February 12, 2009 | WebMemo on Economy
The much-anticipated debut of the Obama Administration's bank bailout plan was correctly viewed as a flop on both Wall Street and Capitol Hill.
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 workers.
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:
This, however, still leaves the most critical questions unanswered:
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 problem.
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.
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.
There is, however, at least one potentially positive element of the program:
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 drawing boards.
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.
James L. Gattuso, David C. John, and J. D. Foster, Ph.D., "TARP and the Treasury: Time to Allow Markets to Work," Heritage Foundation WebMemo No. 2131, November 14, 2008, at http://www.heritage.org/Research/Economy/wm2131.cfm.