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Amidst the hubbub around the Stimulus package, it would be east to miss planned government spending package that dwarfs the $825 billion the House of Representatives approved yesterday.

This is of course the plan to rescue the still crumbling financial sector, where the New York Times quotes Chuck Shumer quoting government officials who "estimate it may take up to $3 trillion to $4 trillion to buy the bad assets" of struggling banks.

Tim Geithner's money quote:

We have a financial system that is run by private shareholders, managed by private institutions, and we’d like to do our best to preserve that system.

In other words, keep giving trillions of dollars to the institutions that caused their own demise, either directly or through the setup of "bad bank" institutions that take on the endless bad debt these banks have accumulated through their own greed and incompetence.

Paul Krugman calls this hope of preserving the status quo without nationalization Wall Street Voodoo.

It's time to take bold action. It's time to nationalize.

Here’s the dirty truth that few want to accept: Many of the country’s banks are already worthless, bankrupt in all but name. As Robert Reich says:

Put simply, the big banks are going under. No one wants to say this out loud for fear of causing even more panic, but the fact is that many of these banks are insolvent. Their assets are worth far less than their face value because so many borrowers can't -- or won't be able to -- repay the loans.

Half measures to prop up the banks on life support are doomed to failure.

Some argue, even on this website, in defeatist fashion, that nationalizing is too hard, or that the effect on bank stock prices would be too harsh. This seems to me to be the corporatist argument which has prevailed for so long. The truth is those stocks are already worth. The only reason the stocks aren’t at zero is in hopes of a government rescue. Those stockholders are gambling on you and I giving them money. If the government announced today that it wasn’t aiding the banks any more, those stocks would go to zero, which tells you their real worth exactly.
So we are not supposed to do what’s right for the economy to reward those betting on government rescue. I don’t think so. The dangers of giving trillions of dollars to the very people who are destroying our economy is simply insane.

It’s been put best by Barry Ritholtz, who in The Moral Hazard of the Bad Bank, slams Geithner’s refusal to nationalize and points out how his closeness to the banking industry is blinding him of what needs to be done:

Defending these idiots was your old gig. In the new job, you no longer work for the cretins responsible for bringing down the global economy. Please stop rationalizing their behavior, and preserving the status quo!
Yesterday’s 13% surge in bank stocks is a clue as to what an obscene taxpayer giveaway this "bad bank" plan is — its free money for the firms that caused the problems, many of whom still have the same incompetent  management in place that caused the problem. Purging toxic assets from bank balance sheets, without punishing the management, shareholders and creditors of these institutions for their horrific judgment will only encourage more of the same in the future. Its moral hazard writ large.
A few reminders for Geithner that are of the utmost importance:
• ▪ You no longer work for the Banks: The NY Fed is a private corporation, doing the bidding of the FOMC and its private sector owners — primarily, the primary dealers. In other words, the President of the NY Fed works for the biggest commercial and investment banks in New York. That is no longer operational for you.
• ▪ As Treasury Secretary, your immediate boss is the President, and your ultimate charge are the citizens of the United States, and the finances of the country.
• ▪ When any conflict comes into play between the nation and the banks, you as Treasury Secretary are on the side of the Nation.
• ▪ You cannot serve two masters, especially when they are in direct conflict with each other.
When the post-script to this era gets written, I suspect we will learn all sorts of unsavory facts about the former Treasury Secretary, and how he unfortunately had a tendency to believe he was working for the benefit of Goldman Sachs.

The bad bank plan is simply a thinly veiled way of giving the banks money to get rid of bad assets, while leaving the same incompetent managers in charge of these institutions. Krugman gives a hypothetical example which explains it perfectly:

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout.
Why would the government bail Gotham out? Because it plays a central role in the financial system. When Lehman was allowed to fail, financial markets froze, and for a few weeks the world economy teetered on the edge of collapse. Since we don’t want a repeat performance, Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars, enough to make it solvent again. But this would, of course, be a huge gift to Gotham’s current shareholders — and it would also encourage excessive risk-taking in the future. Still, the possibility of such a gift is what’s now supporting Gotham’s stock price.

A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners...

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as "fair value" purchases of toxic assets.

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

It’s time to tell Geithner and friends that Voodoo economics went out with the 80s. Speak out for nationalization wherever and whenever you can – contact your congressman, your newspaper, anyone. The stakes are too high to get this wrong.

Originally posted to Maxlongstreet on Thu Jan 29, 2009 at 09:41 AM PST.

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