Obama buys time for zombie banks

Original Link: http://www.csmonitor.com/2009/0212/p08s01-comv.html

By the Monitor's Editorial

Faced with a choice between spending upwards of $4 trillion to save wobbly banks or doing something else, President Obama has decided to do something else. His bank plan, rolled out Tuesday, almost seems designed to simply buy time in hopes the economy bottoms out soon. Maybe then, hard decisions about who sacrifices – taxpayers or financiers – won't be needed.

That explains why the plan, drafted by Treasury Secretary Timothy Geithner, is vague on details and merely broad in strategy – with the uncertainty over its real impact worrisome to business.

Under the plan, government would first send federal regulators into the opaque backrooms of the biggest banks like cave explorers to find the ultimate depth of bad assets, such as mortgage-backed securities. Banks are still trying not to admit those losses on their balance sheets and thus are reluctant to resume lending that could revive the economy.

"Right now," Mr. Obama says, "part of the problem is that nobody really knows what's on the banks' books."

Second, the plan calls for Treasury and the Federal Reserve to invite private investors to buy those toxic assets at whatever price they can get them with a still-unspecified federal guarantee to make sure they don't lose their shirt in selling them later.

How big will that guarantee be? When asked about the potential losses in those bad assets that might be subsidized by taxpayers, Mr. Geithner could only answer: "It's the core of the problem."

Better candor came from Federal Reserve chief Ben Bernanke, who warned Congress that it should prepare to pay for a government takeover of some big financial institutions, such as happened last year with insurance giant AIG.

Over the past year, 34 banks, mostly small ones, have failed – the fastest rate since the 1980s bank crisis. Nearly 200 more banks are on watch by the FDIC. Some experts say hundreds more may fail in the next few years.

The Obama/Geithner plan only continues a deadlock with investors and banks by not being exact in how much government will spend to solve the banks' woes. With a Congress and Obama preferring to throw money at other things, such as the stimulus package, they are putting politics above the economy.

Mr. Geithner says he wants bold action, which Japan failed to do during its decade-long bank crisis of the 1990s. Yet the key negative lesson from Japan is that banks must not only quickly admit the size of their financial problems but government must also be resolute and clear on how much it will spend to solve them – or else let the banks dissolve.

A game of chicken over who takes responsibility for bad debts only holds the US economy back. Obama needs to either let banks fail and pick up the pieces, or put a set amount of money behind the purchases of the banks' bad paper.

The recession will end when the market finds a bottom in both the worth of banks and the value of homes. Government can't create an artificial bottom for either, but it can help markets find it faster. The Geithner plan has yet to do that.