In essence, the U.S. Treasury’s plan to subsidize private investors’ purchases of the banks’ toxic assets is a too-clever-by-half mechanism to fix the banks while avoiding going to Congress for more upfront on-budget expenditures. One can imagine the discussions at the White House: We have a budget to pass, and cannot give up those goals to give the bankers still more. Figure out some way to do this off-budget. [...]
I know that the very same self-limiting discussions took place at Okurasho, the Japanese Ministry of Finance circa 1995-1998. And they ended with the same result, a series of bank-recapitalization plans that tried to mobilize private-sector monies and overpay for distressed bank assets without forcing the banks to truly write off the losses. Even though the top Japanese technocrats at the ministry were even more insulated from a weak Diet than the congressionally unconfirmed advisers currently running economic policy for the Obama administration, they did worse. Whatever the political context, countries usually try to end banking crises on the cheap, with a limited public role at first, overpaying for distressed assets and failing to change banks’ behavior, only to have to go back in a couple of years later.
The question here is what would Adam Posen have done if he had Tim Geithner’s job? And based on Posen’s analysis, I think the only conclusion you can reach is that he’d have done more-or-less the same thing. Talking about a different issue last week, I heard Tyler Cowen forcefully make the point that you have to think of the political constraints as a real policy consideration. Suppose Geithner had asked congress to appropriate $1 trillion to implement a program of bank nationalization, asset writedowns, and loan guarantees—what would that have accomplished? It certainly wouldn’t have gotten congress to appropriate $1 trillion to implement a program of bank nationalization, asset writedowns, and loan guarantees. It might have derailed the budget and thrown the political momentum on the Hill to proponents of a neo-Hooverite spending freeze program. It might have caused panic. And it certainly would have undermined the credibility of the inevitable effort by Geithner to do the most he can with the authority he already has.
Given all that, why not just skip to the last step and have Geithner do the most he can with the authority he already has? The inescapable conclusion of Posen’s analysis isn’t that Geithner’s plan is likely to be inadequate (though it is) but that Geithner’s plan is essentially inevitable. The best we can hope for is to cycle through policy options in a relatively expeditious manner, rather than getting stuck somewhere along the line or moving backwards out of a sense that “doing stuff” isn’t work so we need to stop “doing stuff.”