No downside?

The perils of Obama’s new bailout plan

Written by The Indian Express | Published:March 26, 2009 11:41 pm

American Treasury Secretary Timothy Geithner has finally revealed what his government intends to do to fix the problem of fear about toxic assets,a fear that has frozen credit and imperils much of the world’s economic activity. It has done that in two ways: banks are scared that if they “write down”,or more reasonably value,their dangerous assets,they might appear near-insolvent or at best have to raise fresh capital; and no investor will buy those assets at the current,higher prices. How to get out of this problem?

Obama’s administration intends a “public-private investment plan”,whereby private investors put in a bit of money to a couple of funds,the government puts in a lot,and the funds buy toxic assets. The catch for taxpayers: the public money is “non-recourse” — in other words,the government is guaranteeing the downside: it will bear the brunt of losses,not the private investors.

The plan avoids the giant pitfalls of ex-treasury secretary Paulson’s plan,in which the government overpaid for the toxic assets. It doesn’t go all the way to the economically efficient (at least in the short term) thing,which is to align risk and reward correctly and thereby directly push banks towards lending,even if (horrors!) through what could be described by the paranoid as “temporary nationalisation”. What this plan does is to essentially provide investors with money to make investments that they then are guaranteed to make money on. Unsurprisingly,thus,professional investors love it. That’s a problem. Another: the plan’s structure means that all the assets will be valued higher than they

really are — which means that it doesn’t actually leach toxicity from the system,and whether taxpayers get any money back depends on exactly how risk-loving private

investors are. And,more to the point,surely any recovery plan that relies on a combination of (a) money managers correctly evaluating risk when their downsides are protected,(b) the government subsidising Wall Street profits,and (c) no discernible exit strategy if it goes wrong,should have been considered politically unsustainable. Barack Obama and his treasury secretary must either be very,very confident they’ve got it right — or very,very confused about what they can do.

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