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Commentary: Geithner's fuzzy plan fails to get warm response

This article first appeared in the St. Louis Beacon, Feb. 13, 2009 - The Obama administration's honeymoon lasted about as long as a quickie wedding in Tijuana. After only a couple of weeks in harness, even the liberal New York Times has excoriated the most recent plan to fix the financial mess. And while some will lay off the blame on the Bush administration, just remember that Treasury Secretary Tim Geithner was an architect of that plan, too.

The latest plan does include some public relations lessons learned from the last attempt. The new plan, for example, calls for more transparency and accountability in how the infused funds are being used. The Treasury has even set up a website (FinancialStability.gov) where you can see how banks receiving bailout money are using it. (When I visited there yesterday it said, "This site is coming soon.")

Of course, the problem is that unless you know your way around a bank's financial statement, you will not know any more about how a funds-receiving bank is using the money after going to the site than you do now. This attempt to raise accountability through internet access will not significantly alter bank behavior.

In its zeal to invoke change, the administration has brought forth another fuzzy plan to rescue the financial system. And the markets quickly demonstrated that fuzzy isn't what they want.

In a repeat of its inauguration day plunge, the stock market took a nose-dive as the Treasury secretary laid out his plan. One reason markets tanked is that, aside from a new website, the new plan is a re-run of the old: Shovel more funds into poorly managed banks. So far, the markets and the Times seem in agreement.

But there are a couple notable changes. The plan also calls for a public-private partnership to assess and remove the "toxic" assets held by banks. This is key to the successful resolution of the current problems in financial markets.

Analogous to the workings of the Resolution Trust Corp. in the 1980s, putting a price on the assets and getting them off the banks' books will breach the current lending barriers and get the economy moving again. It may even mean that, like the RTC outcome, taxpayers will not see huge losses on their investment.

The Paulson-Redux plan requires that banks receiving or considering joining the queue for funds must undergo a financial stress test. The stress test will evaluate a bank's ability to withstand a continued or even worsening decline in the economy. Of course, regulations currently in place require banks to undergo similar tests so it isn't clear just how informative the new tests will be.

What the test results are likely to show is that many banks must increase their capital. This will retard their ability to lend and create a paradox of capital. That is, by being more careful they will not take on the risk of making loans.

What if they fail the test? Unlike the current educational system where no child gets left behind despite failing grades, the FDIC should step in and close failed banks.

"As drastic as this process sounds," notes Harvard economist Jeffrey Miron, "it forces bank losses, to the maximum extent possible, on the shareholders and creditors who allowed the banks to assume excessive risk." Now that increases transparency.

The Geithner plan lacks the clarity and guidance that the public -- from Main Street to Wall Street -- expected from the best and the brightest. Perhaps the bar of expectation was set too high for the new guys running the company. Or perhaps we have begun to realize that the complexity of the current calamity exceeds the abilities of well-intentioned government bureaucrats to solve.

Was Ronald Reagan right? Might more government actually be the problem?

Rik Hafer is distinguished research professor and chair of the Department of Economics and Finance and director of the Office of Economic Education and Business Research at Southern Illinois University Edwardsville.

Rik Hafer is a distinguished research professor in the Department of Economics and Finance at Southern Illinois University Edwardsville and a scholar at the Show-Me Institute.

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