The Triangle

Issue date: 4/3/09 Section: Ed-Op

Media Credit: Chuck Kennedy MCT

The Geithner plan is part of a much broader financial program that the U.S. Treasury and Federal Reserve have embarked on to stabilize the financial system. It is now well recognized that the financial systems need to be repaired first in order for the stimulus package to work and the economy to recover. This financial plan aims to help banks purge troubled assets from their balance sheets; those assets have been looked upon as a hindrance to lending by banks and borrowing by businesses and consumers.

The plan calls for the establishment of funds that will be operated by private investment managers of hedge and pension funds and the like. Those funds will purchase the troubled real estate loans from banks and toxic securities from the markets and keep them until maturity or until they make profit. The purchases will be financed by up to $1 trillion that will come from three sources. The allocation will be as follows: $150 billion from the TARP in the form of equity, $820 in the form of debit and $30 billion from the investment managers who will be hired to run the funds.

The plan was well received with open arms by the stock markets. The Dow Jones Industrial leaped by 7 percent on the same day the plan was announced. Why was there so much enthusiasm for this plan? First and foremost, the plan has fed the stock markets with details that the previous announcement of the plan lacked. The markets were hungry for details and found them in this plan. Moreover, the plan relied on the market as a viable mechanism in pricing and managing the troubled assets, negating the idea of nationalization. This mechanism gives a venue of how to value the assets, and reduces the possibility of the government undervaluing them in the stock markets' mind.

Now that the euphoria of the first day has passed, the plan has been looked at more carefully. The plan is no rose garden for it has dangerous weeds. First, it is a massive subsidy to the banks who own the toxic assets and the mangers who will manage them. The $30 billion in private money will be leveraged with up to $1 trillion of government money. The plan transfers most of the risk to the FDIC who will allocate the majority of the funds. But since the FDIC, is insured by taxpayer money, the ultimate recipient of the burden for the risk is the taxpayer. Furthermore, there are those like the 2008 Noble prize economist Paul Krugman - whose opinion is now influencing members of Congress, who believe that the plan is too small to be effective. The size of the troubled assets exceeds $2 trillion but the plan pledges $500 billion with the possibility of expanding the money to $1 trillion. But we should remind these economists that this financial plan is part of a broader program to deal with the crisis. We should remind them that the Federal Reserve is buying an additional $1 trillion of bad debt off the private sector's books and replacing it with cash through its non-traditional policy of quantitative easing. These economists also believe that the market is not the right mechanism to deal with those insolvent banks, and therefore they advocate the Swedish solution which requires nationalizing insolvent banks and keeping them until portability.

I can add that the U.S. government and the Federal Reserve are pursuing a trial approach that moves them up the learning curve to deal with this evolving, extraordinary and multifaceted crisis. Their approach is also gradual and multifaceted. They have learned from their mistakes and they have enlarged their financial stabilization program in scope and financing. Although some time and money have been wasted, it seems that the financial pieces are complementing each other and in the aggregate are sowing the seeds of success. After they take traction, we should focus our vision on the stimulus package and the real economy. The stock market seems to have given us six months from now to see the real economy start to wake up.



Shawkat Hammoudeh is a professor of economics and international business. He can be reached at op-ed@thetriangle.org.

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