Given the stock market’s current rally, it’s tempting to declare that deliverance from economic crisis is at hand. Not so fast. Investors are merely reacting to the rollout of a credible plan to remove degraded assets from the books of troubled banks. That’s certainly worth celebrating, but it’s still just a plan. Having a road map in hand does not guarantee safe arrival at the destination, and this journey is just beginning.
The market’s favorable reaction doesn’t resolve a host of unanswered questions. Will banks be willing to sell their bad assets in a government-run auction if the price they fetch is too low? If they don’t sell, the credit pipelines will remain plugged up.
Another question: Is the government putting up enough money to make a difference? The public-private partnerships envisioned by the Obama administration could raise up to $1 trillion to invest in troubled accounts, but by some estimates the value of bad debt runs to $2 trillion. In other words, the money may be too little and too late to get the job done.
The market’s spike is a welcome sign of optimism, but “irrational exuberance” can be just as damaging as unwarranted pessimism. The proposal put forward by Treasury Secretary Tim Geithner has much going for it, but the details are far less important than the fundamental objective — to get rid of the toxic assets clogging the financial system.
From the moment the crisis became evident more than a year ago, experts have argued that the banking system would not revive unless it could get rid of all the bad debt. Until that happens, the credit markets will stay frozen.
This is what the capital markets have been waiting for. In outline, the plan follows the precedent for the rescue of the savings and loan system nearly 20 years ago, when the government set up a public agency known as the Resolution Trust Corp. to buy up all the properties with failed mortgages that brought the system down. Eventually, the RTC resold those properties for a profit.
The problem is that the magnitude of the present crisis dwarfs the savings and loan debacle by far, and also impacts the global economy. That means the government must put far more of the public’s money at risk, and offer a lot of inducements to private capital to join in the rescue effort. Congress should have a say in fashioning the final plan. If this doesn’t work, there is no Plan B.
— The Miami Herald