Titolo

The ''new'' Geithner plan

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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.