Krugman: Why was I so quick to condemn the Geithner plan?

[ProSense]

March 21, 2009, 12:30 pm

More on the bank plan

Why was I so quick to condemn the Geithner plan? Because it’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted. It’s basically a thinly disguised version of the same plan Henry Paulson announced way back in September. To understand the issue, let me offer some background.

Start with the question: how do banks fail? A bank, broadly defined, is any institution that borrows short and lends long. Like any leveraged investor, a bank can fail if it has made bad investments — if the value of its assets falls below the value of its liabilities, bye bye bank.

But banks can also fail even if they haven’t been bad investors: if, for some reason, many of those they’ve borrowed from (e.g., but not only, depositors) demand their money back at once, the bank can be forced to sell assets at fire sale prices, so that assets that would have been worth more than liabilities in normal conditions end up not being enough to cover the bank’s debts. And this opens up the possibility of a self-fulfilling panic: people may demand their money back, not because they think the bank has made bad investments, but simply because they think other people will demand their money back.

Bank runs can be contagious; partly that’s for psychological reasons, partly because banks tend to invest in similar assets, so one bank’s fire sale depresses another bank’s net worth.

So now we have a bank crisis. Is it the result of fundamentally bad investment, or is it because of a self-fulfilling panic?

If you think it’s just a panic, then the government can pull a magic trick: by stepping in to buy the assets banks are selling, it can make banks look solvent again, and end the run. Yippee! And sometimes that really does work.

But if you think that the banks really, really have made lousy investments, this won’t work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that’s the Swedish solution, it’s what we eventually did with our own S&Ls.

Now, early on in this crisis, it was possible to argue that it was mainly a panic. But at this point, that’s an indefensible position. Banks and other highly leveraged institutions collectively made a huge bet that the normal rules for house prices and sustainable levels of consumer debt no longer applied; they were wrong. Time for a Swedish solution.

more

(emphasis added)

Krugman and others are pushing nationalization. The Swedish solution nationalized about five banks. Their system was not as complex, and even Krugman hasn't dealt with all the ramifications of translating the Swedish model to the U.S. banking system.

Also at the previous link is this excerpt from John Hempton, who challenged Krugman's assumptions:

Sweden could guarantee all banking liabilities because – frankly – their banks were not that deeply insolvent.

We know they were not that deeply insolvent for a few reasons – the best of which is that ex-post the Swedish bailout cost very little (and the Norwegian bailouts were actually profitable for the government).

<...>

But the second part of Krugman’s paragraph contains a deeply troubling false logical step. He says: “but of course we can’t do that unless we’re prepared to put all troubled banks in receivership”.

Here are the details on a successful U.S. nationalization and re-privatization (completed this week):

The IndyMac Example: Nationalized, Cleaned Up, Sold

Yesterday, the Federal Deposit Insurance Corp. (FDIC) successfully completed the sale of IndyMac bank, eight months after it was nationalized following catastrophic losses due to subprime mortgages. The bank’s 33 branches will reopen today as branches of OneWest, a Pasadena-based bank.

Even though it cost more than originally estimated, the successful nationalization and re-privatization of IndyMac — the fourth largest bank ever seized by federal regulators — shows that taking over troubled financial institutions, clearing them of their troubled assets, and selling them back to the private sector can be done. As Stephen Gandel wrote in Time:

For the government, the IndyMac sale provides a shining example of how takeovers can work, at a time when the Obama Administration may soon begin pushing for more nationalizations…The government is in the process of stress-testing the nation’s largest banks as part of Treasury Secretary Timothy Geithner’s plan to fix the ailing banking sector. And many think the outcome of those tests could lead to more takeovers.

We’ve been arguing that nationalization is the best way to handle zombie financial institutions. However, in order for leviathans like AIG and Citigroup to be nationalized and wound down, some mechanism — different from that employed by the FDIC — needs to be created. As FDIC Chairman Sheila Bair explained to the Senate Banking committee yesterday:

The problems of supervising large, complex financial institutions are compounded by the absence of procedures and structures to effectively resolve them in an orderly fashion when they end up in severe financial trouble. Unlike the clearly defined and proven statutory powers that exist for resolving insured depository institutions, the current bankruptcy framework available to resolve large complex non-bank financial entities and financial holding companies was not designed to protect the stability of the financial system.

more

As Bair points out, more complex institutions will require a different mechanism for reorganization. Here is another piece that describes what South Korea and Thailand did (I'm sure with smaller banking systems) during the Asian financial crisis.

Maybe Krugman can wait and comment on the actual plan.







Edited typos.

[Name removed]

1. Deleted sub-thread

Sub-thread removed by moderator. Click here to review the message board rules.

[DJ13]

2. Im not a "Krugmanist" (what ever the hell that is...)

But I most definately agree with Krugman about the Gethner plan.

Our politicians in DC (which includes Obama) are too concerned about maintaining the current banking system to deal with the unpleasant reality that the financial system that caused this mess cannot remain the same if we are going to solve the problems they created.

Forget trying to keep the fat cats in charge and in the money, tackle the problem head on regardless of the wants of Wall Street.

[FrenchieCat]

25. Has Geithner actually proposed his plan yet?

[AZ Criminal JD]

32. The Wall Street Journal wrote about the details today.

Among others.

[stillcool]

49. according to 'leaked' information..

and even though the plan is not complete.

[emilyg]

3. k

[Uzybone]

4. Krugman wants nationalization

every other idea to him is FAIL.

I really wish he was willing to work in the Administration. After so many years of fighting the good fight against the Bush cabal, he has a chance to work actively to fix the problem. But he doesn't want to.

[johan helge]

9. But the administration can just read his blog? (nt)

[AZ Criminal JD]

33. Apparently you are forgetting that Geithner was part of the Bush cabal.

As the NY Fed Chief he was in the room and signed on to all of the Bush decisions on the banks and the bailouts.

[amborin]

5. Krugman also says: look at Japan & learn: took Japan 10 yrs to nationalize: link:

<http://www.nytimes.com/2009/02/13/business/economy/13yen.html?_r=1&scp=1&sq=japan%20and%20banking%20crisis%20and%20assets&st=cse>

[girl gone mad]

6. Geithner's plan is terrible for a multitude of reasons.

visit the economy forum. We discuss it regularly.

[Yavin4]

7. Not To Defend Geithner on This, But Krugman Keeps Ignoring Political Realities

Obama has to walk a tightrope here, not just with Republicans but with his own party. Just this week, Bayh announced a group of 15 Dems who are willing to walk out on Obama on major policy initiatives.

These same Dems won't support a nationalization of the banks plan, and Obama would need their support.

[amborin]

8. as mentioned above, many freshwater economists now also advocate nationalization

and, we did nationalize freddie and fannie, under bush....

so rethugs will nationalize....

and, krugman suggested not using the term "nationalize" but rather "re-patriotize" or some such

[Jakes Progress]

10. If you give up before you begin

you will never win. bush scared democrats into giving in by making them afraid the public would think they be labeled as soft on terror. It is a tactic that President Obama could easily use also. Look at the ire over the AIG mess. We need a better press office. Make sure that every congressman who votes against what is needed for the economy is labeled as friends of the billionaire CEO's.

We can only use the excuse that congress might disagree with us for so long. Eventually you will have to confront them. If not. Every bill will be watered down to a failure. That will end up being the legacy of the Administration.

[Yavin4]

11. If Obama Loses People Like Evan Bayh, Then His Presidency Is Effectively Over

If Evan's gang of 15 Dems walk out on Obama's plans, then Obama's presidency is over and done. He cannot nationalize anything without Congressional support and approval.

[Jennicut]

12. Yup but then Krugman is an economist not a politician and does not

need to worry about such things. There are major "corpratist" people in the Dem party.

[depakid]

13. That's a bunch of cowaerdly hogwash-

and it's EXACTLY that sort of thinking and capitultion to the right that got everyone into this mess and has tuyrned much of the Democratic p-arty into little corporate sycophants- as opposed to leaders.

[ProSense]

14. But it's OK when Krugman tries to employ the same scare tatic:

So here’s the picture that scares me: It’s September 2009, the unemployment rate has passed 9 percent, and despite the early round of stimulus spending it’s still headed up. Mr. Obama finally concedes that a bigger stimulus is needed.

But he can’t get his new plan through Congress because approval for his economic policies has plummeted, partly because his policies are seen to have failed, partly because job-creation policies are conflated in the public mind with deeply unpopular bank bailouts. And as a result, the recession rages on, unchecked.

O.K., that’s a warning, not a prediction. But economic policy is falling behind the curve, and there’s a real, growing danger that it will never catch up.

link

Everyone wants their own damn way, and that is the problem.

[depakid]

17. I don't see that as anything close to the same

Krugman, Stiglitz, Dean Baker, Robert Reich, Nouriel Roubini and MANY others who have been critical of this fiasco simply want to see sound public policy in place. And on the economic and especially the financial front, that's not what we're getting.

We're getting favors and giveaways for Wall Street insiders- and, as Krugman notes, it's creating the impression (and rightly so) that the administration is "owned by the wheeler-dealers."

As Yves Smith notes about these aspects of the "plan:

...To entice private investors like hedge funds and private equity firms to take part, the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets.

The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent.

If this isn't Newspeak, I don't know what is. Since when is someone who puts 3% of total funds and gets 20% of the equity a "partner"?

And notice the hint of skepticism from the Times regarding the Administration's supposition that the bidding will result in fair prices. Huh? First, the banks, as in normal auctions, will presumably set a reserve price equal to the value of the assets on their books. If the price does not meet the reserve (and the level of the reserve is not disclosed to the bidders), there is no sale; in this case, the bank would keep the toxic instruments.

Having the banks realize a price at least equal to the value they hold it at on their books is a boundary condition. If the banks sell the assets as a lower level, it will result in a loss, which is a direct hit to equity. The whole point of this exercise is to get rid of the bad paper without further impairing the banks.

So presumably, the point of a competitive process (assuming enough parties show up to produce that result at any particular auction) is to elicit a high enough price that it might reach the bank's reserve, which would be the value on the bank's books now.

And notice the utter dishonesty: a competitive bidding process will protect taxpayers. Huh? A competitive bidding process will elicit a higher price which is BAD for taxpayers!

Dear God, the Administration really thinks the public is full of idiots. But there are so many components to the program, and a lot of moving parts in each, they no doubt expect everyone's eyes to glaze over.

http://www.nakedcapitalism.com/2009/03/private-public-partnership-details.html

[ProSense]

18. Of course you wouldn't n/t

[Name removed]

26. Deleted message

Message removed by moderator. Click here to review the message board rules.

[ProSense]

27. Your insults are dumb. n/t

[burythehatchet]

29. Possibly. Opinions are, by definition, subjective.

[Yavin4]

19. So, When Evan Bayh Leads His 15 Away From Obama's Plans

And then dominates the news with his walkouts, what will you do then? Declare war against one of your own?

That'll go over real well with the American people.

[depakid]

20. Let him try-

See how far he gets.

High time the progressive Democrats grew a spine and stopped allowing themselves to be blackmailed by these inept and irresponsible folks.

[Yavin4]

22. So, Take A High Stakes Gamble That May Splinter The Party for Years To Come

Leaving the Republicans in control. Real smart.

[Sebastian Doyle]

42. Fuck Evan Bayh in the ass with a dull rusty chainsaw

The only reason treasonous fucks like him have any "power" at all is because people like Harry Reid (and you, apparently) are willing to roll over and let him.

Despite the fact that the majority of the PEOPLE do not back some privileged little fuckstain from Indiana whose only primary difference from Chimp W. Bush is maybe a few IQ points. Other than that its the same old "living off of Daddy's name" bullshit.

[Better Believe It]

16. More Nonsense

Are all those 15 Senators united against nationalization? I don't think so. If so, please post the links.

And isn't it true that some Republican Senators have openly said they might favor nationalization?

What you say might be valid if President Obama supported nationalization and failed to organize an effective national campaign (along with the Democratic Party and supporting Senators) so do you really think the Democratic Party would abandon Obama on that question?

If you think that I suppose you are correct .... surrender to conservative Senators (Republicans and Democrats) is the only "realistic" option.

And that certainly would bring an end to his presidency.

[Yavin4]

21. What I Am Saying Is This...

There are members in the Dem caucus in the Senate who will bolt over any talk of nationalization.

The Republicans will say "no" to ANYTHING that Obama wants to do because they're not there to actually govern. They exist solely to play politics.

It's the Dems in Obama's own party that he has to worry about. He's has to keep them in line, and they will bolt over nationalization because many of them are on the corporate payroll. Heck, even Schumer may bolt over nationalization.

[Mojorabbit]

28. Those same Dems call them selves

fiscal conservative. If it will end up cheaper to nationalize they will get on board. It will have to be done sooner or later. Better sooner than after we have thrown trillions down a black hole.

[Better Believe It]

15. Why would Obama need their support?

"These same Dems won't support a nationalization of the banks plan, and Obama would need their support."

He's not going to get their full support on just about any progessive economic proposal that comes down the pike including the Employee Free Choice Act.

To get anything done Obama will have to challenge Republicans to actually filibuster on the floor of the Senate against progessive proposals that will actually accomplish something.

The only way Obama can get 60 votes to break a filibuster is if he and Senate Democrats actually challenge Republicans to engage in a real filibuster, not the bogus "we'll call it in" phantom filibusters

And if President Obama can't break a real filibuster, the Democrats will have to change Senate rules so that only 50 votes (in case of a tie V-P Biden breaks the tie) are required to pass each bill and/or Presidential appointment.

Will Senate Democrats do that? Not unless Obama takes them to the woodshed like old LBJ did. Too many corporate sponsored conservative Democratic Senators (led by Reid) prefer letting the Republicans control the Senate even if they are a minority that represents only 12% of the voting population.

[olegramps]

45. It is my understanding that it would require 3/4 of the Senate to vote to change the filibuster rule

If my understanding is correct then the chance of that happening is zero.

[camera obscura]

43. Even Lindsey Graham and Alan Greenspan support nationalization. Bayh is nothing.

[Baikonour]

48. Fuck the tightrope.

Obama needs to listen to ALL the best economists in the world, Krugman probably being in the top 3.

Krugman does not need a job within the administration to get his message across: nationalize the banks now. If you do not, please refer to Japan circa 1986.

And yes, it worked for IndyMac, now let's do it to the rest.

[ProSense]

50. Yes, it worked for IndyMac,

a bank with less than $35 billion in assets cost the government $10 billion (that's the loss) to nationalize and re-privatize.

Citi has $1.9 trillion in assets and a more complex structure than IndyMac.

[NJmaverick]

23. How can you tell Krugman is lying?

he typed out an article or his lips are moving (depending).

[inna]

30. bullshit. (unless that was an attempt at a joke.) nt

[burythehatchet]

31. No, its bullshit.

[NJmaverick]

44. "bullshit" is what this freeper asshole writes and it's insulting to see it

posted on DU

[inna]

51. Krugman, the "freeper asshole"~!! bwhahahahahahahahahaha!!!!

:rofl:
:rofl:
:rofl:
:rofl:

[Name removed]

24. Deleted sub-thread

Sub-thread removed by moderator. Click here to review the message board rules.

[burythehatchet]

34. WHAT THE FUCK - WHY WAS THE SUB THREAD DELETED????

BULLSHIT BULLSHIT BULLSHIT

[Kdillard]

35. Perhaps because the discussion had run its course and was no longer constructive.

[inna]

52. i don't understand either. some people are just out-of-control "alerters", i suppose.

i am honestly at a loss sometimes why posts/subthreads get deleted; it has a chilling effect imo.

[ProSense]

36. One attempt to define a nationalization plan

here

[burythehatchet]

37. Will the moderator of this thread please identify themselves by e-mail. Thank you.

[burythehatchet]

38. Will the moderator of this thread please identify themselves by private messsage - Thank you

[burythehatchet]

39. OK - don't respond, I'm certain Skinner has the honor to reply.

[Name removed]

40. Deleted sub-thread

Sub-thread removed by moderator. Click here to review the message board rules.

[xchrom]

41. recommend

[NJmaverick]

46. Krugman compared Obama's supporters to Nixon's people

He is nothing but a bitter PUMA with his own NYT's column

http://www.timeswatch.org/articles/2008/20080211150350.aspx

[ProSense]

47. Another

view.