Legal Commentary

"Normal Values" For "Toxic Assets"

By Big Tent Democrat

If you support the Geithner Plan, it has to be based on the premise that the "toxic assets" held by banks are worth much more than the market is willing to pay for them now. Thus, Geithner Plan supporter Brad DeLong writes:

[G]overnments should undertake additional measures to boost financial asset prices . . . It is this point that brings us to US Treasury Secretary Timothy Geithner’s plan to take about $465 billion of government money, combine it with $35 billion of private-sector money, and use it to buy up risky financial assets. The US Treasury is asking the private sector to put $35 billion into this $500 billion fund so that the fund managers all have some “skin in the game,” and thus do not take excessive risks with the taxpayers’ money. Private-sector investors ought to be more than willing to kick in that $35 billion, for they stand to make a fortune when financial asset prices close some of the gap between their current and normal values. . . .

(Emphasis supplied.) What is the basis for DeLong's assumption that these "toxic assets" are undervalued? He does not say. And if they are not, then what? And even if DeLong's assumption is true, what is the economic purpose of this plan? DeLong posits:

The aim is to reduce unemployment. The appearance of an extra $500 billion in demand for risky assets will reduce the quantity of risky assets that other private investors will have to hold. And the sudden appearance of between five and ten different government-sponsored funds that make public bids for assets will convey information to the markets about what models other people are using to try to value assets in this environment.

This sharing of information will reduce risk – somewhat. When assets are seen as less risky, their prices rise. And when there are fewer assets to be held, their prices rise, too. With higher financial asset prices, those firms that ought to be expanding and hiring will be able to get money on more attractive terms.

(Emphasis supplied.) Say what? DeLong is arguing that the slump in demand and employment is a result of the cost of money? That seems incredibly implausible, given the unprecedented easing by the Fed and frankly, contra to DeLong's argument for government stimulus spending. It is utterly inconsistent with DeLong's other writings on economic stimulus.

DeLong then adds his Martin Feldstein kicker - the Geithner Plan is too small:

The problem is that the Geithner Plan appears to me to be too small – between one-eight and one-half of what it needs to be. Even though the US government is doing other things as well –fiscal stimulus, quantitative easing, and other uses of bailout funds – it is not doing everything it should.

My guess is that the reason that the US government is not doing all it should can be stated in three words: Senator George Voinovich, who is the 60th vote in the Senate – the vote needed to close off debate and enact a bill. To do anything that requires legislative action, the Obama administration needs Voinovich and the 59 other senators who are more inclined to support it. The administration’s tacticians appear to think that they are not on board – especially after the recent AIG bonus scandal – whereas the Geithner Plan relies on authority that the administration already has. Doing more would require a legislative coalition that is not there yet.

This is utterly unsatisfying and unconvincing. First, DeLong implicitly accepts that in fact the Geithner Plan won't work because it is too small. DeLong argues it is too small because the politics won't allow it to be bigger. It seems to me this is a reason to look for another plan, not plow forward with one that will not work.

For example, DeLong states that the "the aim is to reduce employment." If that is the only aim, then a much more efficient stimulus (in terms of saving employment) would be to bail out Detroit in full measure (or even continuing to buy F-22s) and that would certainly be much more politically palatable.

Sorry, but I remain utterly unconvinced that the Geithner Plan makes sense. To recap, it is based on (1) the assumption that toxic assets are significantly undervalued, (2) it won't work because it is too small, (3) it is not much of a spur for employment and fiscal activity and (4) political constraints prevent the Geithner Plan from even being designed in a way that could be effective even if we accept these unlikely assumptions. It should be scrapped.

Speaking for me only

Full post as published by TalkLeft on April 07, 2009 (boomark / email).