In US Treasury Secretary's plan, hope springs eternal

Washington: In these uncertain times, you take your certitude where you find it.

Platoons of academic economists and business commentators spent all weekend griping about the emerging details of the Obama administration's latest attempt to mount a bank bailout.

Then US Treasury Secretary Timothy Geithner unveiled the plan in detail on Monday morning, and the stock market delivered a decisive thumbs-up, with the Dow Jones index rocketing nearly 500 points.

Wall Street was signalling that it felt Geithner's programme, imperfect as it is, bears a quality that has been lacking in the government's rescue efforts almost since the words "bank" and "bailout" became inextricably entwined last autumn. Simply put: With every other option being worse, this is the way to go.

The new programme aims to set up an auction process, financed heavily with taxpayer funds, to establish a market price for the mortgage pools and other troubled assets clogging the banks' balance sheets. Taxpayers and the professional money managers will share in any profits from the investments. The idea is to use public funds to turbocharge the potential gain for the private investors as a way of enticing them to participate.

The plan looks like the best hope yet for creating a viable market for the toxic mortgage-based investments plaguing the balance sheets of banks large and small. The banks today don't have a suitable benchmark to guide them in valuing these assets on their books, let alone selling them.

That's because investors won't bid for the assets at a price anywhere near what the banks think they're really worth, and the banks won't offer them for sale at a price that the investors believe will compensate them for the risk of a loss.

One reason the two sides are so far apart is that the investors can't raise debt financing for their bids - which by raising their risk in the venture pushes their bids lower.

Under the new proposal, the government provides the debt financing. That makes it, once again, the lender of first resort, last resort and every resort between.

The plan turns the government into "the world's largest hedge fund investor", University of California, Berkeley economist J. Bradford DeLong wrote on his blog on Sunday. DeLong, one of the plan's more outspoken supporters in academia, contends that this could be a savvy investment for the taxpayer. The assets at issue are "probably fundamentally undervalued", and placing them in the hands of investors who can afford to hang on to them until markets recover, rather than leaving them with banks that are desperate to unload them quickly, could produce, he said, "an immense profit" - for private investors and the government alike.

The doubters counter that the plan merely prolongs a doomed effort to place an artificially high price on toxic assets that indeed might be worth as little as the current market says they are. In doing so, critics contend, the plan only delays a necessary radical recapitalisation of the banking industry.

The government's financing terms limit the private investors' potential losses, which naysayers believe will give them an incentive to overbid - a strategy that could be overly costly to the taxpayers.

Yet such criticisms themselves skirt a couple of important points. One is that no one has come up with any other bank rescue plan that in the United States would be practical or politically acceptable.

Nationalisation? More government oversight for the banks receiving bailout money is needed, but any plan for wholesale bank takeovers would strain our bank regulatory system and produce rhetorical pandemonium, if not pure legislative gridlock, on the floor of Congress.

Another point is that any benchmark price for troubled mortgage assets is going to make someone unhappy today, based on whether that someone expects the housing market to recover (and how quickly) or deteriorate (and how far).

One can buy a mortgage pool at any price ranging between 100 cents on the dollar, or "par", and zero cents on the dollar, or a dead loss. Any price between those extremes potentially will make winners out of the banks (if the government/investor partnerships pays more for the assets than they're ultimately worth) or the investors and taxpayers (if they underpay).

We can't know how this will play out until, well, it plays out. That will take a couple of years at least, so waiting for the issue to resolve before setting up the auction process is not a solution.

That said, Geithner's plan harbours many uncertainties. They include the role of bureaucrats at the Federal Deposit Insurance Corp and other bank regulators, who are supposed to provide "rigorous oversight" over the public/private partnerships formed to invest in the troubled assets. No one is sure how much control they might want to exercise, or how.

- Los Angeles Times-Washington Post News Service