Treasury Secretary Geithner is quite the guy. Before becoming Treasury Secretary, he was head of the New York Federal Reserve Bank. As the Washington Post reports, in that capacity he was responsible for overseeing and regulating bank activity. Although he raised questions about bank risk management strategy, he did little to reign in speculative activity. In fact, in a May 2006 speech at NYU, Geithner sung the praises of credit derivatives, claiming that they probably improved “the overall efficiency and resiliency of financial markets.” Now he declares that “We’re having a major financial crisis in part because of failures of supervision.”
Geithner’s latest plan for cleaning up the “toxic” assets that currently dominate bank balance sheets is basically designed to once again reward speculators at public expense. It appears that defending the public interest is not part of his job description.
Here is how Dean Baker describes what is being proposed:
[Geithner and his associates] have devised a plan that for $1 trillion (approximately equal to 300 million kid-years of SCHIP, the State Child Health Insurance Program) can alleviate the stress on the banking system. Note that no one claims that $1 trillion spent on the Geithner plan will actually clean up the banking system – that would be asking too much. [Its supporters] only assure us that this $1 trillion (more than enough to have energy-conserving retrofits for every building in the country) will make things better. Isn’t that enough?
Oh, by the way, some people will get very rich off the Geithner plan. Some hedge and equity fund managers could make hundreds of millions or even billions off the Geithner plan. And, under current law, they will pay a lower tax rate on this money than a schoolteacher or firefighter. Are you sold yet?.
So—how does it work? The government is apparently going to encourage large institutional speculators (such as hedge funds) to bid on bank toxic assets by putting up approximately 92% of the purchase price. Take an asset that is up for sale for $150. The speculator would have to put up $12 of its own money. The Treasury would put up $12 of our money. And then the Treasury would provide the speculator with a guaranteed low cost $126 loan. If the asset turns out to be worthless, the speculator loses $12 and we lose $138. If the asset rises in value, say to $200, then the speculator pays back the loan, and we split the $74 profit—the speculator makes $37 on its $12 investment and we make $37 on our $138 investment.
As Joseph E. Stiglitz, former chairman of the Council of Economic Advisers Nobel prize winner, explains:
What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. And such partnerships — with the private sector in control — have perverse incentives, worse even than the ones that got us into the mess.
Oh, and have you heard about Larry Summers, the director of Obama’s National Economic Council? According to the New York Times, he “earned more than $5 million last year from the hedge fund D. E. Shaw and collected $2.7 million in speaking fees from Wall Street companies that received government bailout money.”
Still have confidence in Obama’s economic team?