Sachs on the Geithner-Summers banking plan.

This is another critique of the Geithner bank bailout plan that shows again how taxpayers are buying into a raw deal while the bankers will be making a great deal of money. No wonder financial stocks have been rising the last few days!


http://www.huffingtonpost.com/jeffrey-sachs/the-geithner-summers-plan_b_183499.htmlTwo weeks ago, I posted an article showing how the Geithner-Summers bankingplan could potentially and unnecessarily transfer hundreds of billions ofdollars of wealth from taxpayers to banks. The same basic arithmetic waslater described by Joseph Stiglitz in the *New YorkTimes*<http://www.nytimes.com/2009/04/01/opinion/01stiglitz.html?scp=2&sq=stiglitz&st=cse>(April1) and by PeytonYoung in the *FinancialTimes*<http://www.ft.com/cms/s/3e985de0-1ee7-11de-a748-00144feabdc0,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F3e985de0-1ee7-11de-a748-00144feabdc0.html&_i_referer=http%3A%2F%2Fsearch.ft.com%2Fsearch%3FqueryText%3Dpeyton%2Byoung%26x%3D0%26y%3D0%26aje%3Dtrue%26dse%3D%26dsz%3D>(April1). In fact, the situation is even potentially more disastrous thanwe wrote. Insiders can easily game the system created by Geithner andSummers 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 $1million, but with zero probability of any payout and therefore with a zeromarket 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-PrivateInvestment Fund (CPPIF) under the Geithner-Summers plan. The CPPIF will bidthe full face value of $1 million for the worthless asset, because it canborrow $850K from the FDIC, and get $75K from the Treasury, to make thepurchase! Citibank will only have to put in $75K of the total.Citibank thereby receives $1 million for the worthless asset, while theCPPIF ends up with an utterly worthless asset against $850K in debt to theFDIC. The CPPIF therefore quietly declares bankruptcy, while Citibank walksaway with a cool $1 million. Citibank's net profit on the transaction is$925K (remember that the bank invested $75K in the CPPIF) and the taxpayerslose $925K. Since the total of toxic assets in the banking system exceeds $1trillion, and perhaps reaches $2-3 trillion, the amount of potential rip-offin the Geithner-Summers plan is unconscionably large.The earlier criticisms of the Geithner-Summers plan showed that even outsidebidders generally have the incentive to bid far too much for the toxicassets, since they too get a free ride from the government loans. But oncewe acknowledge the insider-bidding route, the potential to game the plan atthe cost of the taxpayers becomes extraordinary. And the gaming of thesystem 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, buyingassets of other banks which in turn buy Citi's assets. Or other stakeholdersin Citi, such as groups of bondholders and shareholders, could do the same.Several news stories suggest some grounding for these fears. Both *BusinessWeek* and the *Financial Times* report that the banks themselves might beinvited to bid for the toxic assets, which would seem to set up just thescam outline above. What is incredible is that lack of the most minimaltransparency so far about the rules, risks, and procedures of thistrillion-dollar plan. Also incredible is the apparent lack of any oversightby Congress, reinforcing the sense that the fix is in or that at best we areall sitting ducks.The sad part of all this is that there are now several much better ideascirculating among experts, but none of these seems to get the time of dayfrom the Treasury. The best ideas are forms of corporate reorganization, inwhich a bank weighed down with toxic assets is divided into two banks -- a"good bank" and a "bad bank" <http://voxeu.org/index.php?q=node/3320> --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 betterthan is now feared, the bondholders get repaid and the current bank shareskeep their value. If the bad assets in fact default heavily as is nowexpected, the bondholders and shareholders lose their investments. The keypoint of the good bank -- bad bank plans is an orderly process to restorehealthy banking functions (in the good bank) while divvying up the losses ina fair way among the banks' existing claimants. The taxpayer is not neededfor that, except to cover the insured part of the banks' existingliabilities, specifically the banks' deposits and perhaps other short-termliabilities that are key to financial market liquidity.Cynics believe that the Geithner-Summers Plan is exactly what it seems: anaked grab of taxpayer money for Wall Street interests. Geithner and Summersargue that it's the least bad approach to a messy situation, in which weneed to restore banking functions but don't have any perfect ways to dothat. If they are serious about their justification, let them come forwardto confront their critics and to explain to the American people why theother proposals are not being pursued.Let them explain the hidden and not-so-hidden risks to the American taxpayerof the plan that they have put forward. Let them explain why they are sointent on saving the banks' bondholders, even the long-term unsecuredcreditors who clearly knew they were taking market risks in buying Citibankbonds. Let them work with their critics to fashion a less risky and lesscostly plan. So far Geithner and Summers tell us that their plan is the onlyoption, but without a word of further explanation as to why.___________________________________