The Geithner-And-Summers Plan (GASP) to buy toxic assets from the banks is rightly scorned as an unnecessary give-away by virtually every independent economist who has looked at it. Its only friends are the Wall Street firms it is designed to bail out. In an earlier article, one of us (Sachs, FT, March 23) described the systematic overbidding entailed by the proposal. Others have since made similar calculations, including Joseph Stiglitz (NYT, April 1) and Peyton Young (FT, April 1). The situation is even worse that it looks, however, since the GASP can be gamed by the banks that own the toxic assets to boost the purchase prices for their bad assets even higher than has been suggested to date.
The Geithner-Summers plan, officially called the public/private investment programme, is a thinly veiled attempt to transfer up to hundreds of billions of dollars of US taxpayer funds to the commercial banks, by buying toxic assets from the banks at far above their market value. It is dressed up as a market transaction but that is a fig-leaf, since the government will put in 90 per cent or more of the funds and the “price discovery” process is not genuine. It is no surprise that stock market capitalisation of the banks has risen about 50 per cent from the lows of two weeks ago. Taxpayers are the losers, even as they stand on the sidelines cheering the rise of the stock market. It is their money fuelling the rally, yet the banks are the beneficiaries.
One of the vexing problems of the US banking crisis is the difficulty of valuing the toxic assets on the banks’ balance sheets. The government is proposing to remove these assets in return for taxpayer equity in the banks, but at what terms of exchange? It seems that if the government pays too much it bails out the banks, while if it pays too little it de-capitalises them. There is way, however, to be both fair and efficient, by settling the taxpayers’ ownership at a later date, after the toxic assets have been monetised.
The US debate over the fiscal stimulus is remarkable in its neglect of the medium term – that is, the budgetary challenges over a period of five to 10 years. Neither the White House nor Congress has offered the public a scenario of how the proposed mega-deficits will affect the budget and government programmes beyond the next 12 to 24 months. Without a sound medium-term fiscal framework, the stimulus package can easily do more harm than good, since the prospect of trillion-dollar-plus deficits as far as the eye can see will weigh heavily on the confidence of consumers and businesses, and thereby undermine even the short-term benefits of the stimulus package.
The global economic crisis is akin to a power blackout. In both cases, a disturbance in one part of a complex “tightly coupled” system results in a cascade of failures through an entire network. In the case of a power blackout, a single downed power line or transient overload causes power to be shunted to another part of the grid, which in turn leads to new overloads, more shunting and ultimately to a cascade of failures that pushes a region into darkness. Similarly, in the current economic crisis, a U.S. banking emergency caused by worsening U.S. market forces has sent shock waves through the world’s financial system, causing a global banking crisis that now threatens to lead to a global economic downturn.
Before our political leaders get too fancy remaking capitalism next month at the Bretton Woods II summit in Washington, they should attend to urgent business. Since the closure of Lehman Brothers triggered a global banking panic, political leaders in the US and Europe have successfully thrown a cordon round their banks to prevent financial meltdown. What they have not done yet is to co-ordinate macroeconomic policies to stop a steep global downturn. This is the urgent agenda.