Friday, April 10, 2009

Nobel economist slams Geithner plan, praises Fed effort

Original Link:

by Mathew Padilla

Paul Krugman, a Nobel-prize winning economist and New York Times columnist, lambasted Treasury Secretary Timothy Geithner’s plan to subsidize investor purchases of toxic assets from banks. In the same interview, he said Federal Reserve purchases of Treasury and other bonds will help the economy.

I have already posted some pros and cons on Treasury’s plan. On Sunday, I blogged on Naked Capitalism’s very critical view of the plan. But on Monday I quoted economists, a broker and money manager who liked the plan with reservations.

I tend to think the plan is suboptimal but could help a little. However, Krugman makes strong arguments against any good in the plan.

He says the plan is not well focused on the most troubled banks. Krugman thinks even though investors may pay a little more than market value — thanks to government’s generous terms — they are not likely to pay enough for the most troubled banks to become solvent. Thus the Obama administration is delaying the inevitable: a temporary government seizure of big, zombie banks.

The Bloomberg interviewer asks Krugman if the Geithner plan might work as the economy improves and the bad assets recover some lost value.

Krugman dismisses such a notion. He said some of the biggest banks bet heavily on the idea home prices made sense at 2006 levels and that high debt levels to income were ok.

“There is a tremendous loss that you can’t wish away,” Krugman said. Even if the economy gets back to normal, the garbage assets will still be garbage, he said.

However, Krugman says Fed Chief Ben Bernanke is doing the right thing by buying Treasury and other bonds. He said concerns over run away inflation are unfounded. The government is not printing money to pay its bills. The Fed is expanding the money supply to combat deflation, and that is a good thing, Krugman says.

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