I heard the radio show. Unbelievable, I was in agreement with Robert Kuttner. He made very good points. Even better remarks were made by U of Chicago professor Steven Kaplan: he very lucidly explained the issues and why the current Treasury plan is doomed.I was disappointed in Prof Frankel’s views, not because I disagree with him, but because he made no substantial arguments. “Let’s give it a try,” or “people put a lot of effort into this,” etc., are not arguments. It was very partisan, to say the least. As an economist myself, I was disappointed. We expect Prof Frankel to act as an economist and give economic arguments to support his views, not to act as yet another political pundit.

Let’s see an example. “Bank” has a mortgage-backed security (MBS) with original par (nominal) value of $100. In 2008 Bank “marked-to-market” and now values the MBS at $95 in its books. But we all know that this MBS is worth a lot less, maybe less than $60, but Bank won’t acknowledge reality.In 2009 we have the new Treasury plan, whereby “Peter” buys this MBS, for say, $90. That’s because the bank won’t take anything less. If it did, Bank would be shown to be insolvent and would be out of business.Peter puts only $6 out of pocket. Uncle Sam puts another $6, and the remainder $78 is a nonrecourse loan from Uncle Sam to Peter. (Total, $90).Then Peter turns around and sells the MBS to his pal “Paul” for $48. Paul pays $48 b/c he thinks the MBS is actually worth $58 as justified by what the homeowners will actually pay in monthly mortgage payments.Peter’s $6 investment is wiped out. So is the govt’s $6. And the $48 Peter gets from Paul goes to pay back the govt loan of $78. So now, Peter lost $6 but Uncle Sam lost $36 ($84-$48).Since Peter and Paul are buddies (co-conspirators), the latter can compensate Peter. Say, Paul gives Peter his $6 plus another $2 for his troubles. Paul pays $48 for something worth $58, but because he gave $8 to Peter, his profit is only $2. And the banks get fully $90 for paper that is worth actually $58.Summary:Peter puts in $6, makes $2 profitPaul puts in $48, makes $2 profitU.S. puts in $84, makes a $36 LOSSBank had paper that was really worth $58 but got $90 for it, makes a $32 profitYes, the Geithner plan is wholesale looting of the US Treasury. Us taxpayers foot the bill and will pay for it in a combination of higher inflation and higher taxes.

I’ve been wondering if the banks that hold these toxic assets will be able to offload them to hedge funds that own equity in these banks. Also, could the banks sell a Credit Default Swap for their toxic asset to the hedgefund, sidestepping the clause in Geithner’s plan about buying your own toxic assets? Isn’t Geithner’s plan really just a free “put option” for these assets? If investors are only willing to pay 30 cents to the dollar for these assets, and the banks need 60 cents to the dollar, would the put option plus the initial price the private investor would be willing to spend still be less than 60 cents to the dollar? If this is the case, and the banks have billions of dollars and careers on the line…couldn’t they find such a loophole unload their exposue to the taxpayer?