Much rests on rescue plan

That’s the title for my article in yesterday’s Fin, reposted over the fold

The reaction of markets and economists to the bank rescue plan announced by US Treasury Secretary Tim Geithner has been revealing. Stock markets loved both the Geithner plan and the announcement, a few days earlier that the US Federal Reserve would create a $1 trillion loan facility to assist in the purchase of dubious asset-backed security.

By contrast, the US dollar fell sharply against other currencies, including the Australian dollar. Oil prices, denominated in US dollars, rose accordingly, although more accurate measures, based on a basket of currencies showed much less change.

This divergence is not so surprising. The plan is, to put it mildly a high-risk option. If it succeeds, the benefits will largely accrue to holders of stocks in general, and even if it fails, it will certainly benefit banks and their shares, which make up a substantial part of the major market indexes.

If the plan fails, on the other hand, it will be bad for holders of US dollars and US government debt, which is being issued at an alarming rate.

A similar divergence can be seen in the quoted reactions of economists. The views of ‘market economists’, representatives of financial businesses on whom the press commonly relies for instant reaction on such matters, were overwhelmingly favorable. By contrast, the responses from economists who actually undertake research into how the economy works ranged from outright rejection to the most tepid of endorsements.

In many ways, the endorsements are more damning than the criticism. Berkeley economist Brad DeLong, who has been among the most prominent supporters of the plan sees it as the best that can be done without new legislation, which would almost certainly fail in the wake of the outrage over massive bonuses paid to the executives of failed banks. And, he says, it might lay the groundwork to convincing doubters of the inevitability of bank nationalisation. Writing in the New York Times, he says ‘“We tried alternatives like the Geithner Plan and they did not work” might well be an effective argument several months down the road.’

Joseph Stiglitz and Paul Krugman are among the many who disagrees. Krugman points out that the design of the plan gives private investors in dubious assets an effective put option. If the assets rise in value, they get much of the gain, but if they fall, the loss can be put back to the US taxpayer. And, against DeLong, Krugman argues that the financial and political resources used up in a plan that has little hope of success will not be available to support nationalisation.

Supporters and critics agree that the Geithner plan depends critically on the assumption that the ‘toxic’ assets on bank balance sheets, such as securities backed by home mortgages, are actually worth substantially more than the market is willing to pay for them at present.

There is an even more fundamental assumption underlying the Geithner Plan. Geithner, like Larry Summers, Robert Rubin and Henry Paulson, is deeply committed to Wall Street and its economic model. Their plans are based on the assumption that, when the crisis is over, everything will return to ‘normal’ as this term has been defined for the past thirty years, with a global financial system dominated by financial institutions like Citigroup, Bank of America and Goldman Sachs.

The resort to yet another publicly provided put option reflects this thinking. Just as with the ‘Greenspan put’ and the ‘Bernanke put’ that created the crisis, the assumption is that governments must support the financial sector at all costs.

On the Geithner is view, some new regulations may be needed, but contrary to the rhetoric of the Obama campaign, real change is neither possible nor desirable. By contrast, Kevin Rudd has recognised that the financial crisis signals a ‘seismic’ change in the economic organisation of capitalism, even if not all his government’s policies reflect this.

What does the Geithner plan mean for Australia? On the whole, it is probably a positive. The fact that it is a bad deal for US taxpayers is less important to us than the magnitude of the stimulus involved. And the decline of confidence in the US dollar, while not helpful to exporters competing with US suppliers, will probably make allow the Australian government, and Australian banks, to borrow on more favorable terms.

The biggest risk is that the failure of the plan could discredit the Obama Administration and produce a leadership vacuum. That would be a disaster for the entire world. The US led us into this mess, and, like it or not, the US must lead us out.

22 thoughts on “Much rests on rescue plan

  1. Pr Q says:

    This divergence is not so surprising. The plan is, to put it mildly a high-risk option. If it succeeds, the benefits will largely accrue to holders of stocks in general, and even if it fails, it will certainly benefit banks and their shares, which make up a substantial part of the major market indexes.

    Shorter Geithner: Heads Wall Street shareholder wins, tails US taxpayer loses.

    I am depressed by the Rescue Plan Mk III(?), but not suprised. Nationalising the big banks means shutting the MoU’s out of potentially the biggest capital gain in recent history. Pardon self-reference (comment on previous post) as this conclusion pretty much draws itself: “They also probably figure they want to be in on the ground floor when the stock market recovers.” Which they will promptly bail out of at an opportune moment.

    Obama probably does not want to spend political capital trying to nationalise Wall Street now. Not when he wants to nationalise the health insurance industry.

    He has enough policy messes on his hands at the moment. That was my call back in Nov08: “For the first term at least, Obama will be more janitor than Messiah.” Obama, at least as far as economic policy is concerned, will be a “centrist, Clinton, without the sleaze“.

    The “divergence” between the USD and the DOW proves that Wall Street has shown its priority is preserving its dominance over the US’s economic system. This may continue, but at the expense of the US’s dominance over the RoW’s political system. Apology for another self-quotation by its hard to avoid the conclusion that “They are ruining America, just like they ruined Russia, whilst cleaning up for themselves.

  2. 1. Jack # I agree wholeheartedly Jack. I dont think the financial bailout of ailing Wall street firms will go far, let alone solve any of the underlying problems. Benefits will accrue to stock holders and it entrenches more of the same. Mandatory super keeps feeding the financial markets until the next almighty crash (oh and by the way, the level of savings for retirement is now no better in Australia than when they introduced mandatory super, ie it has all vanished).
    So much for people putting away for retirement with super …..its a joke. Dont fall for it folks is all I would suggest – keep your own hands on as much as your own money as you can and make your own investments outside super. It has enriched some extraordinarily and they ahve lost a lot gambling it away. Its a government as much as a market failure, the super laws ended in a market distortion. Im not against government intervention but I recognise the danger in it – overextension of policy and the bureacratic entrenchment of ideas and an unwilligness to change once its in the system. But we dont have to put any but the minimum in and can do our own super (but there are barriers to entry on that – accountants fees offset against an annual return).

  3. And lets not avoid the impetus and reasoning for mandatory super – so the government could avoid penions ie a shifting of responsibility from governments to people after they paid taxes all their working lives. Not only that, when the boom was running hot in Australia and JH was rolling in a surplus – whta did he do with it. Stuck it into the shares of some of Australia’s already richest firms and what for? For the public sector unfunded super liabilities. Hardly a return to all. The only joy I now see is that it is being spent.

  4. “• Setting up a government mechanism to seize and dismantle large institutions whose failure threatens the nation’s financial stability.”

    This part of the latest plan I like but when would the call be made??. Would anyone have made it when the giants of Goldman Sachs and AIG were flying high? Nah – the world looks rosy then especially to the financial moguls and of course they would convince the regulators everything was fine. The time they should be dismantled is now, if at all (otherwise it wont happen).

  5. How, and when, will we know whether is has succeeded? Also will we see definite success or failure, or is it likely that things will muddle along, with it doing enough to stop the economic situation getting worse, but not really pulling us out of the hole?

  6. Alice,

    Why the focus on Goldman Sachs and AIG? What about Merilly Lynch? Have you heard of any firm other than GS and AIG?

  7. #7 Sean – Just because I didnt agree with you blaming Freddie and Fannie for the whole GFC crisis there is no need to get nasty!
    Maybe its time for your dinner. You must be tired having slaved away all day in the financial markets! Now go an relax. Its Friday night.

  8. Alice,

    Don’t point out those two firms. GS for instance has an exceptional history and if other investment banks operated like they did then we would be better off!

  9. Sean#7. The answer as to why Goldman Sachs and AIG is because its convenient shorthand for “the list”. They have been noted in previous threads a number of times. You were there but perhaps you didnt take note.

  10. Sean #9 . “we – white man???” You didnt tell us. OK if you dont want me to focus on Goldie – Ill switch to Meryll and Lehman (gone!).

    Does it matter? We all know…

  11. Goldie is a predator. Acquisitions, takeovers, driving the prices up, demanding 15% a year plus profits out of reasonable businesses – when they fell into the normal phase – Goldie slaughtered them (not enough annual growth) withdrew its institutional investment – all short term. Its not just what the banks do in terms of profit. People want real companies, realistic growth, realistic long term investments, not short term manipulations. Sure they did well on bubbles of their own creation (and a lot of people who thought they were investing in real companies, with real long term growth go sucked into Goldies bubble).

    Speculation aint production Sean and most people dont want to invest their money in hot air (except investment houses).

    Its a turn off that just got turned off. Watch this space – people are foolishly bailing back into the share market. The growth isnt realistic and it will pitch again…until people realise there isnt a bounce coming. Just a real value.

  12. And the decline of confidence in the US dollar, while not helpful to exporters competing with US suppliers, will probably make allow the Australian government, and Australian banks, to borrow on more favorable terms.

    You mean those exporters who are currently negotiating minerals contracts at prices 40, 50, 60 percent lower than last year?

    You mean those exporters who have driven all the growth in the Australian economy and government tax receipts over the past 5 years?

    You mean those exporters?

  13. It seems the world financial problems were caused by too many loans being created against assets that did not exist or were overvalued. The banks, through fractional reserve banking, create new money when they have no money to lend and so there is an inbuilt tendency to create more loans than needed during the years of expansion. Now that many of these loans are bad (toxic) the banks are unwilling (unable) to create new money because they cannot find assets against which to loan money and so create new money.

    We are attempting to solve the problem by increasing the money supply by issuing more loans in the hope that this time, unlike the previous few times, people who borrow money will use the money to create enough assets to back any new money.

    A different way to increase the money supply is to create money AFTER we create an asset. This can be done quite easily, immediately, with little fuss, no legislation, no cost to the government, and no international agreements. Visit
    to see how to do it.

    This will stimulate the economy without increasing debt. As a by-product it will reduce green house emissions and the cost of energy.

    I have floated this proposal before on these pages and so far no one has refuted the claim or shown why it will not work. I would like to hear the arguments against the proposal to find the flaws in the approach.

  14. re: Alice #2. Legislate that (say) 20% of super must be invested in Australian start-ups (maybe green). Some fail, some succeed. Australia produces, innovates, exports. Retirees get returns, the rest of us get jobs. Don’t tell me that it is government manipulation of markets. Market forces will still decide which start-ups fail and which succeed, and small businesses won’t rely so heavily on banks and foreign debt. I really can’t see what the down-side is here, except maybe banks lose some control over business investment, stock market bubbles are reduced and super funds are forced to work for their fees!

  15. sean,
    goldman sachs have been at the centre of this coup from the beginning, they are the most powerful, most important player in the carefully managed collapse of the global economy,

    as i wrote in response to Andrew Reynolds over a year ago on this blog,

    smiths Says:
    March 12th, 2008 at 5:46 pm

    the vast majority of the so called smartest guys in the room have under estimated risks or kidded themselves that they had insured against it,
    and guess what, check out the financial pages and the us fed statements,
    they like you were all wrong,

    except it seems goldman sachs,

    to which he amusingly replied

    The simple fact is that it is not the “great majority” of the “smartest guys in the room” that have been caught by this. Not a single major bank, not one, has gone bankrupt over this. Northern Rock (hardly a major) has had liquidity issues, but it is not (sensationalist journalism aside) bankrupt.
    Some have mis-priced risk – sure. Those who have mis-priced it have lost some money on those instruments. Others have got caught short in liquidity at what was (in retrospect) an important time. Is this market failure? No – it is what markets do. You get it wrong, you lose money. Get it right, make money.

    except that is not what has happened is it,
    the oligarchy centred around goldman that now run america dont lose,
    they fix and destroy and win win win

  16. just found another one,

    smiths Says:
    March 17th, 2008 at 10:35 am

    the bank closest to the powerful in america, goldman sachs has managed beautifully so far …

    i dont care if i am described as a chicken little or a conspiracy monger,
    this is being managed and propelled, and the middle classes of the advanced economies stand to lose most

    i only add these to make clear that goldmans central role has been obvious for a long time sean

  17. Prime Minister Rudd flies to the UK ahead of the G20 meeting on Thursday which is being marred by a vitriolic wave of controversy not only with regard to the anti-capitalist demonstrators protesting in London’s Hyde Park, but amongst world leaders of numerous G20 economies. An important question needs to be raised and that is: How can Kevin Rudd help ensure a coherent consensus emerges from the G20 cohort?

    The Brazilian president Luiz Inacio Lula da Silva gave Gordon Brown who is hosting the G20 summit an embarrassing rebuke a few days ago by saying that the present crisis was caused by ‘white people with blue eyes’. Whilst, Gordon Brown may have been slightly flattered, (not being a bleary blue eyed boy), there is a ground swell feeling of animosity that the origins of the present crisis was well founded in the ‘laissez-faire’ economies of the US and UK at a time when he was Chancellor of the Exchequer.

    Gordon Brown, though parading around the international arena very much like a cross between a wannabe benevolent dictator of the state-capitalist ilk and Superman incognito, has maintained true socialist calibre by encouraging policies that promote a high level of spending in the hope of transporting us out of this ghastly economic black hole he helped create. However, one has to question the ability of national governments especially the UK to spend their way out of this great recession not only to salvage their own economies but simultaneously saving the world from a deep and protracted great depression. Whilst Brown was in Brazil on his international road show ahead of the G20 summit, Mervyn King, the Governor of the Bank of England threw a kryptonite brick at him, effectively warning against the ability of the UK government to continue its massive spending spree, which was reflected in a failed auction for Gilts (government bonds issued by UK Treasury) last week.

    Gordon Brown’s leaked spending plans proposal over the weekend were of the order of $1.5 trillion which drew condemnation from German Chancellor Angela Merkel who said at the weekend ‘I will not let anyone tell me that we must spend more money’. Angela Merkel may have an even greater crisis on her hands later this year if the Euro, which is already showing horrific symptoms of ill-health comes close to collapse if more is not done to bailout frail EMU members.

    It seems that battered and bruised Gordon Brown has reason to be rattled at the way in which many G20 countries seem to have surrounded him. Aided by the huff and puff of his spin machine he may be attempting to back paddle and downgrade the meeting as having the objective to strengthen international financial architecture (amongst other issues) rather than trying to influence the national budgets of governments around the world. This may be a defeatist attitude because this is exactly what world leaders done during the great depression of the 1930s with subsequent ramifications, ending in world war.

    It is quite clear that the forthcoming G20 meeting when it comes to dealing with the economic and financial tsunami drowning the world’s financial tributaries is beginning to descend into a debacle with no clear indication of what is going to be achieved for the world economy, including implications for Australia.

    Despite, Gordon Brown’s need for some Harry Houdini charm, Prime Minister Rudd can help by using all of his well endowed diplomatic skills to ensure this forthcoming G20 summit is a great success by persuading the main disaffected European countries’ leaders like Germany’s Angel Merkel to come on board to support a global co-ordinated economic stimulus package having been initiated by Brown and Obama, as well as improvements in global financial architecture. Without a co-ordinated response by the G20 nations the world is facing ramifications far worse than the Great Depression of the 1930s. Kevin Rudd now has a world stage, afternoon tea with the Queen, CNN and BBC World to crank out how Australia is dealing with the crisis; how Australia made superannuation compulsory a long-time ago; the future fund; how we are stimulating the economy; how the economy has not experienced the downturns experienced by other major G20 countries and how the Australian Government through Australian Prudential Regulatory Authority in recent times never allowed the banks to become under capitalised. He can also call for a rejuvenation of the International Monetary Fund and World Bank, together with greater participation of Australia as an architect for global financial reforms.

    This could be Rudd’s finest hour.

  18. Plaasmatron #16 says
    re: Alice #2. Legislate that (say) 20% of super must be invested in Australian start-ups (maybe green). Some fail, some succeed. Australia produces, innovates, exports.

    Plaasmatron – you heretic!!! Dont youv realise what you are suggesting here – the dreaded no word of domestic industry!! Horror of horrors.

    The mere fact that I might agree with you is a small point. It is against the principles of the G word (not God but globalisation and free trade).

    You are simply not allowed to see your own economy do well, if means sacrificing the “global” economy and keeping some transnationals paying tax and not flying from country to country for the best tax free tax haven deal and the cheapest labour 16 hours a day they can find under ten years old to mainatin their profits so they can create more wealth in holiday houses and more employment in holiday housekeepers and gardeners once a month (oh stop it Alice !!!).

  19. Smiths #17

    You wont change Andrew’s mind. Andrew will just change tack anddevelop a new argument (probably – it was all somehow Fannie’s and Freddie’s fault?? Or it was Greenspans fault?? Or it wany anone else’s fault at all except Goldman Sachs and those who really were at fault because they gambled instead of providing a service (the distinction comepletely unclear to either Goldman et al or their clients who couldnt resist an unrealistically inflated profit).


  20. Oops a few typos. Ill check next time.
    Speculative versus productive – we all know the former causes bubbles, but to some bubbles are a wondrous thing (and they think its really smart if they get away with the dosh from someone else for providing not much except a short term ponzi scheme – smart maybe….clever maybe…but
    Ethical? Honest? Go straight down when you die if St Peter is still in charge of the gates to heaven!.

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