Geithner will institute a stress test to see who is solvent enough to get government money and who should be shut or be forced to sell to better-run institutions. By figuring out who is and isn’t worth saving, he can rally the system around a few well-capitalized institutions and shutter the rest. No more throwing good money after bad. No more fears of shaky banks choking credit.
Geithner then wants to give up to a trillion dollars to a new government entity that will encourage the private sector to get involved by providing financing to vulture investors who want to buy toxic assets but lack the credit. Geithner knows that no traditional lender, no Goldman or Citigroup, will offer big money to anyone willing to take a risk that some of these so-called toxic assets might be worth something if they can just finance them, hold on to them, and clean them up until some come back to life. But lending money to such folks is a good idea, and that’s why Geithner wants the government to do it. Think of the toxic loans as land contaminated by toxic waste. Right now, no bank will give anybody credit to rehabilitate the land and sell it profitably down the road; Geithner’s Treasury wants to lend you a trillion to do so. I’ve heard the skeptics, but my bet is there’s trillions in private money waiting to jump on this option if there’s government financing. And again, this is an idea that allows taxpayers to get paid back, when many of these seemingly worthless bad loans get revived.
Of course, no one knows what the lousy loans are currently worth. I think Geithner should establish a government-run fixed-income trading desk to make a market in these instruments. The big brokerage houses aren’t willing to risk working these orders, but without a real two-way market, a price to buy and a price to sell, no one can meet in the middle. All the government has to do is make such a market and provide financing to the buyers. God knows there are plenty of laid-off bond specialists out there to run a government trading desk. The banks have been loath to sell these assets at any discount from where they carry them on their books because they have to raise capital after incurring big losses to stay in compliance with the regulators. But if Geithner is willing to let the banks take the hits without regulatory jackboots coming down on them, which is what is happening now, the banks would be willing to sell.
Despite what the markets said, Geithner got a lot of things right last week: His plan is big and bold, economically sound and politically viable (no nationalization, no more cost to taxpayers than absolutely necessary). If he’s as great a man as those who criticized me for knocking him say he is, then he’ll flesh out the details in the next few weeks and marshal the forces to get it through Congress. I hope that Geithner’s still got enough Teflon to see him through this brutal moment. If he does, he could wind up worthy of the Hamilton-Morgan mantle. If not, there’s a whole lot more pain in store before we’re in the clear.