Financial markets received the Department of the Treasury's latest bank-rescue plan with a resounding thud. The stock market's swoon was generally attributed to the lack of detail in the Financial Stability Plan, announced Feb. 10. After years of perusing plans and initiatives, investors were dismayed to receive a mere skeleton of a plan.
In conjunction with this week's cover story, this column will focus on one part of the Treasury's plan, a proposal for a "public-private investment fund." While the proposal was rightly pilloried for its vagueness, it does contain the foundation for initial steps toward a recovery short of nationalization.
The proposal to create the public-private fund is unsatisfactory on a number of levels. While private capital involvement is highly desirable, the language is so vague ("could involve putting public and private capital side-by-side...") as to be meaningless. It gives no sense of how the Treasury and its private-sector partners would split their contributions, nor does it provide guidance on how the prospective partners will be evaluated and chosen. While the plan trumpets the fact that the partnership would allow "private sector buyers to determine the price for current troubled and previously illiquid assets," it is silent on how this process might work.
Given the complexities involved in setting up a unique partnership between the public and private sectors, the lack of detail in the plan also creates unnecessary political risks. It will take time to develop a well-conceived and detailed plan, frustrating the public's desire for immediate action. Without such a plan, however, the public-private partnership risks winding up as a windfall for private investors at the risk and expense of taxpayers. Given the rapidly dwindling public tolerance for anything resembling a bailout, such a result would be an absolute disaster.
However, Geithner deserves credit for recognizing the limits of a government-only solution and the need to involve private capital in the process. Rather than creating a public-private partnership from scratch, however, creating a "bad bank" that plays a limited role would be faster, simpler, and fairer. With the Federal Reserve acting as auctioneer, the bank would act as "bidder of last resort." It would be required to bid in all auctions, in the same way that primary dealers always must bid in Treasury auctions. Assuming that the bad bank is sophisticated enough to bid intelligently, it would ideally buy only a small portion of the assets being liquidated, limiting the Treasury's outlays and exposure to risk.
A critical element to any such program's success, both economically and politically, is the perception that it reflects a fair and transparent process. In this light, the private sector's participants should not be limited to large investment firms; any private firm that meets minimum capital and counterparty standards should be allowed to bid in the auctions. In addition to utilizing the resources of small and newly-formed firms (many of which are being created from the talent pool displaced by the credit upheavals), this would limit the ability of politically-connected investors to receive preferential treatment. (In the current political climate, the last thing the government needs is for the banking cleanup to remotely resemble Russia's privatizations in the 1990s, which were plagued by cronyism and self-dealing.)
While the criticism directed at Geithner for offering a half-baked plan to an impatient and exasperated market is well-deserved, his willingness to consider a private-sector role is a significant step in the right direction. Although capital market excesses led to the credit crunch, policymakers should not turn away from using the resources and efficiencies of the markets to help alleviate the crisis.
Bill Berliner is a mortgage and capital markets consultant based in Southern California. His web site is www.berlinerconsulting.net
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