The Geithner Plan and the Krugman Backlash

New York Times columnist Paul Krugman appears to have begun his own personal depression on the news of Treasury Secretary Geithner's plan to separate threatened banks from their nonperforming ("toxic") assets. But in attacking the Obama Administration for collaborating with the banks in order to prevent their implosion, he's made one misleading statement: "...the whole point about toxic waste is that nobody knows what it’s worth." The reality is that that is true only when such assets are sitting inert in a financially threatened bank's portfolio of assets. The only way that a financial asset's value can be determined is through a market, in which potential buyers bid the price up or down. All other methods -- such as a Nobel laureate speculating about its value -- are arbitrary.

Let's think this through: The Geithner plan assumes that lots of investors will buy nonperforming mortgage-related assets if they are stripped from banks and marketed via a public fund. Why? Not only because the government is assuming a good deal of the risk, but also because the underlying mortgages represent ownership of houses that will sell to buyers who can service those mortgages at a certain price, which is not zero (remember that wage-earners, who still comprise more than 90% of employable Americans, have regular income and need housing). If you can't service any longer your mortgage of $200,000 but could service a mortgage of $150,000, and the location of the asset in a fragile bank prevents the asset from finding a new investor, then a newspaper columnist's gloomiest estimate of its market value -- say, $100,000 -- might make it seem very toxic. But we know that such an estimate of that one asset is undervalued, because a $150,000 mortgage can be serviced. Until the asset, representing the nonperforming loan, is priced in a market, its true financial value can never be ascertained. That's the whole point of Geithner's approach: Let the only reliable mechanism (in our economic system) for determining the value of anything, a viable market, do that in the case of these assets.

When the Mellon Bank was on the brink of collapse in the late 1980s, an investment house created a "bad bank" into which Mellon's nonperforming assets were placed. This restored Mellon to solvency, and it became a healthy credit-issuing institution again -- and Pittsburgh heaved a sigh of relief. The "bad bank" eventually sold all of the bad loans, and very little money was lost. The point of doing this was to enable Mellon to do what it was supposed to do: serve the community as a source of credit. The latter is what many banks today cannot readily do because of uncertainty about the weight of these "toxic" assets on the banks' viability. The complexity of the Geithner plan is a function of the sheer scale of the general financial crisis today, as well as the administration's decision to acquire the cooperation of the financial industry instead of terrifying it with the prospect of broad nationalizations and prolonged Washington decision-making about its future.

At the present moment we may not like bankers all that much, because of their past egregious risk-taking, but we are having a historic crisis of confidence in our economic system which is unfolding too quickly for the president and the Congress to invent a whole new financial system, just because a lot of us are outraged and want to punish the bankers, or because some columnists don't want the government to do anything remotely similar to what the Bush Administration might have done. Obama picked Geithner to be Treasury Secretary because he knew he had an excellent working knowledge of the present financial system. Geithner's plan is going to be implemented, because congressional approval isn't necessary. Denunciations of the plan without constructive suggestions about how to improve it will accomplish nothing except fray public confidence in Obama's decision-making. That's the objective of the Republicans and right-wing populists, reinforced by the fear-mongering of most of the broadcast media (and now further abetted by populists on the left). If this onslaught succeeds in lowering Obama's poll numbers sufficiently, the general media may then pronounce Obama a failure, and that could put at risk most everything else that this new president is trying to do.

Paul Krugman has been a trenchant critic of the unexamined love for unbridled capitalism exhibited by the Bush Administration. But whether anyone likes it or not, we still have a capitalist economy, and its abuses have put at risk our collective economic future. Until the immediate effects of those abuses are flushed out of the system, the present toxicity of our national politics offers no prudent context for considering a more fundamental restructuring of the system. Populists picketing financial traders' mansions, gyrating congressmen predicting economic armageddon, and even fervent columnists with cosmic wisdom are not necessarily the best sources of guidance for either that restructuring or the hydraulics of the flushing that's necessary. There's a cooler cat in the White House, and we should listen to and not just lecture him.