Friday, March 27, 2009

Going to Plan G: The Geithner Plan

Treasury Secretary Geithner has now released the much awaited details of his plan to alleviate the banking crisis and return lending to normal levels in the hopes of fostering an economic recovery. As we know, the reactions of the market were generally positive. The reaction of Paul Krugman, not so much. Oh well, you can't please everybody.

I have been reading and thinking about this plan for much of the week and there is a lot to digest, so my blogging approach is going to be more shotgun blast rather than laser beam.

Geithner believes that at the heart of the credit freeze is the fact that banks have assets on their books that they can't sell, at least not at prices they are willing to accept. These assets are of two types: actual loans and securities which are backed by loans. Getting these assets off the books should increase lending, at least that's what Geithner thinks. The method that he proposes to get these assets off the books is the Public Private Investment Program (PPIP).

There are two types of PPIP, one type will buy pools of loans, the other will buy mortgage backed securities. These are the 'toxic assets' we have been hearing so much about. In an attempt to class it up a little, the word toxic has been replaced by legacy, which in this case should be means, "we're not sure what they're worth." The batch of loans or securities that gets purchased from a bank is the "investment" part of the PPIP. So how does the PPIP pay for the investment?

Both types of PPIP involve money raised by private companies. This private capital is then matched by the Treasury, dollar for dollar, using money from the TARP. These two piles of money together form the equity portion of the investment. But this makes up a very small percentage of the purchase price for the investment.

The bulk of the money for the investment comes in the form of a loan guaranteed by the government (that is, the taxpayers) to the private entity of the PPIP. When you hear coverage of the plan that is talking about a subsidy or wealth transfer or some other even harsher term, like boondoggle, this is what they are talking about. When the PPIP's purchase actual mortgage loans from banks, the government guarantee will come from the FDIC. When they purchase securities, the guarantee will come from the Fed.

So the private money, the TARP money, and the borrowed money, all added together, are what pay for the bundle of loans or securities that the PPIP buys from the bank.

The details of the plan indicate that Treasury hopes to purchase anywhere from $500 billion to $1 trillion of these legacy assets. But the money that congress explicitly authorized for the financial rescue, you know, the TARP money, was only $700 billion, and much of that has already been spent, so how do we get to $1 trillion. Here is the NY Times from March 20th:
The goal of the plan is to leverage the dwindling resources of the Treasury Department’s bailout program with money from private investors to buy up as many of those toxic assets as possible and free the banks to resume more normal lending.
This description omits the crucial detail that the leverage doesn't just mean private money, it also means those government guarantees which make up the bulk of the purchase funds. So a small slice of the money that was actually authorized for a financial rescue is being used to foist an obligation onto the taxpayer that is somewhere just south of $1 trillion. It's the paradox of leverage. While we are all trying to de-leverage our private lives, the Treasury is busy ramping up the leverage in our public ones. This begs several questions:

1. Did the original TARP legislation permit the leveraging of those funds into a much bigger obligation for taxpayers?

2. If it didn't explicitly allow the use of funds in this manner, is the Geithner plan illegal, or does it at least violate the spirit of the legislation?

3. Perhaps, since the loan guarantees will come from the Fed (or FDIC), it doesn't matter whether the original TARP legislation permitted the use of funds in this manner or not.

4. If the Fed is indeed allowed to take on huge burdens in the name of the taxpayers without an explicit authorization from congress, does that make it a thoroughly undemocratic institution?

5. Does the fact that I posed question #4 indicate that there is a Ron Paul rally in my future?

I'll leave it at that for now. This quick and dirty version of plan G was meant only as an introduction, a way to get my mind around just exactly what it is our government is doing in our name. More to come in the days ahead since there are many other angles to explore.

Check out the Treasury's fact sheet on the plan here.
For some reactions to the plan click here, here, here, or here.

No seriously, go read the Treasury's fact sheet. It's short. If you can't be bothered, please go back to watching un-reality TV and absolutely do not ever vote again. Ever!


Anonymous said...

I must admit, you have done the best job of exlaining the PPIP from any source I have read.

Nicely done.

Is is correct that only 14% of the funds need to be contributed? e.g. 7% from the private side and 7% from the TARP? 86% guarantee from the Fed & FDIC?


Jeremy R. Shown said...


Thanks. I was shooting for a clear explanation for my own understanding
and hoping others could benefit as well.

The 84% & 14% numbers are correct for the legacy loans portion of the
program. This is the part where the loan guarantees come from the FDIC.

The Treasury plan indicates that the FDIC will determine the amount of funding it is willing to guarantee for each bundle of loans. The maximum that the leverage can be under this program is 6 to 1 debt to equity. The
84 & 14 come from this 6 to 1 ratio.

The Treasury plan is still a bit vague on the legacy securities portion of the program. It indicates some of these details are still being worked out. I have read some articles though, that have the debt percentage for
these purchases even higher than 84%.

Thanks for commenting.