Geithner Answers His Critics: Putting Toxic Assets on Uncle Sam's Balance Sheet Would be Riskier
During his appearance today at the Council on Foreign Relations, Treasury Secretary Tim Geithner was asked the question on many progressives' minds: Why does the Obama administration's bank rescue plan seem to rely on "socializ[ing] risk but keep[ing] profits private?"
But Geithner seemed to sidestep the question at least in part by offering a explanation for why he decided against setting up a "bad bank" -- not directly addressing the option of nationalizaton or receivership. The full exchange is posted after the jump.
Q: [T]he real question, I think, is whether there are mechanisms that would allow, if taxpayers are going to take the risk, for them to enjoy all, not some, of the profits rather than a system in which you're trying to revive the markets on the taxpayers' back.GEITHNER: Understand your concern. But let me just be clear about this. To solve financial crises, governments have to be willing to take risk, because the definition of financial crises is the markets are not willing take risks that looks -- otherwise would be economic.
The central fact is that governments have to be prepared to take risks the markets can't take, for a temporary period of time, in order to get a firmer foundation for repair.
Of course, you want to do that in ways that doesn't have the government assuming all the losses in the system. And what makes these things hard to solve is because the world ultimately will want us to take more risk than we think is prudent for the taxpayer.
And the programs ... we're designing or pursuing are very cognizant of the risk you [described]. And again, just think about the alternatives that most people advocate in this kind of context.
The dominant alternatives people are proposing would have the government come in and purchase these assets on their own, hold them on the government's balance sheet, take all the risk in that choice.
And you know, this is a system that's much, much more complicated than what we went through in the '90s and what other major economies went through over the last couple decades.
And because of the basic complexity of these products, scale of these institutions, that, in our judgment, would pose much, much greater risk to the government that taxpayers are assuming greater share of losses than is necessary or prudent, and taking risks they cannot effectively manage.
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Isn't that only true if the government pays the inflated value that the financial institutions claim the assets are "really" worth?
If the government forced the institutions to value the assets on the books at their true market value, wouldn't that render the institutions insolvent? If the government took the insolvent firms into a recievership then the only "risk" that the government would face is the extent to which the government chooses to honor the firm's debts (to protect the financial system) above the value of the firm's assets.
March 25, 2009 12:06 PM | Reply | Permalink
And again, what does "true market value" mean?
Specifically, why is the market's current valuation of these assets treated as perfect, and, indeed, sacrosanct, by people who simultaneously insist that that same market's valuation was essentially insane this time last year? Is it not at least possible that the same market that massively overvalued them and massively underestimated the risk in a fit of irrational exuberance is now significantly, perhaps massively, undervaluing them and overestimating the risk in a fit of irrational pessimism?
So tell me, please, what makes the current market valuation perfect, such that it must be locked in forever through a program of nationalization and liquidation, when the people doing the valuing are the same ones who created the problem with valuations that the proponents of nationalization say were wildly imperfect.
I have yet to receive a cogent, convincing answer to that question from any proponent of nationalization. Krugman's resistance to even addressing the question with more than a sneering reference to "misunderstood" assets, in particular, undermines his credibilty on this question for me.
Instead, most of the answers I do get seem to boil down to "because the idea of launching a full-bore Hurricane Hugo on the capitalist scum appeals to me ideologically and emotionally and proclaiming the current market valuation of these assets to be perfect enables the argument for doing that." That's really not helping me gat past my fear that "doing what Sweden did" (whatever the hell that means in the context of our banking system) runs the risk of a financial market death spiral that will make the last five months look like a cakewalk.
March 25, 2009 12:36 PM | Reply | Permalink
I'd say that the market value is the true value because that's the amount the financial institution can actually get if they are forced to use that asset today to settle their debts. Any other value is sheer speculation.
Financial institutions which are healthy enough to cover their debts without relying on these assets aren't under discussion. No one is talking about bringing healthy financial institutions into receiverships. If those institutions want to hold on to the assets in hopes that they will ultimately yield more than their current market value, then by all means they should do so.
The institutions under discussion are the ones that need government assistance because they can't cover their debts. If the government denied that assistance, then the institutions would be forced to file for bankruptcy and the only funds available to their pay creditors would be those that the institutions could actually raise by selling their assets. That's the market value. I see no reason why creditors (including the institution's shareholders) should be entitled to one cent more in a receivership than they would get in a bankruptcy. The government might choose to pay more, in the interest of securing the financial system, but creditors aren't entitled to have the government make that choice.
March 25, 2009 1:34 PM | Reply | Permalink
Let's get our language a bit more precise.
The feds right now, today, only have legislative authority and an historic track record on failed banks (credit unions and savings & loan), not on every ramification a financial institution may have in today's world since our Congress critters got rid of separations, regulations and generally became free market ideologues some time ago and are now apparently afraid to admit to it.
AIG was an historic first since Bernanke and Paulson had the chutzpah to offer loans that AIG, on the eve of announcing their bankruptcy, had the good sense to agree to. AIG is a holding company with insurance subsidiaries (heavily regulated, BTW) and the lone ranger of AIGFP. There are zero banks in this company.
Economists are in agreement that preventing AIG from filing bankruptcy (which would mean court mandated and controlled bankruptcy without involvement by the feds) was a very, very good thing.
As I read this plan, it refers to banks only. For example, Citibank would be included and not Citigroup. If I recall correctly, all of the released data refers to banks. Krugman, in his interview with Charlie Rose earlier this week, also referred only to banks.
Do you know something I don't and that now the plan has extended to non-banks?
March 25, 2009 3:02 PM | Reply | Permalink
You are correct that a solution which involves taking non-bank financial into receiverships would require legislation. That's the legislation that the Obama Administration has recently proposed. The TARP bailout also required legislation, so I see no particular reason why we should limit our discussion to only solutions allowed under existing legislation.
March 25, 2009 3:16 PM | Reply | Permalink
I also think you're confusing balance sheet insolvency with cash flow insolvency. The two are not necessarily co-extensive. (When they are co-extensive, I think the technical term for that condition is "well and truly screwed," but that's what we have the FDIC for.)
March 25, 2009 3:50 PM | Reply | Permalink
If I understand the terms correctly, then I think I am talking about "cash flow" insolvency. I don't see how a supposed value that the institution enters on its balance sheet matters for squat if the institution can't raise the revenue it needs to meet its cash flow obligations. Only the market value matters for cash flow.
If by "balance sheet insolvency" you mean that the institution can't meet mininal capitalization requirements, then I suppose that I am talking about that as well. Unless I misunderstand, capitalization requirements are imposed to ensure that financial institutions can raise necessary revenues when needed. The market value represents the actual amount that institutions could raise from these assets if they need it.
March 25, 2009 4:14 PM | Reply | Permalink
Ok. I went back to my original comment, and I see why you wrote that I am confusing cash flow insolvency with balance sheet insolvency.
Let me try to clarify: I see both cash flow insolvency and balance sheet insolvency as relevant to the discussion. My understanding was that institutions holding these assets cash flow solvent and balance sheet solvent only so long as they can record these assets on their balance sheets at the values that the institutions believe they are worth. If the institutions were forced to write the assets down to their market values, then they would need to raise capital to meet minimum requirements. The need to raise capital would make them cash flow insolvent.
I believe that using the market value for the balance sheet is justified because capitalization requirements exist to ensure that institutions can meet their cash flow obligations, and the market value is the amount that institutions can raise from these assets to meet their cash flow obligations.
I also believe that requiring the institutions to write these assets down to their market value would make the institutions balance sheet insolvent. To my thinking, that means that the cost to the government for taking these institutions into a receivership should be minimal. The government ought to be required to reimburse the creditors (including shareholders) only to the extent that they would have been reimbursed if the institution were liquidated in bankruptcy. The government may choose to spend significantly more in order to protect the global financial system, but the government wouldn't be obligated to do so.
(Please correct me if my assumptions are wrong; I can't claim financial expertize.)
March 25, 2009 5:26 PM | Reply | Permalink
Nouriel Roubini now supports the Geithner Banking plan.
March 25, 2009 1:08 PM | Reply | Permalink
with major caveats and a lukewarm response, but yes, he supports it as a road to receivership.
March 25, 2009 1:16 PM | Reply | Permalink
Excellent!
How much will Krugman cost?
Is Krugman politically feasible?
Too emotionally overwrought to be reliable
March 25, 2009 1:10 PM | Reply | Permalink
I think what he's trying to say is that if the government buys it all up, not only do we have 100% of the remaining risks, but we'd have to buy everything. Whereas his plan results in some of the risk in the hands of the private buyer, (Though the purchase price being higher means probably more taxpayer money on the line depending on the numbers) and may only result in subsidizing the purchase of those securities that may be undervalued, or at least salvageable, (Assuming the buyers know what they're doing) instead of everything that the banks are holding.
...maybe.
March 25, 2009 3:39 PM | Reply | Permalink