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Last Build Date: Thu, 26 Mar 2009 05:30:00 -0600

Copyright: Copyright 2009
 



What's Behind the Geithner Debate?

Thu, 26 Mar 2009 05:30:00 -0600

Some liberal critics charge that it is nothing more than a continuation of the Bush-Paulson policy of propping up failed banks and financial institutions until the crisis somehow resolves itself. They question whether Geithner, a former governor of the New York Federal Reserve, is capable of administering sufficiently harsh medicine to his former peers in the realm of high finance. Many conservatives, relieved by the voters of primary responsibility for fixing the mess, are hoping to exploit populist anger over the massive wealth transfer from taxpayers to Wall Street. The essence of Geithner's plan is to reanimate the market for the securitized mortgages and other loans that no one wants to buy now. Until banks can take these toxic assets off their books, they won't be able to resume lending. Geithner proposes to use what's left of the TARP (Troubled Assets Relief Fund) money to entice private actors, such as hedge funds, to buy the assets. The basic idea here is that these private money-managers will do a better job of pricing the assets than the government ever could. If the spoiled assets regain their value, these private buyers win--but so do taxpayers, who would no longer have to foot the whole bill for the failures of the past. Conversely, if the assets do not regain their value, then everybody loses. Well, almost everybody. In order to persuade private buyers to take the plunge into the toxic pool, the Geithner plan insures them against downside risk. Despite their admiration of Obama, many liberals are unhappy with this arrangement. They decry the plan as yet another subsidy to the very people whose reckless risk-taking in search of outsized profits got us into this mess. They complain that Geithner's plan is, at best, a palliative that doesn't address the underlying cause of seized-up credit markets -- namely, the fact that major U.S. banks are, for all practical purposes, insolvent. Elizabeth Warren, a Harvard law professor who heads the panel Congress set up to oversee TARP, likens the Geithner plan to an IV drip for "zombie banks." Putting the big banks on life support, in this view, merely prolongs the agony and could lead to a long period of Japanese-style stagnation. Better to follow the sterner Swedish model: Nationalize insolvent banks, wipe out equity holders, and return a smaller number of healthy banks with clean balance sheets to private hands. But nationalization could wind up costing taxpayers a fortune, while also causing collateral damage to the secondary market for securities backed by mortgages in other loans. Congress' hot-headed reaction to the AIG bonus scandal did little to inspire confidence in the federal government's ability to manage financial companies. Furthermore, Obama's economic team seems willing to bet that bank assets are worth more than today's depressed market prices suggest. In short, Obama and Geithner are working to restore the financial sector as it existed roughly a decade ago, before the frenzied run-up in real estate prices and the bubble in securitized loans. But as the president has said, the regulatory minimalism of the Bush years must be replaced with a new regime that extends oversight to hedge funds and derivatives and ensures that we never again face the necessity of bailing out companies that are too big or too interlaced to fail. The administration's critics envision a more fundamental restructuring: a dramatic shrinking of the financial-services sector; an end to easy credit; a tight corset around any lending practices that might smack of seduction or predation; the permanent intrusion of government into matters of firm strategy and compensation; and, somewhat ironically, a return to the old, black-and-white days when conservative bankers took modest risks for modest profits. Given the unknowns about the real value of bank assets - and the palpable financial and political risks of a government takeover of big chunks of the U.S. financial sector - President Obama and Geithner have the better argument. The strong vote of confidence they received f[...]