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Two big messages from the Geithner plan

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Stephanie Flanders | 18:40 UK time, Tuesday, 10 February 2009

There are two big messages from the latest US bank rescue plan announced by Treasury Secretary Timothy Geithner.

Timothy Geithner with Barack ObamaOne is that, if anything, the Obama administration is even more neurotic about nationalising banks than its predecessor. The other is that right now it needs to be seen to stretch every taxpayer dollar as far as it can go - even if that might increase the final cost to Uncle Sam.

George Soros has said that the US faces a choice: between partly nationalising the banks themselves, or nationalising just their bad assets. Today's plan suggests that the administration doesn't want to do either.

What started as a "Bad Bank" and then later became an "Aggregator Bank" is now a "Public-Private Investment Fund" which would help private investors take on toxic assets rather than have government buy them directly itself.

As is true of the entire package, the emphasis is on providing a "bridge" to private capital and generally avoiding anything that smacks of public control.

This arms-length-and-even-that-only-when-necessary approach to the dirty business of getting toxic assets off banks' books has another supposed advantage: if the government's not buying the assets, it doesn't have to value them either.

But it's not clear how the valuation issue will be avoided in practice - if you "leverage" a private purchase of an asset, for example, by underwriting the borrowing to buy that asset, that itself relies on some implicit valuation of the asset. The government could still overpay.

It may be that the US Treasury has devised a way round this, but if so, Mr Geithner's speech suggests that it's a work in progress. The objective is to "use private capital and private asset managers to help provide a market mechanism for valuing these assets". Precisely what that mechanism will be is still being discussed.

Of course not buying assets is also cheap - at least at first. As I said, that is the other big lesson of this plan: the administration is trying to spend as little as possible up front. In that sense, the "Public-Private Investment Fund" is attractive to the US Treasury for the same reason that the UK's Private Finance Initiative was attractive to Gordon Brown.

The new Consumer and Business Lending Initiative to promote lending across the economy will be based on a pre-existing Federal Reserve lending facility for exactly the same reason. The Treasury will provide the minimum amount of capital to leverage the maximum amount of lending by the Fed.

There's nothing wrong with trying to get the most lending at the least cost. It's already been harder to pass the fiscal stimulus package than the administration had hoped. It doesn't want to go back to Congress any sooner than it has to.

But there is a risk that penny-pinching now will cost the taxpayer more in the end.

That's true in the narrow sense that these kinds of guarantees leave the government liable for more of the losses on these assets and fewer of the gains.

But there's a more general risk in these minimum-cost, maximum-private involvement approaches. That is that this plan will fail to do what the administration desperately needed it to do: to instill confidence, finally, that the world's most important government will do whatever it takes to put its financial system right.

There was plenty in Mr Geithner's speech that was good. But the market's negative reaction suggests that so far, at least, he has not achieved that goal.

Update Wed 0926: From the comments: "your description of a $1.5 trillion dollar package as 'penny-pinching' and 'minimum cost' really does beggar belief" (Adam C).

But there's a huge gap between that headline number and the upfront cost to the Treasury. And that is precisely the problem.

When you look at the small print, nearly all of that $1.5 trillion is supposed to come from private investors - suitably "leveraged" by a small amount of public capital, or guarantee. At least in the initial stages of the plan, the Treasury doesn't seem to be planning to spend more than the $350bn or so left in the original TARP.

The administration was dealing the hand it was given - if you assume that you can't raise much more money from Congress in future, you get a proposal that looks like this.

But the risk is they will end up with the worst of all worlds - a plan that looks to the average voter like another giant cheque to the banks, but on close inspection by investors looks like too little, too late.


  • Comment number 1.

    Playing with bad debt with leverage, with the taxpayer committed to taking most of the losses when it defaults. That does wonders for confidence. You know of course, why the US government does not want to fully nationalise either the banks or their assets. It is financing its operations ever closer to the short end of the curve near the limit of affordability and its tax take is about to go off a cliff. They cannot borrow enough money. They could not afford it even if it existed. They might even have difficulty rolling it in a few years, if by that point their creditors happen to desperately need the cash at home. This crisis is global, remember. Treasuries are a piggy bank with liquidity second only to cash.

    The big message from the Geithner plan: the world's most important government will TRY whatever it takes to avoid getting people to take responsibility for their finances, and it will not work.

  • Comment number 2.

    By the way, there IS a market mechanism to value these assets: bid and ask. Investors can bid whatever they like, and they do, at times in well-publicised fashion, in volume. It is just the prices at which transactions take place are unwelcome, inconvenient, unhelpful, or whatever you may choose to call it, to some market participants, for example the ones whose ask is actually what they need to be solvent. The purpose of this plan can only be to contrive a parallel pricing mechanism that creates a price more acceptable to certain participants. The message to the market is if you do not like the quoted price of an asset, go to a different window and get a better one courtesy of the taxpayer. I doubt they will get less than break-even.

  • Comment number 3.

    Hi Stephanie

    The problem may well be that doing the maximum for the minimum amount of capital is pretty much what the banks have come unstuck doing. That may well be what has affected markets tonight.

    I was hoping that Mr. Geithner had a well thought out plan rather than the policy on the hoof it rather smacks of.

  • Comment number 4.

    How about we punish the people who made stupid investment decisions? At the moment we're wrapping all these folk with their over-valued assets that they over-paid for in cotton wool by slashing interest rates to 1%. How about we jack interest rates up to a (still historically low) 5%.

    Now 5% is no big deal if your business has any kind of cash-generative powers at all. Is it? Really? Those of us who lived through the 1980's still view 5% as peanuts for a mortgage rate. But the effect of a (let's be honest, still pretty low) 5% will be that all those financial kamikazes will be brought to heel an awful lot quicker than if we muck about a la Japonaise pretending that our economy works fantastically as long as the government prints money and we all pretend that it is worth something. Indefinitely.

    Now culturally this seems to work for the Japanese. But our culture is manifestly different. It seems that not only can our political elite turn a blind eye to us borrowing to buy enough rope to hang ourselves whilst all the time trumpeting their brilliance for the availability of debt (rope, for the buying of) but they now seem content to print enough money for us to buy the chair and the ceiling hook as well.

    Come on. We all know what the problem has been this past decade. It's not a 'credit crunch' it's a debt explosion. We've all borrowed too much money and now we need to pay it back. What we don't want to be doing is printing even more money so we can continue living in the debt-fuelled fanatsyland of the last decade.

    C'mon. A little period of austerity and reconnection with the important things in life will do us no harm. Although there are limits. As Comrade Bob's experiment of 'fiscal easing' in Zimbabwe demonstrates. I'll take a decade of paying off debts over a (further) decade of printing cash any day.

    The sooner we pay down all this bad debt the sooner we will emerge blinking into the sunlight of a new dawn. Or at least a new dawn that offers some hope. 'Fiscal Easing' is just voodoo economics that has a 100% failure rate. Even the Japanese have only, at best, marked time since their bust 20 years ago. What hope have our debt-addicted politicians and voters got of making a success of printing money?

    Protect the currency. Revalue the 'assets' of distressed or insolvent companies (and banks) by putting them up for sale or auction. Sell the assets for what you can get. Companies go bust. Shame. Companies get bought for peanuts. Shame. Companies continue to produce product that folk want to buy unencumbered by servicing the debts that their previous muppet management (and shareholders) saddled them with? I'm not seeing any down-side here. The ones who took the risk (and lost) get caned. The ones who kept their powder dry clean up. That's how it's supposed to work.

  • Comment number 5.

    Hey, the US government's $700 billion bank rescue package didn't work! So double the bet! Make it $1.5 trillion! If that doesn't work, we could always try $3 trillion. Or $10 trillion. Or $100 trillion.

    Stephanie, your description of a $1.5 trillion dollar package as "penny-pinching" and "minimum cost" really does beggar belief. This is an astonishingly big package. Stupidity on a scale that makes even Mr Brown look prudent.

    And it's all designed to "stimulate more lending". And it won't work, because at the same time other parts of the government are conspiring to make lending unprofitable (by keeping rates low) and snapping up what credit is available, to fund ever-growing structural government deficits.

    If you really want to solve the problem, we need HIGHER INTEREST RATES (to encourage bank deposits and lending) and MUCH LOWER GOVERNMENT SPENDING (to get out of the way of private borrowers). And both of these will hurt. But not as much as these insane "stimulus" packages will hurt, as they wreck what's left of the financial system.

    The markets reacted badly because the markets are not stupid (even though individual participants - and journalists - may be).

  • Comment number 6.


    Is this the last roll of the US dice? The decision appears to be that 'originate and distribute' is the way ahead and the US is to set its own bank capital buffers and incentivise the bundling of its domestic debts to attract global investors.

    Isnt the joint legacy asset fund a means to attract foreign reserves to share the risk on US bank offal.

    What is the extent of cross fertilization between the UK and US initiatives. What I mean here is that RBS's assets comprise substantial credit card, car and mortgage loans in the US. We, the UK taxpayer, are underwriting these. Are the US initiatives underwriting loans to UK families and businesses? Can we have some figures?

  • Comment number 7.

    I've just had a bit of a spooky thought. There's a wildcard in this equation that people seem to be overlooking: sovereign wealth funds.

    I think the government(s) is(are) going to have to turn a blind eye to SWF purchases in the UK and the EU.

    These people have trillions to spend. Discuss!!

  • Comment number 8.

    You can play with theory. You can amend mechanisms. You can even call black white. BUT In the end you have to be able to back up your promises with cash - and cash that has value.

    Even the mind boggling figures that have been thrown about today are not enough, according to some analysts, to save JP Morgan. As for saving the whole US banking system - FORGET IT.

    Even if you can save the US banks then you have to look to an Obama style rescue package for the real economy.

    Sorry folks, the game's over.

    In the UK we had better start to build a new kind of reality now. The tsunami is getting closer and closer.

    If I were a bookmaker, I'd be giving the US very long odds on the chances of success.

  • Comment number 9.

    I agree with U9461192's comments. People spending above their limits is what has gotten us into this mess both in the US and the rest of the world. The problem is the scale of the US melt-down is also dragging the world with it.

    A little common sense goes a long way. So, I drive a 1988 Chevrolet Beretta that cost me very little and paid off in cash at purchase, I rent a very small house for very little per month. I don't have cable TV (don't really watch much TV). My electric is is low, my phone/internet is normal. My biggest expenses are in the winter with fuel oil for the furnace every 2 months or so. All of that and I make middle income ($50K) per year. And I always end up with some excess $$ going into my savings each month. I have a new flat-panel TV because I SAVED enough money for that and bought it in cash. I would love to have a newer car and I will once I SAVE enough money to buy it in cash.

    Families buying $200,000-$300,000 houses when they can only really afford a $100,000 house are killing us. Financial firms all making shaky and risky investments are killing us. Corporate executives taking $20M bonuses are killing us.

    Common sense! It seems everyone lost it over this past decade.

    And now here we are with these latest announcements. I get to hand over to my son (and his son, and his son, and his son, and his son probably) a country with trillions of dollars in debt that he will have to work to help pay off.

  • Comment number 10.

    #4 & #9

    Welcome to the club. The most irritating thing is, that even when the governments are destroying the currency to try and save them, the banks are not passing the rate cuts on to those in debt but are simply slashing savings rates.

    Likewise the market reaction to the new Obama/Geithner plan shows that the market had been expecting a free lunch and walked out when they didn't get it.

    This arrogance beggars belief. So far no-one has given me a good explanation as to why we cannot hike interest rates, let banks and other firms which have borrowed irresponsibly fail (there is far too much productive capacity at the moment anyway), and then let the responsible and newly founded firms take over. It will be bad, it will be gruesome, but we will be through in 18-24 months rather than condemning ourselves to a decade of woe.

    I suppose the government is worried that the responsible firms are all from overseas......

    Stephanie, any chance of a blog clarifying exactly why we can't do this?

  • Comment number 11.

    "this plan will fail to do what the administration desperately needed it to do: instill confidence, finally, that the world's most important government will do whatever it takes to put its financial system right... the market's negative reaction suggests that so far, at least, he has not achieved that goal. "

    The market's reaction has been negative to all the proposals made so far, even before the inauguration. See here for a recent example. The market seems to have decided that, if inflating the money supply and giving away nearly free credit and government intervention in the market are what created the mess, then more of the same won't get us out of it. What if the market was (gulp) right?

  • Comment number 12.

    And this enlightenment arrived yesterday from my local House Member(Democrat) John Tanner, who emailed his justification for voting for the Pile o' Pork making its way through Congress:

    And the call for stimulus is particularly broad given the fact that, with the federal funds rate at nearly zero, monetary policy is fully exhausted. Fiscal policy is all that remains in the government's arsenal.

    In other words: We have no plan B! We're not at all sure any of this will work, and we are totally stumped and unprepared for the eventuality that it won't work. But, we must vote for it, because Pres. Obama says we must. We have to appear to be doing something, so let's go spend a bunch more money WE DON'T HAVE!

    Just before Geithner began speaking, sell orders began to flood the NYSE. A reporter on the floor heard the traders all shouting at once, like a small riot had begun...and was told what was happening.

    Then Geithner began his address, and the market just kept dropping. And it looks like it still has a ways to go yet.

    Obama and company are in way over their heads. The inmates run the asylum in Congress.

    Remember, between 47-48% of the popular vote went for the other fellow, flawed as he was. They are voting with their feet and wallets, and Obama, Pelosi and Reid are powerless to prevent that.

  • Comment number 13.

    Given that nobody can know what the best policy is, Geithner's plan doesn't seem too bad.

    Undoubtedly there are good arguments for nationalisation. But this plan helps to address one of the key dangers of nationalisation - the 'knowledge problem'. I have written more about this here:

  • Comment number 14.

    #7 FrankSz:

    The only SWF wildcard is forced redemptions. For example when a developing world export economy finds its revenue, currency and employment under pressure and faces unrest. Then the government has to spend. And since it may be unable to borrow debt, it will sell the debt it owns. There are many facing that possibility. The only places with the money to buy bond issues are pensions and equities.

  • Comment number 15.

    In the good old days, the central banks were regarded as the lenders of last resort. Now, they're fast becoming the customers of last resort.

    Hey, if you've no customers for your products, or if you want to sell your assets in distress, the central bank will buy them.....
    The central banks will then store them up and resell them at a profit when the economy returns to normal......

    To my mind, this is no way to run an economy. I don't know about the thin end of the wedge, it's increasingly becoming the fat end.

    Unfortunately, the State can't take the place of the private sector, otherwise why would we bother with a private sector at all.
    Oh, I just remembered, it's the private sector that generates wealth, and the public sector then spends some of that wealth. Also, its unlikely the economy will return to "normal" in the next 5 to 15 years......

    In their desire (panic) to be seen to be doing something, the western governments are throwing good money after bad. It won't stop the bust, but it will waste billions in a vain attempt to slow down the bust. Hence, the recovery will take even longer, as the State will have spend itself hollow.

  • Comment number 16.


    What about the possibility of CIC spending a trillion on European assets? This could cause other SWFs to pile in, boosting the Euro, sending other currencies into a tailspin?

  • Comment number 17.

    Adam C: "Stephanie, your description of a $1.5 trillion dollar package as "penny-pinching" and "minimum cost" really does beggar belief."

    I've added an update on this - see the post above.

  • Comment number 18.


    It was heartening to see your post and your update. We may talk a load of 'bunk' at times and waffle-on about the same thing but, it is really good that you do have a look at what we are saying.


  • Comment number 19.

    If the world's banks and many of the financial business were properly valued using say mark to market today they would all be bankrupt.

    However legal bankruptcy only functions when there is still a functioning global financial system to allow the assets to be sold on and the good parts rescued - this is not the present condition.

    We are thus all up the creek - no paddles - not even a boat!

    So what to do?

    The world's financial system has to be not just bailed out but radically restructured. The latter element is being fudged. This restructuring has to happen before the natural bankruptcy process is allowed to run its course - which must happen. I am very well aware that trained economists do not understand this because of their poor and illogical psudo-scientific education, but this is nevertheless true.

    As an aside consider how it is possible to recycle overvalued assets (the purpose of bankruptcy) when there is no means of money transmission (i.e. working banking system)?

    The US plan for a 'Toxic Bank' logically fails because it does not address the restructuring of the non-toxic banks.

    The Glass-Steagall Act of 1933 established the Federal Deposit Insurance Corporation as well as dividing banks between the high street banks and the buccaneer banks. These buccaneer banks or 'investment banks' historically financed activities that would today be such as close to piracy on the high seas .

    This has to happen again. The boring banks - the Mr Mainwaring Banks must be separated out - preferably transnationally and these must be rescued. The buccaneer banks should be let sink or swim.

    However it is quite critical fro the public to agree to this rescue that the Mainwaring Banks suffer strict supervision of their employment contracts - i.e. no profit based bonuses at all.

    How much will this 'cost'? no idea and anybody who says they do will be wrong.

    I would hazard a guess that a way to find out would be to do a zero-based budgeting exercise on running the branch network and the central accounting and management and that will give a guide to the cost. The revenue can only be established after the return to sound money (i.e. when borrowers pay a reasonable cost and savers and investors get a reasonable return.) The difference between this will be the working capital - with hopefully a return to self-sufficiency at some time. (My guess is in the last third of the next decade.)

    But please note that I have outlined how to go about rescuing the boring banks. The Geithner plan seems to be jumping too many hurdles at the same time to be really useful. The figures that they put upon things suggest that they have not really appreciated the fundamental nature of the problems that they are faced with and that is the total collapse of the idea and reality of money - similar to that which occurred when the Romans left Britain in 410AD. (It is unfortunate that the Dark Ages have not left us with any even fragmentary records on what to do!)

  • Comment number 20.

    Mervyn King says there is a significant risk the recession will be deeper and last longer than expected.

    Please tell us something we didn't know....

    Most commentators regard Mr King's past expectations as wildly over optimistic. With his heavy burden of responsibiltiy, Mr King is obliged to talk up the economy, to avoid denting confidence even further. This duty to support consumer and business confidence applies to politicians, corporate executives, journalists, brokers, agents, officials, and civil servants.

    These duty-bound persons cannot moan and blow off steam in the way we posters can in this forum here. We posters are free from such constraints, even if we can't escape the affects of the recession/ depression.

  • Comment number 21.

    Yea! Whatever. The fact is those maxed on credit have no money to spend and now those with savings are probably too frightened to spend. Whether people can borrow personally or have the borrowing by proxy through the government neither makes sense.

    The depression (which I believe the word Brown consciously used) has come in waves and I think we still have two or three to go before the economy bottoms out. After that - who knows!

    If the government want to stimulate the economy bring uprating benefits and minimum wage forward.

    Whilst waiting for the economy to stablise try spending on sustainability and elimination of poverty.

  • Comment number 22.

    stephanie I'm impressed to learn that you actually read posts on your blog! if only Peston did, he might have picked up a scoop or two

    I watched Geithner and thought he looked scared; Obama remains hugely popular but the expectations of the general public are impossible to manage. And a honeymoon isn't really feasible in this crisis. The US public's hatred of the bankers and fat cats on Wall Street is much stronger than the anti-bank feelings here. Hence the US govt have to be careful on any further bail-outs. The Geithner plan has attracted furious criticism on blogs such as NY Times all the way down to local papers as it is seen as being too favourable to the banks.

    But the NYSE doesn't like it either because they want a totally blank cheque. The idea of any kind of a BAD BANK scares them. I can't see how any of this is going to work. Putting a price on a toxic share - even at a very optimistic 70 cents in the dollar - will confirm tens of trillions of $ of write-downs and show that every big US (and UK) bank is insolvent.

    As #8 foredeckdave says above, even JP Morgan might start to sink. And definitely BoA would, as they have been poisoned by swalled Merrill Lynch. And CitiBank are looking very ill. And on and on. Next week it's time up for GM and Chrysler to come back with their magic bullet solutions by the way. I would like to be optimistic about the Obama administration's chances of turning this thing around but I don't see how they will manage it right now.


    #19 john from hendon you're right that there isn't much recorded about what happened after AD410, when the Romans finally abandoned Britain, but there is a lot of archaeological evidence now

    the population of Londinium and all the other urban centres dispersed to the countryside to eke out a tough life of subsistence; London was slowly buried under a layer of 'dark earth' - a soil horizon you find on abandoned sites - nobody there but worms!

    in other words Market Gardening, just like a lot of bloggers on here and on Peston's blog say that we should be taking up again before it's too late

    it didn't work very well in the 5th and 6th centuries, as the population probably fell by half; people just starved to death or froze in the winters

    no idea what the GDP was in AD 500 but you can be fairly sure that someone who wanted to be in charge of things was claiming in AD 410 that Britain was facing a 'short but deep V-shaped recession'

    The City of London was refounded by King Alfred in the late 9th century, so the downturn lasted about 450 years

  • Comment number 23.

    One possible solution could be the adoption of a command economy. Not only would the UK be able to deal on more amicable terms with Russia and China, who have great resources, but the unemployed and the criminal could be driven at gunpoint into building literally thousands of wind turbines and wave power stations, thus enabling the UK to build an economy based on free energy.

    After unemployment reaches 30% this could be a viable reality.

  • Comment number 24.

    hi Stephanie et al

    here is a link to what the NY Times thinks about the latest US rescue plan proposals, which they say could cost $2.5 trillion

    they suggest that the lack of detail about how a BAD BANK would work is undermining confidence in the plan; and the whole problem of how to put a price on a toxic asset - the banks don't really want to open their books either; and hopes that the so-called vulture funds would want to buy the toxic stuff seem a bit unlikely

    all seems to be a bit of a Gordian knot for Obama, though he can count himself lucky not to be burdened with our Gordon........

  • Comment number 25.

    Now here's a first (though it is possibly a second), I AGREE WITH John_from_Hendon!!

    John wrote "The world's financial system has to be not just bailed out but radically restructured. The latter element is being fudged. ". John, you are so right.

    I am beginning to believe that it is impossible to bail-out the banks. The asset 'values' are just too big and there is no mechanism too even place a true value on them. In the UK and the US more and more precious resource is being pumped-in to no good effect. Therefore we need to do 2 things as a matter of urgency:

    1 Divorce the high street banks from the investment banks - what is becoming known here as the Mainwaring Banks.

    2 Establish an International Trading Authority to oversee all international transactions.

    Where I diverge from John (I think) is to immediately divert the government funds from the banks to a National Emergency Programme which is charged with the responsibility for protecting strategically important companies and sectors and leading a national effort of research and development.

    King's statement today and Brown's slip of the tounge identify to me that both of them are recognising that we are in the teeth of a full blown Depression. Therefore we must look to ourselves, as much as possible, to ensure our economic and social survival.

  • Comment number 26.

    Private investors won't touch this with a barge pole in its current format... so will 'uncle sam' raid the piggy bank? now, that will be toxic to some...

  • Comment number 27.

    Time is running out. The BofE now says we are in deep recession with the economy shrinking by 4%. Well that's hardly a surprise when you look at all the big successful companies announcing 5-10% redundancies. However I fear that is only the start with the initial shrinkage threatening to cause a downwards spiral of unemployment and reduced demand. That is unless the Government gets its act together now.

    There are many sensible suggestions by posters on this blog and elsewhere. Sort the banks out by splitting the high-street banks from the investment banks. Instead of fiddling around with interest rates, use major fiscal stimulous to counteract the ongoing deleveraging of the banks. If ordinary citizens are too scared to spend, then employ builders, engineers etc to produce public sector infrastructure improvements and public sector housing.

    It's not a case of which of these is the answer. All are needed, and now. In addition I would strongly suggest changing the tax system to make it cheaper to emply people (replace allowances and benefits with a Citizen's income, switch from employment taxes like emplyers NI to other forms of tax such as carbon taxes or high levels of tax on top earners).

    But most of all. stop dithering!

  • Comment number 28.

    Maybe, by some miracle or divine intervention, all those derivatives contracts on the retail banks' balance sheets will turn out to be in the money, and the crisis will resolve itself.....

    Many commentators still think that stock markets know everything, and have priced in all likely future events today. What amazes me is the markets still believe a stimulus plan here, or a bail out plan there, will make all the difference. When the markets finally realise that governments can't create money out of thin air, the resulting plunge in equity values and asset prices will be dramatic.

    Given the enormity of this crisis, the punch line "and the FTSE even fell by 37% peak to trough" does not fit the bill.
    A fall of 50%, or even 70%, is more fitting for this story. And we shouldn't expect the markets to bounce back quickly afterwards.

  • Comment number 29.

    I haevn't read all of the comments so excuse me if this in part is repetitive.
    I think that the current problem of how to value so called 'toxic' assets is the major stumbling block to quantifying the true extent of detiorating bank balance sheets and ergo, assessing the level of capital that needs to be provided to strengthen balance sheets.

    From a pure finance perspective the toxic assets consist of an underlying asset, an expected cashflow and a borrower to whom the loan was advanced.

    Since in most cases the expected cashflow is the known value then it would be more practical to look at the value of the expected receipts and the ability of the borrower to meet all or part of that obligation.

    This would assume a nil value to the underlying asset. The issue is then the current position of the original borrower to repay the debt and /or the ability of any investor guarantee to be called on.

    In the case of mortgage backed securities, both UK and US governments should consider acquiring the underlyingassets at nil value and apply a discount factor to the expected cashflow in order to arrive at a natural 'transfer' price.

    Since the Government has a wider 'economic interest', it could reflect the potential cost of alternate housing provision and consequent cost to treasury of welfare payments in arriving at its discount factor.

    Property assets acquired could then be released for social housing or where owners are still in occupation, they are transferred to a social landlord for management etc.

    Thus, the banks receive a fresh capital injection, free of these 'toxic' loans. There would be a consequent increase in social housing stock at a price that would not be attained in normal markets, with the surety that individuals otherwise made or potentially at risk of becoming homeless can be re housed.

    The additional factor of fewer properties being sold at auction and thus minimising the downard price pressure on existing real estate stock would go a long way to stemming the potential of further degrading mortgage loan books.

    In respect of commercial loans, the same is true. Apply a discount factor to the loan derived from the value of outstanding recievables against the existence of and ability of the business to meet the loan. Economic support for SME sector business would come via the valuation of the loan and an easing of the threat of banks forclosing, as the tighten their lending position.

    If the effect is to give the banks 50 cents on the$ then this is a fair trade for keeping people and business going. What is then required is an asset management and recovery business which could attract private capital as a viable long term solution.

  • Comment number 30.

    Perhaps another first, I agree with foredeckdave

    I think the world's financial and political leaders are taking too long to come together on this.

    There are economists who forecast this crisis and proposed a central international bank for regulating international trade as far back as 2001.

    Then there was Keynes who wanted something similar at the original Bretton Woods meetings, but got vetoed by the US, who wanted a dollar centric system with the IMF under their control. It was said at the time that the world would come to regret it.

  • Comment number 31.

    #22. somali_pirate_SP500 wrote:

    "no idea what the GDP was in AD 500"

    Go on guess - some academic (see wiki) has estimated GDP from the 1st century, through 1000AD, 1500 etc.

    That work suggests that even 1000 years after the Romans the GDP had shrunk by about two thirds in Europe. Some recession! (No clue how it was estimated!)

  • Comment number 32.


    SWF investment policy is primarily determined by basic domestic needs. When running massive trade surpluses and facing inflation from inward flows of capital, they sterilise the flows by purchasing foreign assets, especially debt securities. This has the added benefit of lowering the interest rates of their primary customers, allowing consumers to finance purchases of their goods much cheaper. It is the virtuous circle of which bubbles are made, and it can run in reverse too. As consumers reach their debt capacity even under a zero interest rate policy, those trade surpluses fall precipitously, the exporters' governments face budget shortfalls and they will sell foreign assets to repatriate whatever capital they require, or can get, to meet operational needs.

    When the latter happens, the arrival of other buyers will not stimulate buying on their part, because the trades are not purely about investment gain in the classical sense, nor is confidence the issue.

    The issue is the social contracts common in the countries which tend to have SWFs, namely state spending which buys public allegiance or acquiescence in the absence of traditional or earned legitimacy, and their almost complete dependency on an undiversified offering of exports to finance it. Frequently they have insufficiently large internal markets to consume more than a small fraction of their production, and a high credit risk that acts as a barrier to borrowing of their own.

    Ultimately SWF redemptions will be initiated by their respective welfare states. Every overseas buyer then becomes a bid to sell into. They will liquidate into us to whatever extent we allow and ramp our interest rates once their domestic needs become sufficiently urgent.

    If the Federal Reserve and Bank of England start buying yields lower into this, what do you think will happen?

    I will tell you: the flash from our balance sheets will be seen from Neptune.

    It may be a wildcard, but it is in the deck.

  • Comment number 33.

    #29: "Property assets acquired could then be released for social housing"

    In Britain at least, much of the stock of new build flats is not suitable for social housing. Wrong architecture, wrong materials, wrong location for anyone but uncommitted young professionals renting from an agency. I have seen them thrown up. Plasterboard internals, large expanses of sheet glass, no rooms for the kids, and city centre locations with a footprint the size of a postage stamp mean no room outside. A lot of the avant garde architecture on display arose from inhuman space constraints. They would become the new slums with none of the space or durability to last more than a fraction of the lifetime of the last lot. Recovery will be near zero because they cannot hold their value if repurposed.

    The same goes for commercial real estate. There is a widespread assumption this is a mortgage crisis, actually the most troublesome asset backed paper is derived from out-of-town office and retail developments which will lie ever more empty as companies shrink. Without rent, the expected cashflow itself is already under immediate threat and whoever gets stuck with the property will face gargantuan maintenance costs. This is one reason banks are reluctant to foreclose, they know the asset collateral can literally become a liability.

    There are some nice ideas out there, but there is also a fair amount of lead that cannot be turned into gold either by markets or governments.

  • Comment number 34.

    #24 Somali_pirate_SP500

    If banks are not willing to open their books and actually write off the losses on toxic debt, then why should they expect the tax payer to help them out? Make full openness and accountability a prerquisite for any further aid and if banks are so bloody minded that they won't open their books then let them go under - with that attitude the chances are that they would have squandered the money anyway.

    Interesting to note that the EU Commission is proposing that any asset sales to a bad bank be done at mark to market levels, even 5 cents on the dollar/Euro/Pound if the market is not functioning, so that there can be no back door subsidies. If a bank is left unviable by such losses then they propose bankruptcy or nationalisation.

  • Comment number 35.

    Re #32 - WerringtonSilent

    I hadn't even thought of the reverse process. Yes that is another possibility, and should it happen I imagine the whole affair would be pretty dramatic.

    However I see it as unlikely. China needs resources. It's no surprise they bought a chunk of Rio Tinto. They will just wait for labour in places like Australia to keep dropping, then suck their land dry.

    I think they plan on a couple of things:
    a) The right investments now could help keep exports up just a little longer
    b) When the price is right, get off the dollar cycle and run a domestic economy, fueled by overseas low cost mining, logging and etc operations

  • Comment number 36.

    They will want resources, but not debt. With exports to western economies collapsing and currency reserves finite, securing resources and rolling the maturing debt of developed nations will eventually become competing interests due to budgetary constraints. At that point, they can secure discounted prices on the former by declining to do the latter. What would be the price of any industrial or agricultural concern when the owner's currency is in the toilet, interest rates are north of 10% and an overseas buyer is offering foreign exchange in cash?

    This presupposes that their system of government will even survive the crisis, an assumption I would not make without a few caveats, and the same is true of others like them.

    Interesting possibilities though.

  • Comment number 37.

    I think the command economy is more ready for the crisis than a democracy. The natural and logical progression is for command economy and authoritarianism to emerge in the face of poverty and unemployment here.

    I do not understand what you mean by debt. My point was that the SWFs would be here taking stakes in corporations, buying land, etc. If you are mentioning debt as a separate topic, then yes I agree, they want to diversify from debt and especially dollar debt.


  • Comment number 38.

    No. 37 FrankSz

    Britain was the first to the Industrial Revolution, and the first to the Service Economy Revolution. What remains of our manufacturing industry is now foreign owned, which means its cash and profits are taken back to the parent company abroad by way of a dividend.
    (i) The British car industry is mostly owned by America, Japan and Germany. Although it provides employment for British workers and tax revenue for HMRC, the wealth created by the net profits is repatriated back to those countries;
    (ii) Even QinetiQ, which was once the government's defence research agency, has been privatised and sold to an American company;
    (iii) The British nuclear industry is owned by the French;
    (iv) Investment banks in London are owned by America, Japan and Germany. The Spanish own some British retail banks.

    It would be very difficult to impose a command economy on this infrastructure. Nationalising these industries would not go down well abroad, meaning the British government wouldn't be able to borrow any money, as a large proportion of gilts are bought by foreign investors.

    On the other side of the coin, British companies do have investments abroad. Vodafone bought a German company, BAE Systems is quite big in the USA, Shell and BP are involved in joint ventures abroad, etc. We would lose these investments if foreign governments brought them under central control in a tit for tat exchange.

  • Comment number 39.

    Oo I think that in the face of 20% to 30% unemployment, foreign assets would be seized. The problem is that it provides the environment for extremism to flourish. Poverty, boredom, purposelessnes, frustration and violence go hand in hand.

    Under these conditions there is a need for leadership and direction, ideologies propagate through the minds of the unthinking and confused.

    It would be reasonable in such an environment to expect events similar to a repetition of the rise of National Socialism in post-depression Germany.

    ...Or on a more contemporary parallel, events similar to the rise of fundamentalist Islam amongst the unemployed and disenfranchised regions of Saudi Arabia. ...or militancy in the besieged of Palestine...or etc

  • Comment number 40.


    My feeling is a command economy would actually make ideological extremism more likely. A command economy is itself a form of extremism, and is more likely to bring about the things you wish to avoid.

    It would be a case of "divided we fall". I believe the USA, Britain, Europe and Asia must support each other. Although it never gets mentioned much, the Commonwealth is also very important for British trade. We have to stand shoulder to shoulder and hold the line; the world must come together, not drift apart. We cannot fall into panic and disarray. The pressure for protectionism will be great, but Britain will be weakened by standing alone. We have no great empire to back us up anymore, we rely on the goodwill of our friends and neighbours.

  • Comment number 41.


    Yes, indeed. What I am suggesting is that a command economy could well emerge as a consequence of extremist ideas gaining footholds in the minds of the mainstream.

    That is, with 20 to 30% unemployment, or what have you, we could see the rise of extremist political parties, or a crushing resistance of them by the existing elites.

    I agree also about global unity - I think the solutions lie in global administration, but I have little faith in the current leaderships to arrive at a consensual agreement until the domestic social pressures reach an unbearable level.

  • Comment number 42.

    FrankSz (#41) "What I am suggesting is that a command economy could well emerge as a consequence of extremist ideas gaining footholds in the minds of the mainstream."

    Was it extremist ideas which gave us the welfare state after WII? I suggets it was fear-mongering about statist extremism which brought that down after 1979 - in fact, what people had laboured for was sold off which provided an illusion of growth which was really just anarchism.

  • Comment number 43.

    #37 FrankSz wrote: "I do not understand what you mean by debt. My point was that the SWFs would be here taking stakes in corporations, buying land, etc. If you are mentioning debt as a separate topic, then yes I agree, they want to diversify from debt and especially dollar debt."

    You understood; foreign especially sovereign investors want to move away from debt securities and into something of more tangible value. Signals of changing sentiment have materialised in the form of requests for assurances and guarantees which have been coming more publicly and frequently. Like all creditors, they are growing ever more nervous about continuing to lend money and are beginning to make noises about it. More direct forms of investment may indeed follow, if they can afford it when we are no longer buying so much of their output. But as the CNOOC/Unocal and DPW/P&O affairs showed, this is a politically hazardous exercise even at the height of a historic boom, let alone a time of retrenchment.

  • Comment number 44.

    Lets go back to basics. Ultimately the prosperity of the world economy depends on productivity. Companies need to produce goods that people need and want and we need a sound infra-structure. Core to this retaining a high level of employment. Banks fail, other companies can't get finance where necesary and start to fail. People out of work can't afford their mortgages - the value of those "potentially" toxic mortgages is revealed to be less and less. Bank mortgage assets are worth less, more start to fail etc. etc. repeat. So commentators that like the idea of a letting this unwind quickly without the big support packages need to think quite carefully. Maintain productivity and employment and you will see those 'toxic'assets are really not so toxic and worth something after all.

    One solution to avoid such chaos is clearly to nationalise banks at least to an extent to avoid falls. We know from historic experience however that extensive nationalisation ultimatelydoes not provide proper productivity stimulus and creates too many inefficiienciences. Mrket forces are needed to ensure we produce goods/services that people need and want efficiently.

    Markets went off the rails because too many companies leveraged up too far using rising markets to effectively maintain this plan.

    But, yes we borrowed too much but that borrowing ihas effectiely stimulated productivity else where in the world - China, India and Japan etc.

    If we go into our shells now then that won't do the whole world economy any good.

    So the US i is looking to stimulate and maintain the economy. Support those in housing to support in part the value of those potentially toxic assets. It doesn;t want to remove the market forces - but then it must ensure good bank regulation. The Us can't spend too much money on the banks now - it needs funds to stimulate the economy elsewhere. It all makes sense just about but yes - there needs to be market confidence and unfortunately this package has not done anything for that yet.

  • Comment number 45.

    I do not see how your recommendation follows from your assessment.

    'Too many companies with too much leverage, we borrowed too much, we need to produce goods that people need and want, etc...'

    Yet your solution appears to be more of all those things that went wrong. "If we go into our shells now then that won't do the whole world economy any good," you say. We have derived too much benefit from the debt spiral to abandon it now, is the implication. I do not think it has any life left in it. I could go out and buy several cars from indebted car manufacturers right now, but what would I do with them, stick them in a box? And why should they make more when the sales would come from months of inventory?

    I think we are suffering from a crisis of too much of everything. The demand fundamentals are not there to justify either the prices or the jobs. Give every worker an award for productivity so awesome it has saturated the market for the decade to come. We have earned it.

  • Comment number 46.

    Re: comment above. Are you actually saying "going into your shell" is a good idea? Even if deeply in dept you shouldnt go into your shell! Basically you should work harder to pay off you debts!!!! Which brings me back neatly to the productivity point! If I got into debt that is what I'd do!

    The other point is you can easily go too far the other way from historic bad behaviour if you get burned - something that i should have stressed is the problem is usually over-reaction.

    In good times some companes, specifically banks here, go way over leveraged because they could get away with it only in the rising markets and good times. Really banks should be more secure - they shouldnt be the big risk takers.

    Now there can easily be an over-reaction the other way. Only really in terms of where new money is really needed for companies to conitinue proper operation that is being denied finance because banks have become too scared. New business has need for capital and finance to be the fresh roots for recovery. (Banks if they are sensible can manage, spread and "re-insure risk to help their security). Banks need to support - they are getiting it (although the amount is still debatable)

    The underlying reality of the economy doesn't change to such extreme that seems to be reflected in the financials that are just being far too volatile to reflect really the true value. Our economy is really not that bad - but we can make it bad by compnies failing and laying off workers because it can be a downward spiral.

    People who are in debt by the way shouldn't make things worse for themselves by getting deeper into trouble.* However I dont think its true to paint us all as debt ridden. It is true that many perfectly run companies need to be able to run properly. Many people with savings (rather than debt) such as myself want a mortgage to buy a house. I.e banks can't simply shut up shop.

    *Governments need to manage their debt againts economy stimulus - at the moment I think its right to provide the stimulus but would have to agree that the debt management needs to be considered carefully.

  • Comment number 47.

    I think perhaps my first comment in my response above was a bit hasty. In that, paticularly for an individual, if you are in debt badly you do need to cut back on your spending. Working harder is also good but may not be possible. It is the obvious sensible point so is a valid one. As a model for a whole economy however, cutting demand is not quite so good. We may, and are seeing cut backs and have to accept that. However the debt on the economy is no where near bad enough for us to ruin our overall productivity on the misguided opinion that it will cut out debt. Remember as well that we should be looking at exports as an important factor as well now, particlarly given the current exchange rate.

  • Comment number 48.

    AndyW, the most appropriate and responsible action to take with respect to serviceable debt is to repay it as quickly as possible, and with unserviceable debt, to default it. Everyone must be given the information they need to distinguish between the two.

    Here is why:

    * Debt interest crowds out demand. *

    I want you and everyone else to think long and hard about this, and understand exactly what is being said.

    Demand only materialises with means to pay. Cash is one means. Debt is another, with interest acting as a fee for pulling demand forward in time. This has legitimate uses. But interest compounds, and left for a long enough time, or permitted to compound on a large enough base, it displaces demand and acts as a parasite, sucking out the earnings that would facilitate demand, disproportionally to the benefit conferred in the original transaction.

    Honouring such debt contracts means neutralising that entity as a source of demand for a protracted period. In some cases (25 year mortgage beyond reasonable affordability), forever.

    Now, default does several things.

    1. The lender and borrower share the loss of the bet they made not working out. The former makes a loss on his loan and has an incentive to price risk more accurately in future, the latter loses the collateral (if any) and has to work for several years to rebuild his credit history.

    2. Freed from onerous interest payments, the ex-borrower can use his earnings to create demand.

    Repayment does several things:

    1. Lender and borrower take the profit or (in some cases, depending on assumptions made originally) loss.

    2. Once freed from interest payments, the ex-borrower can use his earnings to create demand. However during accelerated repayment, demand is suppressed.

    Either way, in the short term the economy is depressed, but sound fundamentals are laid for rebuilding in the long term, by unencumbered companies and individuals.

    This is what I mean. Everyone should review their own situation, acts dispassionately and the short term consequences are accepted come what may.

    The alternative, attempting to artificially stimulate demand while debt interest hijacks the disposable income of the nation at an exponential rate and destroys demand even in healthy sectors, will see the economy collapse. The debt growth curve, unless dealt with, will pulverise everything.

  • Comment number 49.

    Admitting I have only had a "first read" of what you say, i do have couple of points:

    Yes cutting back spending if in too much debt was meant to implicilty imply you were using the saving to pay back your debt. Being more productive also implicity was meant to imply you could better pay back the debt.

    I wouldnt at present though get too carried away with the point about interest rate hijacking income while the base rate is just 1% :-). Too high interest payments is not really the problem causing the current crisis (and yes with lower current interest rates people can repy debt better) . For many who already had mortgages (not fixed ones) they have seen a drop in their out-go for example. With my mortgage I'm paying alot less than if I was to rent currently. Interest rates can be this low at the moment because banks are so reluctant to lend. Once this changes, yes interest rates will move up but an extra 3 or 4% for example is hardly much (considering history). This would actually be good as well and will hapen with more banking confidence.

    One of my main points in all this is that you can get a bit too carried away with financial concepts while in the end the health of the economy depends on employment and productivity - although this needs to be productivity that improves everyones well being in the end. In part this needs proper market forces, keeping demand at a reasonable level and banks that can lend where required. Its almost impossible to start new business without that really. (i'm starting to repeat myself.. so I'll stop)

  • Comment number 50.

    #49 AndyW wrote: "I wouldnt at present though get too carried away with the point about interest rate hijacking income while the base rate is just 1%"

    A variable rate mortgage is one type of debt the burden of which has eased recently, but personal loans, credit cards, car finance, corporate debt (especially rolling over of maturing facilities) all add to the wider problem. Corporate debt in particular will generally refinance to much higher rates, while declining asset prices and more desperate competition damage revenues. You have to look at the really big picture - nationwide measures of personal, public and corporate debt and comparisons to GDP to see the damage interest service is already doing and will continue to do to the economy. The interest rate environment cannot be assumed to be benevolent either. We may have years of zero base rate to come, or a Treasury/FX dislocation may force it to 10% in a matter of days. We cannot know. Carrying a high principal balance with that hanging in the air is very risky. It is better to accept the costs of restructuring now than to find oneself gradually squeezed to oblivion over the years (a process that has already begun) or destroyed without warning.

    Before we can talk about a recovery driven in part by employment and productivity, we need an unburdened consumer, be it household, public or corporate, to supply the demand. The latter must be recognised by policy makers as an absolute prerequisite to the former.

    Much of current policy addressing this point amounts to government supply of credit (ie more pulled forward demand) alongside attempts to discourage default or even accelerated repayment of borrowers' existing commitments. This is an attempt to eat the cake and have it.

    This interferes with market rates to an extent where risk cannot be accurately priced and liquidity ends up trapped, it continues to feed the overproduction that is in large part responsible for the collapse in asset prices, negating the normal effects of cheaper credit on those asset prices, and it ensures the debt already accumulated remains largely unchanged in size even as asset prices and revenues drop - in time leading to a fatal balance sheet squeeze.

    It is late so I apologise if this is a little unclear, but the essence of my argument is that unless we have a frank discussion about the carrying of nonproductive debt, we will have no demand on which to base either employment, productivity or recovery. And the thing about exponential behaviour is it only looks like there is a lot of time.


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