The Obama administration is standing by its "cash for trash" Public-Private Investment Plan, the latest attempt to disguise its reincarnation of the Bush administration's tax dollar giveaway to Wall Street. Under this scheme, the US government pays private "investors" to buy rotten assets from banks at highly inflated, artificial prices: the government subsidizes 90% of the purchase price of assets; but if the private buyer pays too much for the assets, the buyer can walk away and the government only gets the actual resale value of the assets. In other words, it's a one-way sure-loss bet in which the taxpayer pays private investors to get rich.
There are many problems with this scheme. One is that it won't do the things the Obama administration says it will do. They say it creates a market mechanism for "price discovery" of the bad assets banks are saddled with. But a one-way bet that is almost completely subsidized by the government doesn't encourage price discovery; it encourages gaming the system. Jeffrey Sachs wrote two weeks ago that the plan would rob the American taxpayer. Now he writes that the plan is even worse than previously thought. Essentially, as Paul Krugman explains, "a bank can create an off-balance-sheet entity that buys bad assets for far more than they’re worth, using money borrowed from taxpayers, then defaults — in effect a straight transfer from taxpayers to stockholders." Krugman earlier named the scheme "cash for trash". The scheme has also been denounced by Joseph Stiglitz as "ersatz capitalism, the privatizing of gains and the socializing of losses. It is a 'partnership' in which one partner robs the other. And such partnerships — with the private sector in control — have perverse incentives, worse even than the ones that got us into the mess." Peyton Young calls it the "taxpayer's curse". Willem Buiter also thinks it's a bad program that robs the taxpayer. Martin Wolf says the plan leaves a successful banking rescue a long way off.
Aside from the perversity and injustice of the plan, it is based on a false premise: the premise that the US banking system is facing a liquidity crisis, not a solvency crisis. In other words, the Obama administration appears to believe that the assets owned by banks are essentially good and are undervalued because of a liquidity crunch - there's a crisis of confidence and no one wants to buy. If we can just get some of those assets moving, money will start to flow again. But almost no economist believes that. What we are facing is a solvency crisis: some banks are bust. The zombie banks need to be killed, and some viable banks need to be recapitalized. The longer this is delayed, the more it becomes politically and economically intractable to do what is needed. Yet the Obama administration is busy finding ways of handing cash to Wall Street while delaying the actions that are needed. The Obama approach is distressingly similar to the disastrous ways the Japanese government avoided dealing with its banking crisis in the 1990s.
All of this is why economists left and right think this plan is an expensive disaster that doesn't deal with the banking crisis at the heart of the economic crisis. As Sachs and Kotlikoff write, "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."
The cash for trash plan came hard on the heels of the AIG bonus scandal. Remember that the Obama administration was not blindsided by these bonuses: Obama's Treasury Secretary, Tim Geithner, actively lobbied for an amendment to bailout legislation that would allow these bonuses to be paid. When the scandal broke, Obama and his economic advisor Lawrence Summers preached about the sanctity of contracts. Yet when it came to bailing out auto companies, they didn't argue the sanctity of auto workers' contracts. They argued that the contracts needed to be renegotiated. No wonder Paul Krugman writes, "the sense that the administration is just too close to Wall Street continues to grow." That's not surprising. After all, many of Obama's top economic officials are Wall Street insiders and Clinton era veterans who engineered the deregulation that helped create this crisis.
(But wait, there's more! Under pressure from Congress, the Financial Accounting Standards Board has revised its guidelines to allow banks to value trash assets as they see fit in "impaired" markets. These are the same banks whose inability to price risk, or worse, whose willful ignorance, got us into this crisis in the first place.)
The failure to understand the nature of the crisis and the perverse insistence on handing money and power to Wall Street raise the question: why? Is it, as Paul Krugman suggests, a naive and foolish bewitchment by the market mystique? Is it that they are clueless? That has to be part of it; if you understood there was a solvency crisis, why would you delay action on it? But the way the Obama administration has blithely brushed aside criticism, its closeness to Wall Street, and its double standards for Wall Street bankers and US auto workers, suggest the problem is bigger than that: incompetence, arrogance, and corruption in the service of the ruling class. Change you can believe in.
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