Distributing the Bank Rescue Surplus

Eric Umansky writes: “Citibank up 20% and BofA, up 26% on Geithner’s plan. Does that mean it’s a good plan…or really really bad?”

It means it’s good for shareholders in troubled large banks. As for whether that’s a good sign or a bad sign, one should consider the possibility that these aren’t exclusive choices. One option for dealing with current problems is simply for the federal government to continue offering implicit guarantees to big banks, combined with low interest rates. That will allow the banks to operate profitably, and over time they’ll recapitalize themselves out of profits, and the crisis will resolve itself. But that will take a long time and be very bad for everyone. Geithner’s plan, by contrast, will almost certainly succeed in restoring the banks’ capital positions more quickly. That will create a better overall situation than the alternative.

The question around the plan concerns how the “betterness” is distributed. During the previous economic expansion, an absurdly large proportion of the growth was pocketed by a relatively small number of people working in the financial sector and, apparently, earning a living by selling snake oil. One question facing current policy is when will we shift into the next expansion. But another question is what will the expansion look like? How much of its gains will go back into the pockets of finance? Shifting from a “years of depression” scenario to a “deep recession followed by swift recovery” scenario generates a lot of extra wealth and well-being for everyone. But how much of it will actually go to “everyone” and how much will go to the owners and managers of large financial firms? A plan can work and help restore growth while still being unduly favorable to the interests of finance.