And Just like That... Geithner's Plan Was Gone

News came out in an under reported story last week:

The Federal Deposit Insurance Corp. indefinitely postponed a central element of the Obama administration’s bank rescue plan Wednesday, acknowledging that it could not persuade enough banks to sell off their bad assets.

In a move that confirmed the suspicions of many analysts, the agency called off plans to start a $1 billion pilot program this month that was intended to help banks clean up their balance sheets and eventually sell off hundreds of billions of dollars worth of troubled mortgages and other loans.

Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses. Even though the government was prepared to prop up prices by offering cheap financing to investors, the prices that banks were demanding have remained far higher than the prices that investors were willing to pay.

Robert Kuttner goes further to describe why the plan failed, and where it leaves us:

First, the government has bent the accounting rules to allow the banks to carry nearly worthless securities on their books at their nominal full value. The Wall Street Journal ran a terrific investigative piece June 3 on how the banking lobby and legislators of both parties pressured the Financial Accounting Standards Board (FASB) to suspend its rules requiring assets to be carried on banks' books at their current market value.

With this change, banks had no incentive to sell these deeply depressed securities at anything like their actual market value. So if a speculator, armed with Fed funding and a government guarantee against losses was prepared to take a speculative flyer in a bond by bidding, say, 30 cents on the dollar, the bank was not prepared to sell at less than 90. Hence, no deal.

Second, some hedge funds and private equity companies sniffed around these deals and concluded that they weren't worth the bad publicity or government scrutiny if the deals resulted in big windfall profits (the only kind that hedge funds pursue).

Cooking the books to inflate the value of depressed securities also explains how zombie banks like Citigroup could pass the government's "stress tests" with flying colors. Citigroup, which has depended on $45 billion in straight government cash and hundreds of billions more in guarantees, was found by the stress-testers from the Fed and the Treasury to need only $5 billion more to be adequately capitalized. This is, of course, preposterous if you value the junk on its books accurately.

The failure of Geithner's plan is actually good news for those of us who don't believe in rewarding speculating hedge fund managers with a trillion dollars of taxpayer money. The plan was immoral, and while it's a setback for the administration, it's good news that they get sent back to the drawing board. With Geithner and Summers in charge who knows what you're gonna get, but you'd think it would be better than their first effort.