Geithner's Folly: The Bank Rescue Plan Is a Disaster in the Making

The financial bailout plan unveiled by Treasury Secretary Timothy Geithner yesterday reminded me of the time my cousin Jethro Billy Rex Reed came over to my house and offered to pay me $50 for the privilege of scraping roadkill off my street.

"Well gee," I said to Jethro.  "What are you going to do with all that roadkill?"

"I'm gonna sell it for eatin'," he said proudly.  "The market for grilled flattened squirrel is booming right now!"

"But Jethro, there ain't no sane person out there that'll pay any price for crushed squirrel meat!" I said.  "What's going to happen if no one buys it?"

"That's the best part," he said.  "I figure that if no one buys, then my dad will pay me at least $100 to clean all the roadkill out before it stinks up our basement."

Much like Jethro's stock of roadkill, toxic mortgage-backed securities are now stinking up our financial system and Geithner seems to be willing to pay a premium to just get rid of them.  A key part of the plan he unveiled is to have the government create a public-private investment fund that will use government dollars to insure private investors against losses they could suffer from purchasing those bad assets if the economy keeps heading south. 

Geithner says that letting private investors bid on these assets -- with government guarantees against large losses -- will allow the market to define concrete prices for them and thus "avoid a program that has government overpaying for a bunch of financial assets."

The trouble with this, of course, is that many of these assets will never be worth what the banks will accept for them. Economist Dean Baker, co-director of the Center for Economic and Policy Research, told me that the worst of these assets "have lost value because they rest primarily on underwater mortgages."  The only way these assets will ever regain the value they've lost over the past few years, says Baker, is in the unlikely event that the housing bubble makes a comeback.

Economist James K. Galbraith told me that the government is simply in denial if it thinks it can ever recoup the losses it will inevitably take by paying insurance for those "toxic" assets. Instead of trying to sell them off in an attempt to hide the depth of the banks' losses, Galbraith says that the government should instead acknowledge that they are insolvent.

"If someone within the Government Accountability Office does their due diligence on these assets, they'll find that they're not marketable for a reason," he told me.  "Many of these securities were backed by mortgages that had sloppy and inadequate documentation."

Another problem with Geithner's plan is that it leaves bank executives and shareholders relatively unscathed. If government dollars are used to prop up bad asset values and thus protect shareholders from being wiped out, then future banks will have more incentive to invest in risky assets, safe in the knowledge that the government will help pick up the tab and leave their executives intact when the next bubble pops.

"This is the issue of moral hazard," says Hale Stewart, a tax attorney and former bond broker who writes frequently about economics at the Huffington Post. "By bailing out banks, the government is rewarding bad behavior. The alternative is to let the banks go broke and probably take the country down with them."

But although letting the banks completely fail is an unacceptable outcome, alternatives to the Geithner plan do exist. While there is no happy solution to a massive financial crisis, many economists have concluded that the United States will have to nationalize its insolvent banks. While that initially involves a government takeover of the banks, Baker points out that it's actually a more market-oriented solution than artificially propping up the value of bad assets and shielding bank shareholders from losses.