Geithner's plan to save the banks...

In order to help everyone cut through all the nonsense being spouted about financial bailouts and Geithner's plan, here's the basic concept of what the government is trying to do. I've tried to keep in as non-technical as possible, but there is some accounting lingo, because you can't get away from it in banking. I've also provided, below my quick op-ed, the link to the treasury documents and a thorough op-ed by Dean Baker of the Center for Economic and Policy Research. Baker is a lefty economist, similar to Stiglitz and Krugman, but this particular article provides very solid analysis of the pitfalls of Geithner's approach.

Essentially, to fix the financial system, the government had three broad options:

(1) Sit back and do basically nothing, while encouraging the Fed to keep interests rates low. Allow "zombie" banks (those in the red) to borrow money from the Fed at 0 or 0.25%, invest that money in stable assets (e.g. 90-day treasury bonds) and use the spread on those bonds to gradually pay the losses on bad loans. This is the worst option for the economy, and similar to what Japan did in the 1990s. Under that approach, it could take a decade for the banks to recover, prologing the recession and keeping credit tight. People would still suffer, but they couldn't easily point a finger at the government, because they wouldn't have an obvious policy with big numbers to blame. Besides, the zombie banks are still being subsidized at the expense of those wanting to save in the economy (because of low interest rates), its just a blanket subsidy that those without economics/finance background won't notice.

(2) Temporarily nationalize the banks, inspect their books, and forcibly divest them of all the toxic assets. This approach would require the government to somehow value the assets - either by using the current market value (currently about 30 cents on the dollar), or some other method. Stiglitz, Baker, Krugman, and other left-of-center economists prefer this approach, and would like the valuation to be close to the reduced market price, to minimize the potential subsidies to the bank. Sweden used this approach in it's banking crisis, and had good success with it.
--- The upside: This approach also functions as a stress test, telling the government which banks are merely illiquid (don't have enough short-term cash to cover their debt) versus those that are insolvent (have more debt than assets, period). Given the government control of the banks, they could leave the illiquid ones alone, after removing the bad assets, but could use the nationalization to break up the insolvent banks - allowing the risky divisions (e.g. those focused on home lending) to go under, while keeping the profitable divisions as seperate companies. This also reduces the problem of banks that are "too big to fail." Also, if it turns out that the market is underpricing assets (possible, in the current panic), and the government pays less than they're worth, later on the road we make a profit (this has happened before, when the US bailed out Mexico in the mid-90s).
--- The downside: This arguably takes much more up-front government money, because they directly purchase the asset - which makes it a hard sell. Also, if the assets lose value, the government takes a loss (though this can happen under Geithner's plan, too). Lastly, the government might be under pressue from the bankers to overvalue the assets when they buy them - particularly because the public has no idea what they're worth.

(3) Some form of hybrid public-private approach, where the government entices private investors to purchase the bad assets, to remove them from the bank's balance sheets. Essentially, under Geithner's plan, the government creates a restricted market for these assets, by guarenteeing a loan to private investors. So, an investor will put 15% down, borrow the remaining 85% from the government at a low rate, and buy the asset. Also, the investor wouldn't have to pay back the government for the loan, if the asset went bad - so the only loss they would take is their initial investment of 15% of the asset price.
--- The upside: This approach takes less money down. Also, it harnesses the market to do the pricing for the government, requiring less staff time and (again, arguably) potential for screw-up by the government officials. It also (arguably) minimizes the potential losses on the part of the government, because they are simply providing a loan.
--- The downside: The biggest problem is that this "market" is distorted, because the government is subsidizing the purchase of the assets. Investors will be more willing to take risks, overpricing the assets of the banks, and leaving the government to pick up the tab. The higher price asset means that the government may end up spending as much or more money than it would in a simple nationalization plan. Also, the government is not as likely to make money on this plan, because they are loaning investors money at a low fixed rate, in order to buy mortgages that are likely to default. That low rate is likely much less than the potential value of the bad asset if it eventually pays off. After all, why take out a loan if you (the investor) won't profit on the deal? Lastly, the government doesn't have control over the individual banks, however temporarily, so we are likely to be left with the current "megabanks" who - in the event of another bubble - will put us through all of this again.

Hopefully that wasn't too confusing. In any case...

Here are the actual documents distributed by Treasury: http://financialstability.gov/

Here is an interesting op-ed analyzing the potential downfalls of this approach: http://www.guardian.co.uk/commentisfree/cifamerica/2009/mar/23/timothy-geithner-toxic-asset-plan

Spitzer as Columnist

Just a quick one here - Eliot Spitzer is apparently an excellent columnist, despite his personal problems. For some excellent commentary on the current economic crisis, problems facing governors, AIG, and the stimulus package, see the link below.

http://www.slate.com/?id=3944&qp=49481

Indian attacks in Context

For those looking to really get a glance at the root causes behind the recent Mumbai attacks, and previous incidents, I would suggest this op-ed from the Globe and Mail.

It does an excellent job of putting the attacks in the broader context of Hindu-Muslim tensions - with dual flashpoints in Hindu nationalist extremism and Muslim instigators in Kashmir. However, it also adds the extra step reminding people that this is a pluralist, mostly peaceful democracy. Indeed, the pluralism is such that it is mind-boggling to most Americans.

One excellent quote, which provides the important context to keep in mind amidst the sensationalism of the media:

From this, you may believe that India has been overtaken by sectarian divisions and religious polarization. That also would be wrong.

This is, after all, a country whose people, 80 per cent of whom are Hindu, have overwhelmingly elected a government with a Prime Minister who is Sikh, a President who is Muslim and a governing party led by a Roman Catholic woman.

Most Hindus have no interest in the politics of religious nationalism. And most of India's 150 million Muslims have nothing to do with Islamic politics – they're the Muslims who rejected Pakistan, an Islamic state, during the Partition of 1947.

India has the honor of being, by far, the world's largest democracy - and has been a stable one for sixty years. This is not a country on the verge of collapse or instability from terrorist attacks. Indeed, relative to some of the disruptions from mass protests India has seen, this attack is a minor "flash in the pan." Small comfort to the victims, but true nonetheless. No government, no matter how stable and prosperous, can prevent all misfortune. India's stability, despite the persistent poverty of millions, is a testament to how (broadly) tolerant and accustomed to plurality its citizens are. Indeed, the best step we can take in preventing instability is to is to remove the poverty itself. After all, it is poverty that often breeds a bitter mindset and enables people to look for someone to blame.

Thus, I will end with another quote, this time from Suketu Mehta's recent op-ed in the NY Times:

But the best answer to the terrorists is to dream bigger, make even more money, and visit Mumbai more than ever. Dream of making a good home for all Mumbaikars, not just the denizens of $500-a-night hotel rooms. Dream not just of Bollywood stars like Aishwarya Rai or Shah Rukh Khan, but of clean running water, humane mass transit, better toilets, a responsive government. Make a killing not in God’s name but in the stock market, and then turn up the forbidden music and dance; work hard and party harder.

Good Op-eds on Economic Policy & My Take

There have been quite a few excellent op-eds on economic policy over the past few days, due in large part to Obama announcing his economic team.

Paul Krugman on financial crises and the need for regulation: Lest We Forget

David Brooks on forcing stimulus to have a long-term strategy: Stimulus for Skeptics

Dean Baker on the selection of the current economic team: Geithner at Treasury: Can He Learn?

For a bit more innuendo on why this economic team might be suspect, see this article in the Washington Post: Familiar Trio at Heart of Citi Bailout

My Take:
On the one hand, I am somewhat heartened to see that Obama seems to have something of a long-term strategy attached to stimulus - green technology, infrastructure, and patching the holes in the safety net. I will note one caveat there - he has also mentioned "aid to local and state governments" but has not mentioned what the aid would be used for. Might I suggest local public transit initiatives as an excellent option? Connected with a real rail infrastrucure (at least in California and East of the Missisippi), a good network of local public transit would do a lot to solving energy problems and building integrated markets. There are still a number of major cities that lack a real metro system, for instance (Philidelphia is but one example).

On the other hand, I am worried that Obama has been so cautious in his selection of his economic policy team. I expected to see a few old hands in top policy positions - particularly Geithner. But I was also hoping to see Obama do a little reaching out to the left - the source of his core support. In fact, his economic team is arguable more conservative than Bill Clinton's - after all, Clinton had Joeseph Stiglitz has his chairman of the Council of Economic Advisors. Christina Roemer is a solid choice, giver her expertise on the Depression, but having all of the other top positions held by centrist figures (Summers, Voelcker, Geithner, and Goolsbee) makes one wonder exactly how much debate there will be on economic policy.

Furthermore, all of these gentlemen (excepting Goolsbee), have had a hand in serious policy blunders. Summers is well-known for his part in the deregulation leading to this crisis - he was Treasury Secretary when the bank holding provisions of Glass-Steagall were repealed, and when the SEC avoided regulating credit default swaps (at the behest of Hank Paulson when he was at Goldman Sachs, among others). Voelcker spearheaded the end of stagflation, but he did so by strangling the US economy and raising interest rates to ridiculous levels. In doing so, he also sparked the debt crisis in the developing world, known as the "Lost Decade" in Latin America.

Geithner, on the other hand, was a member of the team that ensured IMF austerity conditions would be attached to loans in the 1997-8 Asian crisis. In essence, he forced countries facing an outflow of investment capital to spend less on their economies and to raise their interest rates... and these were countries that had balanced their budgets for years (unlike the US). These policies are known as "pro-cyclical" in economics jargon, and they have the effect of exacerbating a pre-existing crisis. In fact, the country that recovered most quickly from the crisis was Malaysia, who ignored IMF advice and imposed controls on capital flight, cut interest rates, and increased spending. This is exactly the opposite of what the US is doing now, and the exact opposite of what economists recommend should be done in a crisis.

Whether these gentlemen have learned from the past twenty years of supposed "consensus" that led to this fiasco remains to be seen. Until I see proof that they have, however, I worry that any response to the current crisis will be luke-warm - too small and too short-term. That was the mistake FDR made in the Depression, and if we learn from history, we should not make the same mistake again.

Two worries about Obama

Given the amount that we have heard about "change" coming to Washington in the Obama administration, let me mention that for all my support for some of the President-Elect's new policies (e.g. renewable energy, infrastructure spending, and health care), and guarded optimism about others (e.g. higher education finance reform), I still have worries about his willingness to tackle the biggest issues in national politics - the two "complexes" that constrain policy the most. They are (1) the "military-industrial complex" (term coined by President Eisenhower) and (2) the "Wall Street-Treasury complex" (term coined by centrist Columbia Economist Jagdish Bhagwati).

Military-Industrial Complex:

To really understand this issue, let me refer you to three sources. The first is a recent article in The Nation that is an excellent primer on the problem. This article identifies two central concerns and challenges related to our military spending.

The first is simple and straightforward: we should not be spending money on weapons systems adapted to an outmoded geopolitical situation - namely the Cold War. Big culprits include the F-22 Raptor, the Ballistic Missle Defense System, and arguably most of the US nuclear arsenal. An excellent line-by-line report identifying key programs to be targeted for reduction was done by Foreign Policy in Focus, and is entitled "A Unified Security Budget for the United States, FY2009."

The second issue is more fundamental and concerns the position of the US in the world. We have, since WWII, become accustomed to using our military to project influence into the world. Part, though not all, of this is related to energy politics (one of the many reasons for renewable energy). Overall, we have over 700 bases and outposts stationed in foreign countries. Perhaps the most comprehensive coverage of this issue has been done by esteemed political scientist Chalmers Johnson, emeritus at UC San Diego. For a list of some of his fairly regular op-eds, see this page at AlterNet. More importantly, see the trilogy he wrote on US intelligence, military, and the potential decline of the American Republic - including parallels to Rome and Britain. The books can be found on Amazon, and are titled: Blowback, The Sorrows of Empire, and Nemesis.

As the article in The Nation mentions, Obama has signaled that he wants a shift out of Iraq and into Afghanistan, but he hasn't signaled that he is willing to take on the Pentagon's ever increasing budget requests or its unwillingness to phase out old programs - to say nothing of whether we should take a fundamental look at where we have bases and why. I voted for Obama because I think he understands that we're looking at a multipolar world. Unfortunately, I don't have any indication that he's willing to take on the established old guard at the Pentagon. Toning down our militarism is the central component to finding a new place in the world. We need to remove our "big brother" and "world policeman" mentality and return to a simple concern with our own national security. Besides, the only thing that will force more military responsibility on other countries is if we don't have the resources to do it all for them.

The Wall Street-Treasury Complex:

My problem here is much simpler - Obama's economic team is populated by old-guard economists, many of whom contributed to the rise of the "Washington Consensus" and the deregulation of financial markets that got us into this mess. When your house falls down, do you hire the same contractor who built it in the first place? I take a little hope that the Treasury Secretary is Tim Geithner, and having a respected hand there is important, but I would be much happier if the economic policy posts weren't completely filled with Robert Rubin's protégés. Rather than complaining about it too much myself, let me suggest two good sources. The first is this article from the NYTimes, and the second is this op-ed by Dean Baker at CEPR.

In short, it remains to be seen if change is really coming to Washington. Old habits die hard, and people are often loathe to unlearn ideas they formed over decades-long careers. Who will Obama listen to, and how will he synthesize their opinions? Is there enough diversity to ensure a proper balance? All of his advisors are bright, well-educated, and experienced - but it remains to be seen if they are stuck in their ways.