank Paulson inanities, avoiding at all costs even a hint of bank nationalization and radical financial surgery.
In his column in The New York Times, Nobel prize-winning economist Paul Krugman summed up the fallacy of Timothy Geithner’s toxic assets rescue plan as follows, “But the real problem with this plan is that it won’t work. Yes, troubled assets may be somewhat undervalued. But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus-for that is what the Geithner plan amounts to-will change that fact”
Unfortunately, hocus-pocus is exactly what has been proposed by Geithner, to the delight of Wall Street. It will prove as effective an antidote to our economic and financial crisis as the toxins injected through the fangs of a cobra.