Financial policy despair

By
Paul Krugman                                                                 Read Spanish Version

From
The New York Times

Over
the weekend The Times and other newspapers reported leaked details
about the Obama administration’s bank rescue plan, which is to be
officially released this week. If the reports are correct, Tim
Geithner, the Treasury secretary, has persuaded President Obama to
recycle Bush administration policy — specifically, the “cash for
trash” plan proposed, then abandoned, six months ago by
then-Treasury Secretary Henry Paulson.

This
is more than disappointing. In fact, it fills me with a sense of
despair.

After
all, we’ve just been through the firestorm over the A.I.G. bonuses,
during which administration officials claimed that they knew nothing,
couldn’t do anything, and anyway it was someone else’s fault.
Meanwhile, the administration has failed to quell the public’s
doubts about what banks are doing with taxpayer money.

And
now Mr. Obama has apparently settled on a financial plan that, in
essence, assumes that banks are fundamentally sound and that bankers
know what they’re doing.

It’s
as if the president were determined to confirm the growing perception
that he and his economic team are out of touch, that their economic
vision is clouded by excessively close ties to Wall Street. And by
the time Mr. Obama realizes that he needs to change course, his
political capital may be gone.

Let’s
talk for a moment about the economics of the situation.

Right
now, our economy is being dragged down by our dysfunctional financial
system, which has been crippled by huge losses on mortgage-backed
securities and other assets.

As
economic historians can tell you, this is an old story, not that
different from dozens of similar crises over the centuries. And
there’s a time-honored procedure for dealing with the aftermath of
widespread financial failure. It goes like this: the government
secures confidence in the system by guaranteeing many (though not
necessarily all) bank debts. At the same time, it takes temporary
control of truly insolvent banks, in order to clean up their books.

That’s
what Sweden did in the early 1990s. It’s also what we ourselves did
after the savings and loan debacle of the Reagan years. And there’s
no reason we can’t do the same thing now.

But
the Obama administration, like the Bush administration, apparently
wants an easier way out. The common element to the Paulson and
Geithner plans is the insistence that the bad assets on banks’
books are really worth much, much more than anyone is currently
willing to pay for them. In fact, their true value is so high that if
they were properly priced, banks wouldn’t be in trouble.

And
so the plan is to use taxpayer funds to drive the prices of bad
assets up to “fair” levels. Mr. Paulson proposed having the
government buy the assets directly. Mr. Geithner instead proposes a
complicated scheme in which the government lends money to private
investors, who then use the money to buy the stuff. The idea, says
Mr. Obama’s top economic adviser, is to use “the expertise of the
market” to set the value of toxic assets.

But
the Geithner scheme would offer a one-way bet: if asset values go up,
the investors profit, but if they go down, the investors can walk
away from their debt. So this isn’t really about letting markets
work. It’s just an indirect, disguised way to subsidize purchases
of bad assets.

The
likely cost to taxpayers aside, there’s something strange going on
here. By my count, this is the third time Obama administration
officials have floated a scheme that is essentially a rehash of the
Paulson plan, each time adding a new set of bells and whistles and
claiming that they’re doing something completely different. This is
starting to look obsessive.

But
the real problem with this plan is that it won’t work. Yes,
troubled assets may be somewhat undervalued. But the fact is that
financial executives literally bet their banks on the belief that
there was no housing bubble, and the related belief that
unprecedented levels of household debt were no problem. They lost
that bet. And no amount of financial hocus-pocus — for that is what
the Geithner plan amounts to — will change that fact.

You
might say, why not try the plan and see what happens? One answer is
that time is wasting: every month that we fail to come to grips with
the economic crisis another 600,000 jobs are lost.

Even
more important, however, is the way Mr. Obama is squandering his
credibility. If this plan fails — as it almost surely will — it’s
unlikely that he’ll be able to persuade Congress to come up with
more funds to do what he should have done in the first place.

All
is not lost: the public wants Mr. Obama to succeed, which means that
he can still rescue his bank rescue plan. But time is running out.

http://www.nytimes.com/2009/03/23/opinion/23krugman.html?_r=1