What’s Plan B?

One of the determinants of how you feel about the Geithner Plan is what you think will happen if it fails. By “fails,” I mean that the buyers’ bids are lower than the sellers’ reserve prices, so the toxic assets don’t actually get sold.

Brad Delong, for example, is moderately in favor of the plan, even though he thinks it is insufficient. In his words, “I think Obama has to demonstrate that he has exhausted all other options before he has a prayer of getting Voinovich to vote to close debate on a bank nationalization bill. Paul [Krugman] thinks that the longer Obama delays proposing bank nationalization the lower it’s chances become.” (”Voinovich” is DeLong’s hypothetical 60th senator, whose vote would be needed in the Senate.) In other words, DeLong thinks that if this plan fails, the administration will be more likely and able to go forward with nationalization.

Paul Krugman, by contrast, is strongly against the plan, first because he thinks it has no chance of succeeding, and second because he thinks there is no Plan B. “I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second.”

I think the plan is likely to fail, or at least to be very insufficient, for reasons described elsewhere. I am also worried that the Obama administration has committed itself so strongly against taking over large banks that it cannot reverse course, at least not unless it sacrifices Geithner. So I expect Plan B to be more generous to the banks – which means it will have little chance of getting any money out of Congress (and the $700 billion will run out at some point). The increasingly friendly stance toward Wall Street also implies this course of events.

On the other hand, today’s reporting on what Bernanke and Geithner were actually asking for yesterday is a little bit promising. From The Wall Street Journal:

The bill, said Treasury, would cover financial firms that have the potential to severely disrupt the U.S. financial system. That would include bank holding companies and thrift holding companies as well as companies that control broker-dealers, insurance firms and futures commission merchants.

On my read of this passage (I haven’t seen an actual bill yet), the proposed legislation would enable regulators not only to supervise bank holding companies, which they can do today, but to take them over and wind them down just like the FDIC can do with depository institutions. If Treasury and the Fed have this power – and I think they should have it -  it could improve their negotiating position relative to the big banks. It could also indicate that the administration wants to have this power in its back pocket just in case it needs to use it. (Using the AIG scandal to get this power is a clever political move.) I still don’t think this is Plan B, but it could mean that they want all options open.

Originally published at the Baseline Scenario and reproduced here with the author’s permission.

One Response to “What’s Plan B?”

Hamlet2009March 25th, 2009 at 7:34 pm

Oh Hell. Blame a couple of technocrats for a failure of political management, such as the blowup over AIG bonuses, and guess what? They go before Congress and ask for expanded regulatory powers to lock up that barn door, now that the horses are out. Insurance companies are, notoriously, regulated but not exactly supervised by the States. As for Plan B, what we are looking at in the public-private (or is it private-public) partnerships is it. It is Plan B. Treasury and the Fed and the FDIC will do what they can to push up prices of toxic assets with cheap financing–ye old capital assets pricing model at work. It solves the problem that Paulson’s original proposition, in its haste, failed to address. But banks wont sell into this mechanism unless their backs are to the wall. There is a fundamental flaw in Bernanke’s idea that printing money equates to spending, or that liquidity promulgates velocity of monetary turnover. To create liquidity the Fed offers to buy, these days just about anything. These measures may or may not reverse a deflationary de-leveraging spiral. The academic theory of economic reasoning that says it will has never before been tested on anything like the present scale. From an inside a bank perspective, selling an impaired asset at a profit to its marked down carrying value may add a little bit to the book equity, but it forces a never-to-be reversed realized loss and that makes it the option of last resort. Banks fail when they run out of liquidity. The Fed can’t buy complete trash. The idea that a multi-national financial services conglomerate such as C or BAC can be laundered overnight by the FDIC or someone and turned back out all pressed and ready to go work is an absolute fantasy. And so, we temporize. We say yet another way to offer liquidity will solve the problem. What else to do eludes us. by

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Richard has published papers on wages policy, the taxation of financial arrangements and macroeconomic issues in Pacific island countries. Views expressed in these articles are his own and may not be shared by his employing agency. He is the author of How to Solve the European Economic Crisis: Challenging orthodoxy and creating new policy paradigms