As more details emerge about the Treasury Department’s plan for dealing with the toxic assets currently plaguing our banking system, it’s becoming clear that Treasury Secretary Timothy Geithner is betting the house on a rather large assumption.
He seems to believe that the problem with the assets is not that they are actually relatively worthless, but that they have an “artificially depressed value” that will return as soon as a market for them is created. As Paul Krugman explained:
[S]omehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets, often referred to these days as “toxic waste,” are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away
Geithner has posited that the toxic assets have a “basic inherent economic value” that is absent because of “the absence of financing and credit.” Unfortunately, today’s market valuations may reflect actual prices, which would throw a serious wrench into everything about the administration’s plan.
As Financial Times reported, JP Morgan and Wachovia have been picking apart some assets, to see what the underlying loans and mortgages are actually worth, and the outlook is pretty bleak. The recovery rates on some of the junk “have been a mere 5 per cent” and even the best of it is worth 35-40 cents on the dollar.
So where is Geithner getting his theory from? Well, Goldman Sachs — upon hearing the first details of Geithner’s plan — organized a roundtable, and attendees claim they “received the invitation after the speech and decided to attend because of the speech.” Meanwhile, Simon Johnson at the Baseline Scenario wrote that Geithner’s plan is “essentially the same plan that Goldman Sachs has been shopping around for the past month or so.” Was Geithner’s plan crafted along Goldman’s guidelines? (Goldman has since denied that the meeting was organized as a result of Geithner’s speech.)
Any way you cut it, Geithner is counting on the assets being artificially depressed, which exposes taxpayers to a serious loss if he’s wrong; under the plan investors who buy toxic assets would be able “just walk away if prices fell substantially.” Now, maybe Geithner knows something we don’t. But right now, the conventional wisdom is that the assets are pretty much garbage, and Geithner is taking Goldman Sachs’ word in order to avoid talk of nationalizing the banks.