Toxic Assets Plan: a Good Buy, or a Good Diversion?

Treasury Secretary Timothy Geithner has just unveiled his new plan for a public-private partnership to buy up “toxic assets”. The government will provide a small amount of upfront money and a price floor guarantee to encourage hedge funds and other investors to buy up troubled assets. While economists debate if Geithner's new plan will work, an equally important debate is whether Obama and Geithner even believe it will work. I call these two possible views of the administration the optimistic and pessimistic strategy.

It is impossible even for economists and industry leaders (let alone pundits) to properly judge the new Geithner plan. Geithner has vastly unequaled access to important data. He has been able to examine the banks' balance sheets, talk with potential buyers, and he knows what government policy changes are likely to be in the future. While his plan may seem misguided now, it may be a very good investment because Geithner knows there will be a new trillion dollar stimulus bill, big change in money supply, or a massive home owner tax cut.

Given what limited information the public has to judge this plan with, it is impossible to know how much stock the Obama administration puts in this plan working.

The administration may take the “optimistic strategy,” anticipating their plan will work. There will need to be some changes around the edges, and it will be months before the economy turns around, but for the most part, the plan is over. There will be no more need to focus so strongly on the banking sector, and Obama will be able to move on to his real agenda.

The “pessimistic strategy” is the idea that the administration expects this current plan to fail partly or fully. In that case, this is only a band aid plan. It serves two main functions. Obama may know that he will need to nationalize some of the big banks and does not have (or want to use) the political capital to do it now. After this plan fails, he will be able to go Congress and the American people claiming that he has literally tried everything else, and temporary receivership is the only option left.

The other purpose of a band aid plan would be to ease the passage of both his budget and health care reform. It may not be coincidence that the new toxic assist plan was unveiled right before the budget comes up for debate. Many fiscal conservatives are freaking out over the size of Obama's $3.6 trillion dollar budget, but $750 billion of that is money set aside for another potential bank bailout. If after unveiling this new plan the administration can claim it will not need all of the extra $750 billion, his budget drops from $3.6 trillion to $2.9 trillion. Overnight without cutting any programs, Obama's budget would become 20% smaller and would complete null and void the CBO deficit projections. The amount that is going to be set aside just for this year for another round of bank bail outs is roughly equal to the amount of new money need for health care reform over the next decade.

Wall Street No Longer Believes in Capitalism

It is amazing to see that Wall Street is so willing to throw ideals of capitalism under the bus. We are being told that the problem with the current financial sector is that there is about a $1-3 trillion worth of "toxic assets" on their books. But "toxic assets" is only a fancy propaganda way of saying bad investments. The toxic assets are simply assets that the banks paid too much money for and now can't sell for a good price.

The foundation of capitalism was summed up by Adam Smith as "Everything is worth what its purchasers will pay for it". Yet America is being told to now ignore that principal. The market is willing to purchase these "toxic assets" at about 25 cents on the dollar. By definition that is their true value. The banks don't want to sell their "toxic assets," not because they honestly think they are worth more than 25 cents on the dollar because if they did, they would be forced to acknowledge that they are bankrupt.

The banks want us to ignore the principles of capitalism now that they are no longer working to their advantage. Their hope is that the government will allow itself to be ripped off by purchasing the "toxic assets" for more than they are worth (by the definition of free market economics: what the market is willing to pay for them). Or by insuring a pricing floor individuals willing to purchase the "toxic assets." People who buy the "toxic assets" would make a profit if the assets gained value, and the government would pay them if they lost value. This would only perpetuate the tails-you-win, heads-we-lose mentality which ruined the market.

The simple problem with the major banks is that they are already bankrupt, but neither the banks, Wall Street, Barack Obama, or Tim Geithner want to admit it. Any plan put forward to deal with the "toxic assets" without taking over the banks involves the American tax payers absorbing their trillions of dollars in losses for them. There is no such thing as a "toxic asset," only a bad investment. The banks made plenty on them, and now they want the government to buy them at twice their real value.