Here are the details of Geithner’s plan.
If the intentions of the plan are laudable – restore some level of confidence, and activity, in the credit markets by using government’s guaranty as a trigger – and the instruments appropriate (attracting private capital should ensure better efficiency of the funds disbursed), the diagnosis itself is questionable.
“[..] The excessive discounts embedded in some legacy asset prices are now straining the capital of U.S. financial institutions, limiting their ability to lend and increasing the cost of credit throughout the financial system. The lack of clarity about the value of these legacy assets has also made it difficult for some financial institutions to raise new private capital on their own.”
To talk about a “lack of clarity” about the value of legacy assets right after stating that “excessive discounts” are embedded therein clearly indicates that Tim Geithner believes this is a crisis of confidence more than one that is triggered by the invisible hand of a market that rediscovers the unescapable law of gravity.
Let’s face it, most banks, including the biggest, are overloaded with junk. Starting from the assumption that former AAA-rated assets (in the old economy, ie 2 years ago) still deserve an A or AA rating in the current economy seems really like a wild bet, on which the government is prepared to go all in.
If the plan works, the deflationary pressure coming from falling asset prices and destruction of wealth will lose steam, and we will be left with the inflationary pressure coming from the intense money creation that is currently taking place (and will have to continue for quite some time). This could lead to further devaluation of the US dollar, and create upward pressure on interest rates. In an economy where depressed investors and consumers alike have been paying a heavy price to learn that markets always end up adjusting back to fundamental values, the likely outcome is stagflation.
If it does not work, we will be back to square one, and, considering the pace of money infusion into banks, insurance and car companies, probably lighter of a few trillion dollars by then.
The question is: is there any better alternative? Some like Paul Krugman advocate a swedish-style nationalization of the banking system, others believe that the government should stay on the fringes in a pure regulatory role and let the market forces find the bottom themselves, whatever the short-term cost is.
It is really tough to form an opinion when nobel-prize economists can’t seem to agree on anything. Current market volatility is just a reflection of this fact. The current rally in the equity markets does not matter, really. Until at least some form of consensus emerges in the form of a long flat, our approach will remain the same: prudence.
Filed under: Economy, Markets, Credit Markets, Economy, Equity Markets, Public-Private Investment Program, Treasury
