The Geithner plan: collective delusion as economic policy

Treasury Secretary Timothy Geithner backs so-called âÄúlegacy assetsâÄù for up to $1 trillion with a plan aiming to jolt credit markets into motion by passing troubled subprime mortgages and derivative financial securities from banksâÄô balance sheets to the taxpayers. But with the very same goal, previous Treasury Secretary Henry PaulsonâÄôs initial $700 billion in TARP funds sits cold in banksâÄô coffers. How much debt will America take on to revive its indebted, delusional financial network? Each American is already responsible for $116,000 of federal debt, MSNBC recently reported. Treasury Secretary Geithner laid out the plan Monday, which would allow the Federal Deposit Insurance Corporation to price qualifying junk mortgages at a debt-to-equity ratio no greater than 6-to-1, then sell half the equity to private investors bidding for contracts. Geithner repeatedly claims no subsidy is involved as if the plan merely locates toxic assetsâÄô market price. But to do so, the FDIC will finance up to 84 percent of the âÄúprivate-publicâÄù asset sale with default protection in the case of downturn. While officials boast the public would share investment with bid-winners, the proportion of liability held publicly under the plan could be higher than 10 to1. Private investors are playing a game of âÄúheads I win, tails you loseâÄù with the publicâÄôs money. Wall Street adores incentivized inflation, especially the mode of real estate and mortgage derivatives. A misunderstanding of cause and effect has the Treasury fighting fire with fire. Trillions of dollars are being burned. Geithner does not fail to perceive that a housing downturn occurred before any credit crunch. A recent policy fact sheet from the Treasury reads: âÄúOrigins of the Problem: The challenge posed by these legacy assets began with an initial shock due to the bursting of the housing bubble in 2007âĦâÄù But from the point of action, Geithner approaches the economy as if the problem were merely a bank run, spurred by mutual panic. A strong ally of the administration up to this point, economist Paul Krugman, said as much of the Geithner plan: âÄúThe Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system âÄì that what we’re facing is the equivalent of a run on an essentially sound bank.âÄù Indeed, Geithner turns ignorantly away from the fact that there was reason for panic: banksâÄô balance sheets are as red as the hands of Bernie Madoff because in staggering proportion their equity or value consisted of subprime mortgages and their treacherous financial derivatives. GeithnerâÄôs economic history is accurate.

Image courtesy of JD Crowe

But ironically, his policy is premised upon the very ignorance of it. Accordingly, the fundamental problem is not that capital markets tend to convert loose, subprime money into risky derivation, or that the assets our economy incorporated were ridiculously inflated. The treasury secretary concerns himself merely with a shortage of liquidity: the symptom. To patch the symptom, Geithner would convert capital markets into one federal subprime delusion and ignore the disease: inflated economic reliance upon the practices of leveraging, conjuring from a single dollar a geometrically fragmenting network of illusory wealth, mistaking liabilities for assets, bundling them up, rating them, dividing gains but keeping risk and chumming up to falsely legitimizing insurers; in short, the plan is a belief in the mentality that âÄúprices never fallâÄù or more frighteningly, âÄúif we all must fail together, no one will fail.âÄù This delusional mantra is moral hazard, and it has a price beyond its bureaucratic management. When the government applies the fallacy, national debt soars and the dollar plummets: inflation. The to-big-to-fail rationalization that justified investors to take on unfathomable risk is now the rhetoric of the president and treasury secretary. Such a mantra will âÄúlay the foundations for economic recovery,âÄù Geithner claims. Actually, it works toward longer or larger economic contraction. To put the crisis in context, peer back before Bear Stearns was bailed out in March 2008. Analysts had lowered investment banks rankings as home prices dropped. They knew a drop in home prices brought subprime mortgages, too. As defaulted mortgagers quit paying interest on their mortgages, the sheen of a lucrative bubble began to fade. Analysts did not create the bubble burst, they merely pointed it out. The same mortgages and securities taxpayers buy under the Geithner plan were discovered to be overvalued because they could not weather a downturn in real estate prices. Geithner assumes these now foundational legacy assets are sound, even after their instability prompted the largest economic upheaval in decades. Bear Stearns, Merril Lynch, Lehman Brothers and others involved in the subprime mortgage market like insurer AIG had not begun to lose solvency nor banks their willingness to lend until the real estate market came to its sense of reality. But Geithner thinks our current condition is a product of banksâÄô fear to lend. The voluntary hesitation of banks to buy one anotherâÄôs âÄúlegacy assetsâÄù represents the sobering admission of unsustainable practice. The economy has just fallen violently off a bike. Geithner says get up, brush off, and ride full- speed-ahead off a cliff. In practice itâÄôs much easier to avoid cliffs if one simply heads the other way. Krugman and Ron Paul deem the plan a recipe for a lost decade like JapanâÄôs, where recession became exacerbated as government kept unsustainable, zombie banks open at taxpayer expense. âÄúThe Japanese experience of holding large losses as opposed to taking a hit and moving on was a direct cause of the Japanese malaise,âÄù said Graham Fischer & Co. analyst Josh Rosner. Instead of coughing of taxpayer cash, Geithner should signal the banks that theyâÄôll be held accountable for their mistakes, not from here on out, but this time. Politicians and officials must renew faith in the utility of contraction, in spite of obvious political liability. Allowing bankruptcies âÄî inefficient, wealth-destroying agents âÄî to fail is a necessary part of economic harmony. The policy of stimulate, re-inflate must be abandoned. If not, ever sooner down the road will we be ever more violently reminded of the unsustainable nature of the too-big-to-fail mentality. By definition, if any organization is too big to fail, its subject is bound to offer ever larger sacrifice until all significant doubt of its success is erased. Surely we cannot erase history. Surely we must admit a bubble has burst. The best âÄúfoundation for economic recoveryâÄù is a humble admission that collective delusion cannot keep a popped bubble afloat indefinitely. Johnathan Brown is a member of the editorial board. Please send comments to [email protected]