Earlier this week, the editors gave Treasury Secretary Tim Geithner’s toxic-asset plan the thumbs-down: “This plan is unlikely to work, and even if it did, the cost to taxpayers would be unacceptably high.”
As I understand it, three scenarios could come out of the Geithner plan:
Scenario One: The value of the toxic assets isn’t too bad. The partnership between hedge funds, FDIC and Treasury’s matching funds buys the toxic assets from the banks. The banks get recapitalized, the investors profit a lot, FDIC and Treasury do okay. This is the happy ending. This is also a scenario that few economists are willing to bet on.
Scenario Two: The value of these toxic assets turns out to be way below what the banks were willing to sell them for even in the worst-case scenario. Henry Blodget lays out this scenario, and paints a picture of the banks finding that the assets they have are worth so much less than they were counting on that they fail the “stress tests” that Treasury is conducting. These banks effectively declare bankruptcy. This is a pretty disastrous ending.
Scenario Three: The value of the toxic assets varies widely, but the setup of the investor partnership means that on the ones where the value is extremely low, the losses are disproportionately carried by the public part of the public-private partnership. John Carney runs the numbers on this scenario and finds that investors come out with reasonable profits, the banks get a nice price for some assets worth almost nothing, the Treasury Department at first glance comes out of the deal okay, but the FDIC gets hosed because of the 6:1 leverage. But because FDIC is ultimately funded by taxpayers (since the banks will claim that they can’t pay additional fees for FDIC coverage), the taxpayers pay at the end. This is an ending that will look good for Wall Street and the banks, but egregious for most of us.
In light of the $500 billion to $1 trillion in public financing and guarantees put into this plan, the over-the-top public outrage over the $165 million to AIG executives looks perverse. A hundred million and change to folks who didn’t deserve it may warrant some public ire, but a much bigger gamble is being undertaken, with losses disproportionately falling on the government, with barely a shrug from the public.