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The Problem With The Geithner Plan: The Financial Industry's Thrift Paradox

By Big Tent Democrat

Hale Bond writes a diary that I believe demonstrates, inadvertently, precisely what is most wrong with the Geithner Plan - the decision to ignore the fact the banks are simply not going to lend very liberally, even when bailed out. Bonddad is critical of "pressure" on JP Morgan (because it took TARP money) to do a deal with Chrysler to help Chrysler avoid bankruptcy. Bonddad says this is a pitfall of "nationalizing" banks.

It seems more of an indictment of TARP and TARP 2 (the Geithner Plan) to me. Suppose for a moment that instead of TARP and TARP 2, the $750B had been spent instead to fund a government bank dedicated to stimulating the economy and job creation/saving. Thus, a borrower like Chrysler would have made the case that loaning money to it would help stimulate the economy and save and create jobs. The government could have taken a convertible debt position and/or negotiated with existing creditors on how senior the debt to the government would be. Chrysler (and GM) are just examples of how this could have worked. TARP and TARP 2 have not spurred significant activity in the credit markets. Lending is not significantly increasing in response to TARP. Direct government loans outside of the financial industry would have been much more effective. More . . .

Bonddad writes:

[There are] three inherent problems with nationalization. Who do you nationalize, how do you actually accomplish the process of nationalization with minimal market disruption and how do you prevent the politicalization of the nationalization process.

These three questions seem easy enough answer in my view - (1) You place in regulatory receivership banks that are deemed insolvent; (2) you follow the existing regulations for regulatory receivership and (3) you avoid politicization by following the existing process for regulatory receivership. Was that hard?

Pointing to the TARP money given to JP Morgan hardly supports the argument that "nationalization" leads to politicized lending policies. On the contrary, it demonstrates that politicization is endemic to bailouts.

Nationalizing insolvent banks actually removes these questions from politicization because FDIC regulators will be doing the grunt work of regulatory receivership, not deciding who gets a loan from the bank. Insolvent banks will not be giving loans, they will be in receivership.

However, a bailed out bank WILL be subject to political pressure in its lending practices. After all, the people running the bank have an incentive to play the political game - they want the bailout. The regulators do not care.

Of course the reality is JP Morgan should not have gotten TARP money - it is not insolvent. The crazy idea of "stigma" is the problem here. From Paulsen to Bernanke to Geithner and Summers, they have all sold us this idea that all banks should take TARP money. They should not have. the process has been, ironically, politicized as a result.

The problem at the heart of the Paulsen/Geithner/Bernanke approach is this idea that we must maintain and support the existing financial industry in order to reignite our capital markets. But putting aside whether lending can only be reignited by our existing capital markets is true (I think it is false), TARP and TARP 2 will not accomplish that anyway. The JP Morgan/Chrysler example is illustrative of the problem. Banks will be tighter now with their money (and our money, except for compensation apparently). Pumping money into them does not lead to increased lending on the scale required to stimulate the economy.

Again, it is striking to me that so many folks can see the need for government spending as fiscal stimulus for our economy but they can not see the need for government lending that bypasses the existing financial structure for the same reasons - that the private sector will not lend in the amounts needed. They won't, ironically, take risks NOW.

The thrift paradox applies to more than consumers.

Speaking for me only

Full post as published by TalkLeft on April 12, 2009 (boomark / email).