If Geithner Plan Fails, What's Plan B?

by: The Baseline Scenario

One of the determinants of how you feel about the Geithner Plan is what you think will happen if it fails. By “fails,” I mean that the buyers’ bids are lower than the sellers’ reserve prices, so the toxic assets don’t actually get sold.

Brad Delong, for example, is moderately in favor of the plan, even though he thinks it is insufficient. In his words, “I think Obama has to demonstrate that he has exhausted all other options before he has a prayer of getting Voinovich to vote to close debate on a bank nationalization bill. Paul [Krugman] thinks that the longer Obama delays proposing bank nationalization the lower its chances become.” (”Voinovich” is DeLong’s hypothetical 60th senator, whose vote would be needed in the Senate.) In other words, DeLong thinks that if this plan fails, the administration will be more likely and able to go forward with nationalization.

Paul Krugman, by contrast, is strongly against the plan, first because he thinks it has no chance of succeeding, and second because he thinks there is no Plan B. “I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second.”

I think the plan is likely to fail, or at least to be very insufficient, for reasons described elsewhere. I am also worried that the Obama administration has committed itself so strongly against taking over large banks that it cannot reverse course, at least not unless it sacrifices Geithner. So I expect Plan B to be more generous to the banks - which means it will have little chance of getting any money out of Congress (and the $700 billion will run out at some point). The increasingly friendly stance toward Wall Street also implies this course of events.

On the other hand, today’s reporting on what Bernanke and Geithner were actually asking for yesterday is a little bit promising. From The Wall Street Journal:

The bill, said Treasury, would cover financial firms that have the potential to severely disrupt the U.S. financial system. That would include bank holding companies and thrift holding companies as well as companies that control broker-dealers, insurance firms and futures commission merchants.

On my read of this passage (I haven’t seen an actual bill yet), the proposed legislation would enable regulators not only to supervise bank holding companies, which they can do today, but to take them over and wind them down just like the FDIC can do with depository institutions. If Treasury and the Fed have this power - and I think they should have it - it could improve their negotiating position relative to the big banks. It could also indicate that the administration wants to have this power in its back pocket just in case it needs to use it. (Using the AIG scandal to get this power is a clever political move.) I still don’t think this is Plan B, but it could mean that they want all options open.

Update: More information on the proposed new bill in the WSJ.

Treasury said the draft bill would enable the federal government to seize troubled bank- and thrift-holding companies as well as firms that control broker-dealers and futures commission merchants.

An Obama administration official confirmed that the legislative proposal would also give the government authority to shut down troubled hedge funds, which currently face minimal oversight. The government could potentially use the new “resolution authority” on any nonbank financial firm that is deemed to pose systemic risk, the official added.