I don't really have much to add to what Paul Krugman has already said on the subject in a couple of posts in his blog. The approach is, quite simply, nonsensical. The relevant quote from the NYT article is the following:
Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60 cents on the dollar.
The approach of this administration, and of the previous one as well, seems to be that the investors are unreasonably risk averse, or irrational, or whatever, and they should buy the toxic assets at a price closer to what the banks want. Otherwise, you see, the banks would have to ''book huge losses''. Why the market is not working is left unexplained. The solution is simply to fill the gap between the 30 and the 60 cents with a huge public subsidy.
We can only hope that this approach will fail, the same way that it failed when it was first proposed in the fall of 2008. Yes, of course, we do need some sort of intervention. The point has been made by many, and I find this exposition by fellow game theorist Sandeep Baliga very clear. But there are many different ways to intervene. In a previous post I have tried to explain how to set up a better mechanism for price discovery of the toxic assets. Other ideas have been floated. Bulow and Klemperer, for example, have suggested a clever variation on the good bank / bad bank approach. As a minimum, if the administration is really unwilling to consider new ideas (but why?), it should at least consider some variant of the Swedish approach: let the banks fail, take them over, recapitalize and then resell them.
The plan instead is to use public money to help the creditors (other than depositors, already covered by FDIC insurance) and the shareholders of the banks. No explanation is given of why private investors are so reluctant to buy the toxic assets. What if the investors are correct in their assessment and these assets are really worth no more than 30 cents on the dollar? Why should the taxpayers bear all the risk? And what if the money is not enough and we keep having zombie banks? The whole thing is almost too depressing to contemplate.
Which is why they (namely, Geithner and Bernanke) do not, and instead try to buy time hoping that an economic recovery will eventually raise the assets prices again to match the debt backed by them (this is what someone called "a three-pronged approach: delay, delay, delay"). The fly in the ointment is that this can't happen, at least in real terms, precisely because the economic growth in the past decade was supported by a bubble in the real estate (consumption was fuelled by rising debt under the name of "equity extraction") rather than genuine increases in productivity. At that time the FED seconded this state of affairs by keeping the interest rates artificially low, and now its people (Geithner is the former president of the FRB of NY) don't seem capable to face the consequences of that choice. Had they carefully read their Adam Smith, they might have had a few doubts:
A dwellinghouse, as such, contributes nothing to the revenue of its inhabitant; and though it is, no doubt, extremely useful to him, it is as his clothes and household furniture are useful to him, which, however, makes a part of his expense, and not of his revenue. If it is to be let to a tenant for rent, as the house itself can produce nothing, the tenant must always pay the rent out of some other revenue which he derives either from labour, or stock, or land. Though a house, therefore, may yield a revenue to its proprietor, and thereby serve in the function of a capital to him, it cannot yield any to the public, nor serve in the function of a capital to it, and the revenue of the whole body of the people can never be in the smallest degree increased by it.
(An Inquiry into the Nature And Causes of the Wealth of Nations, Book II, Chapter I)
In other words, the fair value the real estate is determined endogenously by the level of economic activity, and trying to base economic growth on its increases is very similar in spirit, and in final outcome, to a Ponzi scheme where profits are paid to new investors out of new inflows of capital coming from other investors.
So where does this leave us? My personal opinion is that the strategy chosen in the end will be to unleash a bout of inflation sufficient to raise the nominal prices of the assets to the debt they back, thus healing the balance sheets of the banks (regardless of their ownership). And this explains the $1.15T of quantitative easing now in the pipeline (which may be just the beginning). Whether the inflation will be brought down quickly after doing its dirty work of wealth redistribution, or will keep lingering for many years, is anybody's guess.