The Banker Boys Are Alright! by Dean Baker

[Joanne98]

Treasury Secretary Timothy Geithner told the country last week that the banks are essentially okay based on his stress tests of the country’s 19th largest banks. Secretary Geithner’s call may not seem quite right. After all, the bad case in stress tests assumed that unemployment would average 8.9 percent for all of 2009 and we just hit that last week, but there’s no reason not to take the Treasury secretary at his word.

So, we are told that the banks have the means necessary to get through the downturn. In that case, why should we spend hundreds of billions of taxpayer dollars to keep these healthy institutions afloat?

As long as the banks were on their death beds there was a plausible argument that taxpayer dollars were needed to keep the financial system from collapsing. But if the banks now have a clean bill of health from the Treasury, then it’s time for the banks to stop relying on taxpayer handouts.

First and foremost, this should mean the end of the Public Private Investment Partnership (PPIP) program that was designed to clear the toxic assets from the banks’ books. PPIP involved a massive subsidy to the banks since it provided enormous leverage to buyers of toxic assets, while assigning them very little risk.

The basic story was that if an investor put up a million dollars, the government would put up $13 million. The investor would have the opportunity to profit on $7 million of this investment (her $1 million, plus $6 million of the government’s money), but could not lose more than $1 million. The government would profit or lose on the other $7 million that it put up directly.

Even assuming that there was no gaming of the PPIP (banks could pay third parties to bid up the price of their assets), this incentive structure would lead investors to bid far more for toxic assets than they would in a free market. The result would likely be that many investors would incur large losses with the taxpayers’ dollars.

If the banks were hopeless zombies, perhaps there is an argument for this sort of subsidy from taxpayers to clear the books and allow the banks to start lending again. But if Secretary Geithner is telling us that the banks are healthy, can’t we just let them sell their loans in the market like anyone else? What’s the argument for special bank welfare now?

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http://www.counterpunch.org/baker05122009.html