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Geithner’s “Toxic” Asset Plan – A Long-Term View

The sign of a thawing frozen credit market and rising home sales was not enough to stop Treasury Secretary Tim Geithner from constructing another unnecessary big-government plan. The market may have initially reacted in favor to the announcement; however, the long-term picture does not illustrate anything nearly as positive.

Last Monday, Geithner announced a hybrid plan between the public and private sector that would help to remove toxic assets from the balance sheets of banking institutions. The plan will provide financing for $500 billion with some funds coming from taxpayer dollars from the initial Wall Street bailout and the rest from private-sector investors. The plan’s cost could expand to $1 trillion over time according to Geithner. (1)
Geithner’s plan is hardly original, as former Bush Administration Treasury Secretary Hank Paulson had initially proposed a plan of this nature, although he never followed through. He decided to give the funds directly to the failing banking institutions. Regardless, both approaches continue to avert systemic risk because investors have a guarantee from the government.

After all that has happened, it is still unclear to our lawmakers that the government cannot fix a problem that it caused. Government guarantees are what caused the financial turmoil in the first place. Fannie Mae and Freddie Mac guaranteed over half of the United States’ $12 trillion mortgage market, and both were among the largest lenders in the secondary mortgage market. (2) Now the government wishes to guarantee the very same assets it guaranteed in the past.

There is no talk anywhere in Washington D.C. about reviving sound lending practices, doing away with the sub-prime mortgage market or stopping government meddling in the financial sector – the very actions that were responsible for the crash. Instead, the government offers more guarantees for the same type of recklessness.

Also, absent from Geithner’s plan is assurance regarding regulator cooperation with the Financial Accounting Standards Board’s willingness to change mark-to-market accounting rules. If this valuation technique is not changed, Geithner’s plan will do little to help, as it will not have a positive cash flow effect. The current rules force companies to show realized losses (“paper” losses) because the “mark-to-market” price is lower than its cash flow value. For this reason, institutions were forced to show losses in the hundred billions – hence the “toxic” asset effect.

Perhaps the most concerning issue with Geithner’s plan is the likelihood of more government control. If the government becomes both a shareholder and stakeholder in the financial sector, it could very well have the power to regulate executive compensation. Driven by populist outcries, the government has been empowered to attempt to pass unconstitutional ex post facto laws. These types of actions could very well cause the private sector to say “thanks but no thanks” to the government’s generosity. The fear of success being taxed to unprecedented levels along with negative publicity will make investors in the private sector reticent to partner up with the government. However, this could be a ray of hope that a limited non-interventional government works best for everyone.

Geithner’s plan in conjunction with the Federal Reserve’s announcement last week gives a despairing long-term picture. The U.S. dollar is on the decline, and China and Russia are calling for a new reserve currency. Both countries are among the United States’ largest debt holders. In the midst of these events, President Obama has spent this week selling his budget that will cost over $9 trillion over the next 10 years according to Congressional Budget Office estimates. If only our elected officials were half as concerned about the long-term impact of their spending decisions…