Wednesday, March 25, 2009

Give Credit to Timothy Geithner says Nouriel Roubini

A noted economist, Nouriel Roubini, and Matthew Richardson has just published an Op-Ed in the NY Daily News concerning the plan introduced by Secretary of the Treasury Timothy Geithner. He gives it high marks and praise with some conditions and some ifs, but still sees it as a good plan.

This is high praise indeed from a man who normally is reserved in his acclamations.

First a little background about Nouriel Roubini. Dr. Roubini (born on March 29, 1959) is a professor of economics at the Stern School of Business, New York University and chairman of RGE Monitor, an economic consultancy firm. After receiving his doctorate in international economics from Harvard University, he began academic research and policy-making by teaching at Yale while also spending time at the International Monetary Fund, the Federal Reserve, World Bank and Bank of Israel. Much of his early studies were focused on emerging-market countries.

Fortune magazine wrote of him, "In 2005, Roubini said home prices were riding a speculative wave that would soon sink the economy. Back then the professor was called a Cassandra. Now he's a sage." In September, 2006, he announced to a skeptical International Monetary Fund (IMF) that an economic crisis was brewing. "In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession," according to the New York Times. According to the Times, he accurately foresaw "homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt." The NY Times even labeled him "Dr. Doom." In hindsight, IMF economist Prakash Loungani has called him "a prophet," and the vice chairman of AIG said "Roubini was intellectually courageous, and he called the shots correctly."

Because his descriptions of the current economic crisis have proven to be accurate, he is today a major figure in the U.S. and international debate about the economy. Although he is ranked only 410th in terms of lifetime academic citations, Prospect Magazine in January, 2009, voted him #2 on its "list of the world’s 100 greatest living public intellectuals." He has recently appeared before Congress, the Council on Foreign Relations and the World Economic Forum at Davos. Having become a sought-after adviser, he spends much of his time shuttling between meetings with central bank governors and finance ministers in Europe and Asia."

Now to the Op-Ed and what he says about the Geithner plan as it is being called.

For the economy to be viable, the financial system must be healthy. For this to occur, the system needs to be cleansed of its poorly performing loans and so-called toxic securities backed by loans. This way, once creditworthy institutions and individuals come to the market looking for capital to borrow, financial firms will be in a position to lend them money.

Secretary Timothy Geithner's new toxic asset plan is a serious step in the right direction in that it creates a public-private partnership to buy the troubled assets of financial firms - in other words, to do the necessary cleansing. Up until now, with all the government bailouts, the financial system has been barely treading water. With this plan, it will still be a hard swim, but, at least, there is a path to shore.

The plan essentially calls for private asset management firms - private equity, hedge funds, mutual funds, pension funds - to invest side by side with the government.

The private investors need the government because there are so many bad loans held in the financial sector that only the government's balance sheet can handle taking them over. The government needs help from private investors so it doesn't get hoodwinked by the banks.

Why will investors participate? The deal is structured so that firms will be responsible only for losses on their initial investment. The hope is that by giving this big "freebie," the government will induce investors to participate, and that competition among them will lead to higher offer prices for the loans and securities, thus encouraging banks to sell them.

A lot of ifs, but if indeed successful, the plan accomplishes mission No. 1, namely the removal of the bad assets from banks' balance sheets. Even if banks wanted to do this on their own, they can't because the market for these illiquid assets has dried up.

But let's not have any illusions. The government bears the risk if and when the investors take a bath on the taxpayer-provided loans. If the economy gets worse, it could get very ugly, very quickly. The administration should be transparent in making clear that there is still a wealth transfer taking place here - from taxpayers to investors and banks.

Also, while this plan is designed by the Treasury, many of the big guarantees are being made by the Federal Deposit Insurance Corp. and the Fed. Why not use only Treasury funds? Well, then the administration would have to deal with Congress. While the populist hysteria of last week suggests this end run might make sense, there is something a little worrying about circumventing the legislative process on such a huge investment.

Moreover, there's the issue of transparency - or lack thereof. No one knows what the loans or securities are worth. Competing investors will help solve this by promoting price discovery. But be careful what you wish for. We might not like the answers.

Finally, we have to anticipate the likelihood that some banks will resist selling their loans and securities. Why? Currently, the government has been giving them the option to keep holding them with the hope that market conditions will improve.

Going forward, the government must insist on the banks' involvement in the new program. The reason that financial institutions must be pressured is that they are the cause of the financial crisis. They took advantage of loopholes to avoid regulatory requirements, taking a huge bet on securities they were never meant to hold in the first place.

What happens if removing toxic assets from a bank's balance sheet at near-market prices shows it is effectively insolvent? Then we will have to face the elephant in the room. We may then have to start asking, "Why keep insolvent banks afloat?" And having asked that, we will have to search for ways to manage the ensuing systemic risk.

Either way, once the plan is fully implemented, we will be entering a new phase of the financial crisis. The water is choppy. Let's hope we are strong swimmers


As I noted, yes he does have some reservations, but all in all he still holds more hope and gives it mostly a thumbs up. As most people have stated, this is a huge step to correcting what is wrong with our economy. Once these "toxic" or "Legacy" Assets whatever you want to call them are off the books of the banks, it will be easier for them to start lending and moving money again.

With the money starting to move again our economy can really start to become profitable again, or so the hope is. I don't pretend to understand it, in fact I am mostly clueless.. but I do know as long as the banks have these things laying on their books, holding down their profits they can't do anything. Just as you are in your home books, if you have more owed than you do coming in, there is no way you can ever break even.

That's why the banks can't do anything. Once the banks move these holdings off their books, by selling them.. to investors, then they can start to show an income again and start moving money... just as if you had a garage sale, or an auction, (which is what they are going to do ) and bring in some money, so you can buy more junk....lol

1 comment:

ZenYenta said...

I'm at work so I can't go read the article you reference right now, but it's a very nice thing to hear that Roubini is overall positive about it. I think a lot of the criticisms of the whole administration so far are based on the idea that can operate in a vacuum and there would be no negative consequences to some of the idealogically preferable choices. In so many areas they have to deal with what we've got now and help without causing further problems. With everything so unstable that's very limiting for now.