[R-G] [BillTottenWeblog] The Geithner-Summers Plan

Sat May 16 17:59:30 MDT 2009

Even Worse Than We Thought

by Jeffrey Sachs, Huffington Post

AlterNet (April 08 2009)

Two weeks ago, I posted an article showing how the Geithner-Summers
banking plan could potentially and unnecessarily transfer hundreds of
billions of dollars of wealth from taxpayers to banks. The same basic
arithmetic was later described by Joseph Stiglitz in the New York Times
(April 1) and by Peyton Young in the Financial Times (April 1). In fact,
the situation is even potentially more disastrous than we wrote.
Insiders can easily game the system created by Geithner and Summers to
cost up to a trillion dollars or more to the taxpayers.

Here's how. Consider a toxic asset held by Citibank with a face value of
$1 million, but with zero probability of any payout and therefore with a
zero market value. An outside bidder would not pay anything for such an
asset. All of the previous articles consider the case of true outside
bidders.

Suppose, however, that Citibank itself sets up a Citibank Public-Private
Investment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will
bid the full face value of $1 million for the worthless asset, because
it can borrow $850,000 from the FDIC, and get $75,000 from the Treasury,
to make the purchase! Citibank will only have to put in $75,000 of the
total.

Citibank thereby receives $1 million for the worthless asset, while the
CPPIF ends up with an utterly worthless asset against $850.000 in debt
to the FDIC. The CPPIF therefore quietly declares bankruptcy, while
Citibank walks away with a cool $1 million. Citibank's net profit on the
transaction is $925,000 (remember that the bank invested $75,000 in the
CPPIF) and the taxpayers lose $925,000. Since the total of toxic assets
in the banking system exceeds $1 trillion, and perhaps reaches two to
three trillion dollars, the amount of potential rip-off in the
Geithner-Summers plan is unconscionably large.

The earlier criticisms of the Geithner-Summers plan showed that even
outside bidders generally have the incentive to bid far too much for the
toxic assets, since they too get a free ride from the government loans.
But once we acknowledge the insider-bidding route, the potential to game
the plan at the cost of the taxpayers becomes extraordinary. And the
gaming of the system doesn't have to be as crude as Citibank setting up
its own CPPIF. There are lots of ways that it can do this indirectly,
for example, buying assets of other banks which in turn buy Citi's
assets. Or other stakeholders in Citi, such as groups of bondholders and
shareholders, could do the same.

Several news stories suggest some grounding for these fears. Both
Business Week and the Financial Times report that the banks themselves
might be invited to bid for the toxic assets, which would seem to set up
just the scam outline above. What is incredible is that lack of the most
minimal transparency so far about the rules, risks, and procedures of
this trillion-dollar plan. Also incredible is the apparent lack of any
oversight by Congress, reinforcing the sense that the fix is in or that
at best we are all sitting ducks.

The sad part of all this is that there are now several much better ideas
circulating among experts, but none of these seems to get the time of
day from the Treasury. The best ideas are forms of corporate
reorganization, in which a bank weighed down with toxic assets is
divided into two banks - a "good bank" and a "bad bank" - with the bad
bank left holding the toxic assets and the long-term debts, while owning
the equity of the good bank. If the bad assets pay off better than is
now feared, the bondholders get repaid and the current bank shares keep
their value. If the bad assets in fact default heavily as is now
expected, the bondholders and shareholders lose their investments. The
key point of the good bank - bad bank plans is an orderly process to
restore healthy banking functions (in the good bank) while divvying up
the losses in a fair way among the banks' existing claimants. The
taxpayer is not needed for that, except to cover the insured part of the
banks' existing liabilities, specifically the banks' deposits and
perhaps other short-term liabilities that are key to financial market
liquidity.

Cynics believe that the Geithner-Summers Plan is exactly what it seems:
a naked grab of taxpayer money for Wall Street interests. Geithner and
Summers argue that it's the least bad approach to a messy situation, in
which we need to restore banking functions but don't have any perfect
ways to do that. If they are serious about their justification, let them
come forward to confront their critics and to explain to the American
people why the other proposals are not being pursued.

Let them explain the hidden and not-so-hidden risks to the American
taxpayer of the plan that they have put forward. Let them explain why
they are so intent on saving the banks' bondholders, even the long-term
unsecured creditors who clearly knew they were taking market risks in
buying Citibank bonds. Let them work with their critics to fashion a
less risky and less costly plan. So far Geithner and Summers tell us
that their plan is the only option, but without a word of further
explanation as to why.

http://www.alternet.org/story/135532/

TO POST A COMMENT, OR TO READ COMMENTS POSTED BY OTHERS, please click
on the word "comment" highlighted at the end of the version of this
essay posted at http://billtotten.blogspot.com/