...from economists Joe Stiglitz, Peyton Young and Jeffrey Sachs.
By the 'Geithner plan' I mean the latest iteration of the plan to deal with 'toxic' banking assets in the US, drawn up by US Treasury Secretary Timothy Geithner. The Obama administration is suffering from a surfeit of lame economists in the upper ranks - Geithner and Larry Summers, to name but two. A bit of analysis shows that the plan is fatally flawed, but it seems to be going ahead anyway.
The two basic flaws can be summed up as follows (there's more detail in the articles by Young, Sachs and Stiglitz - they're all well written):
1. Incentives for the market to inflate the price of assets by competitive bidding wars, with the US taxpayer footing the bill
The US Treasury is promising to pick up most of the tab if the assets turn out to be worthless, which means that there is an incentive to buy them even if there's only a small chance they turn out to be worth anything. (In economist-speak the 'expected value' of the assets is inflated). This inflation in the expected value leads to an inflation in the actual value which the asset is being bought and sold at. This is due to a logical flaw in what the Treasury is trying to do. Geither believes that his plan will allow the 'real' value of toxic assets to emerge via market pricing, once the US Treasury provides the necessary confidence to underwrite investors' losses. But the Treasury intervention will itself the real value of assets. The plan is incoherent.
2. Incentives for insiders to manipulate the price of the assets without even bothering with a competitive process of buying and selling.
Sachs' article goes one stage further by pointing out that a big financial entity - like an investment bank - could sell a toxic asset back to itself (via an intermediary or subsidiary, for example) and collect a big sum from the US taxpayer by doing so. If the asset is worthless, the 'buying' part of the investment bank makes a large loss - but as it's sold the asset to itself (via the 'selling' part of the investment bank) there's no net loss on the transaction. And because the 'buyer' gets a large wodge of US Treasury compensation, there's a guaranteed profit. It's literally a licence to print money.
Of course, it may be that the US financial regulatory authorities can somehow police the insider option which Sachs points out - although it's sure as hell gonna be fiddly to do that given how adept financial companies are at setting up artificial entities (e.g. to minimise tax bills). But even if they can, there is still ample scope for price inflation through competitive bidding.
The Geither plan is a time-bomb ticking under the Obama adminstration's reputation for economic credibility. Partly of course that's because it's a slight modification of the Paulson plan from the Bush administration, which was complete pants, but somehow can't get off the table. Obama needs to sort this out quickly - what about sacking his entire tranche of senior economic advisers and getting people in who know what they're doing? Otherwise the consequences for his presidency and for the US economy could be disastrous.