A Fourth Way Neither Geithner nor Krugman nor Nothing

Robert Waldmann

A lot of the blogolandian debate on the Geithner plan is based on the assumption that there are only three options
1) The Geithner plan
2) Try to convince congress to nationalize banks now (real quick before they knew what hit them)
3) Do nothing.

Now this is reasonable in the sense that no way in hell is a blogger going to manage to get any 4th option to be seriously considered.

On the other hand, that also means there is no harm in arguing for a fourth way
as I do after the jump.

Before you get bored I have a plan

1. Private partners put up 1% of the money and get a 1% share of a public private partnership. They also get paid a fee. They have incentives to maximize the present discounted stream of revenue, discouted at a rate which corresponds to their modest risk.

Simple, does not create incentives to overpay and alligns public and private interests except 1% of a trillion is a good chunk of change and not totally unscary and 1% of up and down sides are not enough to keep private partners from effectively taking bribes.

I think this is the least bad proposal

The cases for and against nationalization are overwhelming — the irresistable force meets the immovable object.

For) It is the only approach that has ever worked in situations like this.

Against) It would cost a ton, includes the word nationalization and needs the support of 60 senators. Oh and there would be monstrously bad incentives during any long and drawn out debate about nationalization.

I’d say that the immovable object called the US senate wins this one.

In any case, the Obama administration has to convince people that they tried everything else and it didn’t work.

The problem with the Geithner plan is that it involves a large transfer from the public purse to the current owners of toxic sludge. This is unfair and unjust and also will stave off collapse for a while, reducing pressure to really deal with the problem rather than increasing it.

The transfers are due to the non recourse loan Geithner put aspect. which can, and probably will, drive prices up so high that the US debt will be enlarged by the plan — that is prices will be above hold to maturity value when treasury interest rates are used to discount cash flows.

The claim is the plan addresses the problems that all private agents are short of cash right now *and* that perceived risks are high so the US government which can borrow at low rates and has no reason to be risk averse (rather the opposite it should go deeper in debt when things go badly) has to be involved.

Now except for the “all” this makes sense (the “all” is needed to explain the extremely low trading volume that is the market freeze up). I will assume that the argument is true.

That does not imply that the solution is the Geithner plan. The Geithner plan pushes up prices by an amount (which depends on the variance of returns on the assets) which was arbitrarily decided. It does not just provide extra cash (the 99% share in my proposal) or reduce the risk that private managers have to bear (the Treasury bears 99% of it under my proposal). I don’t think it is designed to address the problems used to justify it. I think it is designed to address those problems and transfer public money to banks.