Stiglitz: Obama's Ersatz Capitalism

Joseph Stiglitz is not a fan of the Geithner bank bailout plan:

Obama’s Ersatz Capitalism, by Joseph E. Stiglitz, Commentary, NY Times: The Obama administration’s $500 billion or more proposal to deal with America’s ailing banks ... is based on letting the market determine the prices of the banks’ “toxic assets”... The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets.

The two have little to do with each other. The government plan in effect involves insuring almost all losses. ... This is exactly the same as being given an option. ...

Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership! ...

But Americans are likely to lose even more ... because of an effect called adverse selection. The banks get to choose the loans and securities that they want to sell. They will want to sell the worst assets, and especially the assets ... the market ... is willing to pay too much for...But the market is likely to recognize this, which will drive down the price... Only the government’s picking up enough of the losses overcomes this “adverse selection” effect. ...

The main problem is not a lack of liquidity. ... The real issue is that the banks made bad loans... They have lost their capital, and this capital has to be replaced.

Paying fair market values for the assets will not work. Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time.

Some Americans are afraid that the government might temporarily “nationalize” the banks... What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. ...

So what is the appeal of a proposal like this? Perhaps it’s the kind of Rube Goldberg device that Wall Street loves — clever, complex and nontransparent, allowing huge transfers of wealth to the financial markets. It has allowed the administration to avoid going back to Congress to ask for the money needed to fix our banks, and it provided a way to avoid nationalization.

But we are already suffering from a crisis of confidence. When the high costs of the administration’s plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.