The Obama administration’s new bank rescue plan is simultaneously a statement of faith in free markets and an acknowledgment of free market failings. The plan represents a “third way” between the first TARP giveaway to banks on the one side and private companies and the “stimulus” bill on the other.
Geithner’s plan is to utilize investors to affix a market price to toxic assets such as mortgage-backed securities, and then use government and investor money to purchase those assets in order to remove them from bank balance sheets. Investors will compete with one another to purchase toxic assets in an auction-type environment. The percentage of private investor money used in the purchase of these assets is small, somewhere on the order of 5-20%. The rest of the money will be from the government in form of loans or matching funds or a mix of both.
Some in the media have been calling this plan a “partnership” between private investors and the government. The term “partnership” is quite an exaggeration. Private investors are not “partners” if they are putting in 10-20% of the money and the government 80-90%. The plan attempts to turn Wall Street investors into honest consultants or secondaries acting on the government’s behalf by establishing an environment in which market forces will be at play, with mostly government money at risk. It does not establish a partnership in the sense that both partners are equally sharing the financial risk.
This plan is a carefully crafted, deliberate attempt to use government bailout money as efficiently as possible to remove toxic assets from bank balance sheets. Unlike with previous bailout attempts, Geithner has probably wargamed potential outcomes with various Wall Street investors in order to determine the ideal percentage of private investment required to obtain a fair market price for the government. Geithner is gambling that investors would be scared away from investing at all if they had to put a greater percentage of their own assets down in order to play ball.
The most important aspect of Geithner’s plan is not necessarily the details of the scheme but rather the increase in confidence in the market that this plan has already brought (the Dow jumped almost 7% on Monday). As confidence in the market increases, so does the value of the troubled assets that are weakening bank balance sheets and making banks nervous about new lending. Geithner’s calculated leaking of the plan for Wall Street to mull over last weekend was intentionally designed to prep the market for a strong week, which will further increase confidence in the plan and the market itself.