"The Geithner Plan: Effective At What Cost?"
Under the plan, the government and private investors will invest together to buy up between $500 billion and $1 trillion worth of real estate-related loans and securities from banks. The government will use up to $100 billion from the Troubled Assets Relief Program, matched by private funds, to capitalize the purchases.
As Robert Waldman characterized it, “the key to the Treasury argument is that asset prices are far far below hold to maturity values and that no one wants to buy them — that is, that no one shops during fire sales.” There is also wide concern that investors — since they are subsidized by the government — will overpay for the assets, potentially exposing the taxpayer to losses which the investors can, for the most part, walk away from.
Now, Geithner’s plan may very well work (though Paul Krugman and many others seem firmly convinced that it will not). But there are also concerns that go beyond the simple effectiveness of the program. For one thing, as Matthew Yglesias pointed out, “under the administration’s plan the existing banks under existing management will go back into ‘normal’ business.” Will it be right back to the same old risky behavior?
Furthermore, this plan doesn’t change the fact that financial institutions will be too-big-to-fail. Regardless of whether or not Geithner’s plan works, systemic changes to the financial system need to be made. As Simon Johnson laid out:
If Secretary Geithner’s scheme works, we draw the lesson that our banks became too big and we aim to make them smaller relative to the economy moving forward. …We need simple caps on bank size, leverage relative to the economy and – this is harder – measures of interconnected tail risk (i.e., is everyone making the same kind of crazy loans?). Design a system with this in mind: regulators get captured and super-regulators get super-captured. If the scheme doesn’t work, we draw the exact same lesson.
So even if the plan goes off without a hitch, it can’t be the end of the line. And if the plan is a dud, “the cost will be continued vast over-capacity in banking, and a consequent weakening of the remaining, smaller, better- managed banks who didn’t participate in the garbage-loan frenzy.”