Holes in Geithner’s Plan

Treasury Secretary Timothy Geithner’s got a plan to wrestle our economy from its downward spiral. In short, he wants investors to buy toxic debt banks may later resell at a huge profit.  Geithner believes the proceeds from such sales will restore balance sheets on Wall Street and magically induce bank lending again. 

What’s been unsettling to date is the government’s huge assumption that banks will lend rather than pocket the proceeds as they’ve done in the past. But in the latest issue of BusinessWeek, readers learn there’s much more to worry about in Geithner’s plan.  Leading economic experts advise the public to look out for the following weaknesses:

1. Since hedge funds and banks may be allowed to lend to public-private entities created to buy toxic debt, the sellers could pass off the absolute worst debt as better than they actually are to sell them at the highest price possible, which could lead to profits for the sellers responsible for the toxic debt.
2. An investor, if it owns shares in a hedge fund or bank with toxic debt, could overbid for the toxic debt, driving up bank shares and profits. If the investment later tanks, the government would suffer the worst hit. 
3. Since the government is assuming 93% of any losses and only pocketing 50% of any profits, investors have ample incentive to gravitate towards the riskiest deals offering the highest payoff, and leaving the government footing the bill if the deals go south.
4. Banks and hedge funds could simply sell its toxic debt and use the proceeds from the sell to purchase similar debt at a discount and backed by the government, thus reducing the capital at risk to almost nothing.
5. Banks and hedge funds could invest in the private entity that buys toxic debt using a loan guaranteed by the FDIC, divide and sell the new debt as securities to other investors who do the same thing. The seller’s risk is reduced to nothing, and the government remains on the hook as leverage.

I’m sure most folks would normally argue that there’s nothing wrong with banks making a profit. But when lenders hoard their TARP funds, reduce lines of credit for small businesses and trigger layoffs while spending millions of dollars on bonuses, luxury retreats and gold bidets, and when a-holes like Rick Santelli, CNBC Business News’ on-air editor and member of the Chicago Mercantile Exchange, brazenly declare that they’d rather die than bail out a neighbor, one has to ask whether it would makes more sense to set up new banks, let the old ones fail, and otherwise hand the bail out directly to the people and small businesses.

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