Appropriate Criticism on Obama’s Emergency Plan

Economists in the U.S. are very critical of the emergency plan that President Obama has issued to get the American banking sector out of trouble. But it still denies the most fundamental problem.

The American Minister of Finance, Timothy Geithner, announced a new plan on Monday afternoon, March 23rd, that is aimed at reviving the American banking sector.

It has become the centerpiece of President Obama’s policy to make banks healthy again and especially to get them to lend money once more. But prominent economists have already cut down the plan – and rightly so.

Private parties

Geithner wants to lend a total of $500 billion to private parties who buy toxic credits of banks with that money. Those are credits that have, for example, houses as guarantees, which have significantly dropped in value lately.

In the plan, the government will bring in $75 to $100 billion in tax money. The private parties pitch in the rest, up to $500 billion dollars. With this plan, Geithner and Obama hope to kill three birds with one stone.

First, they hope the insecurity about the banks will disappear in the financial market. The bad credits have been cut out of the banks and this will hopefully assure a rebuilding of trust in the banking system.

Second, the banks will get money from private investors with which those banks fill up their cash reserves. So they are able to recapitalize and lend that money to ailing companies, which is good for the economy.

Third, those private investors will give a value to those bad credits as they offer a price for them. By doing so, a price floor is created for exactly those toxic credits, whose insecurity about the value stood at the base of the credit crisis.

For the loan-issuing government, the risks are small, states Geithner, because in the end the investors will have to pay back the borrowed money with interest.

Strong criticism

It sounds perfect. But eminent economists like Paul Krugman are very negative about the plan. They rightly so state that there are too many pitfalls in the plan, which will make it a very expensive failure.

For example, a less highlighted part of the plan is that if an investor buys a package of bad credits, but incurs a loss on that package when he sells it again, he does not have to pay back the government loan.

Less risks

The risks for the investor then become very small while he can take off with a fair deal of taxpayer money. And the chance that such a resale actually fails is huge; the fact that one investor assigns a value of $100 to that package of loans does not mean that potential buyers agree with that value.

Then, you have only spread the problem because the toxic credits have been replaced by even more players in the financial market. They are stuck with them, just like the affected banks are now. Not an attractive foresight.

Because of all this, the government takes up a large part of the burdens of the bad credits without one single guarantee that the problems will be solved. It all remains too dependent on the value determination of the toxic credits in the free market.

Problem

The political supervision of the new plan lies mainly with the White House. Geithner has set up his plan in such a way that permission from Congress is not needed for decisions that are taken within the scope of the plan.

That has one advantage: it takes significantly less time to make important decisions. But it also has a big disadvantage: if a large share of the population does not agree with, for example, a proposition about bonuses, Geithner can still push it through.

Obama = Bush?

After President Bush, who mainly had ex-bankers at the top, President Obama is now accused of listening too much to the bankers on Wall Street. Influential columnists and commentators, who are normally big fans of Obama, point out that he has also surrounded himself with ex-bankers from the same circles as Bush’s people.

Timothy Geithner himself was director of the bank of the state of New York and has many bankers among his friends. For a long time, Larry Summers was one of his mentors under President Clinton. Summers is the president of the National Economic Council under President Obama.

It’s been said that Summers is good buddies with the top guys at Citigroup. He’s also thought to have urged for the possibility of issuing bonuses to managers of banks that are being held upright by tax money.

Because of this criticism interweaving with Wall Street, Obama continues to agree with the more unorthodox solutions that are ultimately good for the American economy, but bad for bankers’ bank accounts in the short term.

Nationalize

The most conspicuous ‘unorthodox’ solution would be, according to economists and financial experts, the (temporary) nationalization of American banks that suffer from toxic credits, such as subprime mortgages.

A bank gets sold, the government conducts ‘stress tests’ on all outstanding credits to see which ones are good and which ones are bad, and it puts the good credits back on the balance of the bank.

The bad credits go to a ‘bad bank’ that has been established especially for that goal. Next, the management of that bank goes to work to make those bad credits solvent again, while the cured nationalized bank is privatized again.

Simultaneously, banks are faced with new financial legislation and starkly improved supervision that has to make it more difficult to take large risks with other people’s money.

Politically charged

But ‘nationalization’ is for many Americans a dirty word. Especially on the right side of the political spectrum, it is put on the same level with ‘socialism,’ which for Americans is completely indigestible – even though one has nothing do to with the other.

That political aversion against nationalization is so big that Obama won’t take the risk easily. This is despite the fact that later it will most likely turn out that $500 billion has been thrown about, of which it is not clear what has happened with it or what have been the effects of it.