It's been a week since the Obama Administration first announced its strategy to stabilize U.S. banks by establishing an orderly plan for them to unwind the so-called "toxic assets" currently weighing down balance sheets. Is it too early to pass judgement?
As Paul Krugman declared the Saturday before the Geithner plan's formal release, it represents a coin toss in which "heads [the financial industry] wins, tails the taxpayers loses." These are pretty unfavorable odds indeed, and I've been surprised by the number of Wall Street heavyweights I've spoken to who readily acknowledge this fact, at least privately. No matter how you slice it, the plan offers plenty of upside to institutional investors and very little to the tax payer relative to the risk they shoulder (essentially all of it).
Given that Krugman had access to the full plan when he penned his column -- the Treasury strategically leaked it -- Dr. Summers's implication isn't that Krugman didn't appreciate the details, so much as he didn't appreciate how those details would be received broadly--given how sweet a deal it is for Wall Street, the markets loved it. Because this plan shows some early indication of bringing potential buyers of these assets to the table, and so creating a market that can assess their real value, Summers would have us believe that this is the best plan that is politically possible.
For the moment, let's leave aside the very real possibility that a plan less generous to big investors could have achieved similar ends (or that Treasury's prior missteps in announcing half-baked rescue plans and its general tilt toward a Wall Street worldview may have weakened the government's position more than anything else). If one judges the plan simply on its market-making abilities, it still leaves much to be desired. Though the Administration is right to note that its market based plan is better than the absence of markets, it's as vital to note: not all markets are created equal.
First, it has built-in distortion by having the government effectively subsidize buyers' risk. In this equation, private investors stand to reap 50% of all upside, though face only slightly more than 7% of the total exposure, which Paul Krugman shows is a sure-fire way to lead to overvaluation. How is the market to arrive at efficient pricing if a buyers' risk is not aligned with reward?
Second, the plan creates significant barriers to market entry, establishing room for only five initial participants to be chosen by application from among managers with "a demonstrated track record of purchasing legacy assets." The plan pays only lip service to encouraging participation among "individual investors, pension plans, insurance companies and other long-term investors," offering no suggestion whatsoever of how they might play into the market when only these five chosen managers can participate directly. Nor does it offer any road map for expanding participation, simply an openness to doing so over time. When it comes to markets, generally speaking, the more participants, the more efficient.
The final and perhaps most critical missing ingredient here is information, without which a truly well-functioning market is difficult. The Geithner plan is shockingly silent on this element, especially considering the Administration's much touted push for transparency, manifested in such initiatives as recovery.gov. We need a recovery.gov for the bank rescue program that takes this mission of transparency to a completely new level. This online resource would serve to aggregate all of the available data on the various outstanding pools of securitized assets -- including who owns what and the best current estimate of the real underlying assets (foreclosed houses, condos, etc) -- and update that information in real-time as new data comes in from banks, repossessors and the like. Further, the government should make this data available via an open API that would allow programming access to everyone and anyone, from Greenwich based financial wizards to enterprising 13 year-old computer nerds working from their mom's basement. With this sort of information increasingly available over time, there will be less need to induce market participation and the government can scale back its icentives and increase its own upside in kind -- a right it should reserve by proceeding in clearly outlined phases.
With only $135 billion left in the TARP funding, and remaining bank liabilities well in excess of that sum, the administration will soon enough be forced to return to Congress for more money. As the weak theoretical foundations of the current proposal strain under continued scrutiny, the administration may find that the plan's seeming political expediency follows suit. For while Wall Street may be a ready and willing seller, but Main Street very well may no longer in the mood to buy in.