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Bad Banks

Today’s big news is the unveiling of the “Public-Private Investment Program for Legacy Assets,” the Treasury Department’s latest attempt to address the national banking crisis.

While the merits of the plan and the effectiveness of its details will be debated, two facts must be kept squarely in mind.

First, the Treasury has adopted the banking industry’s view of the problem; namely, the assets owned by banks are fundamentally sound and are simply undervalued by jittery investors. If confidence returns and investing resumes, all will be well. However, if the real problem is that the bank’s assets are essentially worthless, then the banks are insolvent and the plan won’t change that.

Second, the plan will transfer public resources directly to the banking sector and investors. The partnership model that stands at the center of the proposal commits the public to provide most of the resources (equity and loans) needed to purchase troubled assets and backstop the losses of private investors. This might work, but to be clear, it is a subsidy that will allow private investors to gamble with public dollars. If the plan succeeds, private investors will walk away with huge gains (the public also would gain, though likely not as handsomely). If the plan fails, the investors can walk away and leave the bill with the taxpayers.

(For a nice description of this dynamic — a description that uses the idea of buying cars as a proxy for the idea of buying mortgage-based assets — see the blog Economist’s View.)

And what about all those commentators who inevitability point to today’s Wall Street rally as evidence of the plan’s wisdom? Notes economist Dean Baker:

Suppose [Treasury Secretary] Timothy Geithner announced a new program that would tax every family $10,000 dollars and give the money to Wall Street banks and hedge funds. (Any resemblance between this hypothetical program and real world programs is purely coincidental.)

We would expect the stock of Wall Street banks and other financial sector firms to rally based on the anticipation of higher profits. Is this good for the economy? It’s not in any obvious way. After all, we can always tax people more to raise profits for Wall Street, but that doesn’t help the economy.

3 Comments

  1. Bad Banks

    March 23, 2009 at 5:01 pm

    [...] Random Feed wrote an interesting post today onHere’s a quick excerptToday’s big news is the unveiling of the “Public-Private Investment Program for Legacy Assets,” the Treasury Department’s latest attempt to address the national banking crisis . While the merits of the plan and the effectiveness of its details will be debated, two facts must be kept squarely in mind. First, the Treasury has adopted the banking industry’s view of the problem; namely, the assets owned by banks are fundamentally sound and are simply undervalued by jittery investors. If conf [...]

  2. Louis

    March 24, 2009 at 7:02 am

    I know people who work for banks who choose to be members ofcredit unions

  3. [...] ink (and type) already has been devoted to the new “Public-Private Investment Program for Legacy [...]