The much-anticipated debut of the Obama Administration's bank
bailout plan was correctly viewed as a flop on both Wall Street and
As announced Tuesday byTreasury Secretary Timothy Geithner, the
plan is a grab bag of policies of doubtful effectiveness and
uncertain consequences financed with $2 trillion or more in
taxpayer dollars. To make matters worse, key elements of the plan
were nothing more than placeholders lacking any meaningful
substance about how they would be structured or work.
The one thing that does seem certain is that the massive new
programs will increase Washington's control over the financial
system, placing politicians in the role of bank managers and hedge
fund investors, to the long-term detriment of consumers and
More Questions Than Answers
Geithner has waved off criticism of the problems with the plan,
citing the danger of a complete collapse of the financial system.
But in fact the Obama plan in many ways seems crafted as much as a
further effort to stimulate the economy than as a financial
stabilization measure. Rather than wave the red flag of emergency,
policymakers need to carefully consider the costs and dangers of
the proposed actions.
Among the problems with the plan:
- Massive purchase of "toxic assets": The plan includes
$500 billion to establish a "Public-Private Investment Fund" to
purchase "toxic assets" from banks. The initial $500 billion could
grow to as much as $1 trillion. No detail has been provided on how
this would work, but in some fashion Treasury would provide
incentives for private investors to purchase bad assets from banks.
Although the plan is intended to be a public-private partnership,
how private money will be induced to participate in the program is
unexplained. The general concept would be similar to the "bad bank"
plan the Administration had earlier considered but with the
acquisitions filtered through the private sector.
This, however, still leaves the most critical questions
How will the purchase price of these assets be
determined? There are literally hundreds of asset classes the
fund would have to purchase, many of which are extremely complex
securities that were difficult to price in the best of times. By
definition, the "toxic assets" at issue are those that banks have
been unable to set a value for, so there is little reason to
believe that government intervention can magically solve this
How will the costs and potential profits of this new type of
entity be divided between taxpayers and potential private
investors? The answer to this question will determine whether
private sector money will participate and whether the taxpayers are
taken for another ride financially.
Even if these questions are resolved, the approach will take a
lengthy period to actually begin operating, and during that time,
it will do little to mitigate the toxic effect firms are
experiencing from these assets.
- Expansion of a new and untested asset purchase plan: The
plan expands Federal Reserve's Term Asset-Backed Securities Loan
Facility (TALF) program from $200 billion to $1 trillion. Announced
on November 25 by the Bush Administration, when operational the
TALF will loan money to holders of asset-backed securities
collateralized by student loans, auto loans, credit card loans, and
loans guaranteed by the Small Business Administration. It is
intended to stimulate the issuance of new asset-backed securities
and thus additional lending. Tuesday's announcement also expands
TALF to cover commercial real estate and residential lending. Since
the smaller program has just gone into effect, it is unclear how
well this approach will work.
There may also be unforeseen consequences from this plan.
Policymakers must ensure that this program does not encourage bad
lending decisions of the sort that--at least in part--contributed
to the present crisis.
- Refinancing delinquent mortgages: Geithner also issued a
vague statement that the Administration would help refinance
delinquent mortgages. Like most of the plan, few details were
given. Under any circumstances, however, such an initiative would
be not only difficult to administer but more importantly likely to
encourage future abuse of the mortgage finance system.Mortgage
financing is complex to begin with, and the many types of
mortgage-backed securities add yet more layers of complexity making
execution and administration of this plan highly questionable.
Moreover, just how the Administration would keep this massive
program from rewarding borrowers who intentionally abused the
system--by lying on mortgage applications, borrowing to speculate,
or draining their equity to live well above their means--at the
same time as it helps those who are in trouble through no fault of
their own remains unclear. Rewarding those who abused the system
sends a strong message that those who sacrificed to pay their
mortgage on time should have taken the easy way out.
- Political interference into business decisions: The
plan, as announced, contains a number of mandates and restrictions
on bank operations, including limits on purchasing healthy
institutions, salary caps, and caps on dividends. These
restrictions, however, are likely only the first steps toward a
vastly increased government role, opening the door to additional
- Lack of any credible exit strategy to return financial
services and lending activities to private-sector control over
time: Given the size of the TARP programs and the level of
political interference that they are likely to cause, this element
must be an essential part of any financial rescue plan.
There is, however, at least one potentially positive element of
- Stress-testing bank assets: The plan to have federal
banks regulators jointly examine the asset quality of all banks
with more than $100 billion in assets is a good idea. This covers
the 15-20 largest banks and the ones that appear to impose the
greatest risk to the financial system. A unified regulatory
presence is valuable as it would eliminate both contradictory
regulatory priorities and the chance that some key element would
fall in the cracks between various agencies' jurisdiction.
"Stress-testing" the assets to find what problems will develop if
the economy continues to deteriorate will make the results even
more credible, thus enabling the market to determine the actual
risk each bank faces.
The Administration's plan is deeply flawed and in some ways
repeats the mistakes made by the Bush Administration and
then-Secretary Henry Paulson. Looking strictly at the process, its
only improvement over the Paulson era is that, so far at least, all
of the programs were announced at once instead of being revealed on
a near daily basis that seemed structured to disrupt the financial
markets. Unfortunately, Geithner asserted in his remarks that he
expects the policies to adapt over time, thus signaling to markets
a continuing government-generated uncertainty reminiscent of
Paulson. Not surprisingly, the Geithner plan seems to have had the
same result as the Paulson plans in that stock values of financial
institutions dropped by as much as 20 percent in a single day.
Waving the Flag of Emergency
Responding to critics of his plan, Geithner has argued that,
despite its massive cost and certain flaws, the plan is necessary
to avoid a "complete collapse of our financial system." The banking
system is still fragile, and the Administration should be watchful
and ready to respond as appropriate. But there is not an imminent
threat of a collapse. Financial markets are impaired, but--despite
the rhetoric--no substantial markets are "frozen." Instead of
forestalling an imminent collapse of the system, the purpose of
TARP will morph under the Administration's plan into yet another
effort to stimulate the economy. This kind of intervention is
ill-suited for that goal.
Today's problems are real and certainly should not be minimized.
This, however, provides further reason for policymakers to
carefully evaluate the costs and dangers of proposed actions rather
than to ignore them under the flag of emergency.
Return to Sender
The Administration's financial bailout strategy announced by
Timothy Geithner, despite some positive elements, is filled with
incomplete and unsound policy proposals financed by trillions of
taxpayer dollars. The Administration should recognize that this
plan is flawed and send it back to the Treasury Department's
David C. John is
Senior Research Fellow in Retirement Security and Financial
Institutions, and James
L. Gattuso is Senior Research Fellow in Regulatory
Policy in the Thomas A. Roe Institute for Economic Policy
Studies at The Heritage Foundation.