Geithner’s Plan: What is it?

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Tim Geithner

Laurence Summers—head of the National Economic Council—responded to criticism of the Geithner Plan, “I don’t know of any economist who doesn’t believe that functioning capital markets in which assists can be traded are a good idea.” Economist Paul Krugman responded (NYT) saying that if Summers believe that bribing traders to participate is “better functioning” then Summers should get out more. Many economists believe that this plan could be disastrous.

The Plan would auction bad mortgages held by banks. The government would join the highest bidder with an equal purchase and provide a loan to the bidder up to 85% of the bid. The loan is supposed to provide leverage such that small upward movements will bring large gains to the speculator. According to Summers and Geithner, such auctions will determine their “fair” market value.

Of course small movements downward will bring loss to the speculator as well as the taxpayer, but the speculator can count on the government to do all it can to jack up home prices. Many economist, financers, and bankers have found the Plan disastrous.

Paul Krugman, Nobel Prize-winning (2008) economist, challenges the notion that such an auction will determine fair value as “market mystique.” He analyzes the arithmetic of the Plan and shows that it’s just another attempt to subsidize the real estate industry and mortgage bankers.

Geithner’s Plan is just a backdoor way to stimulate the housing market. By subsidizing the housing market by tax credits and low subsidized mortgage interest rates, Geithner hopes to restart house price escalation. Also, by encouraging a highly leveraged market for mortgage based “toxic assets” to speculator, Geithner hopes to insure that his plan is a “success.” Such speculation is exactly what got us into this mess.

For years politician have promised affordable housing. When the market delivers it, the politicians act like it’s the bubonic plaque!

James Galbraith, professor of economics, University of Texas at Austin, calls Geithner’s Plan “extremely dangerous.” Galbraith challenges Geithner’s Plan basic assumptions. The main assumption is that this is just a liquidity crisis that can be solved by injecting capital into the banking system and that banks can’t lend because they don’t have capital.

The reality, according to Galbraith, is that “banks aren’t leading (much) because they have decided to stop making loans to people who can’t pay them back.” The bailout certainly illustrates Galbraith’s point. Bad banks and speculators splurged, but good banks didn’t want the money and want to give it back.

Actually, there is very little loan demand from creditworthy customers since by definition such customers will not borrow unless they are sure that they can pay back. Lending will start when lenders and borrowers feel that risk is low.

We have an economic crisis, but we have a great opportunity to solve it. Public work projects can rebuild our infrastructure, build global renewable energy and provide jobs.

The Obama Administration should make healthcare, energy and affordable housing its top priority. Banks will lend when risk of default and foreclosure are low.

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