Fresh from the Senate vote on his $800 billion stimulus plan, Obama will have to turn to explaining to Wall Street and Main Street what his FSP is. His new Treasury Secretary, Timothy Geithner, tried to do that, but fluffed it a bit, causing markets to fall, pundits to pontificate, and media – the ignorant, ill-educated, lazy press and TV corps – to flounder in helplessness, deprived of their sound bites.
What is Obama trying to do?
“Our plan will help restart the flow of credit, clean up and strengthen our banks, and provide critical aid for homeowners and for small businesses. As we do each of these things, we will impose new, higher standards for transparency and accountability.”
Note the three prongs of Obama’s FSP. Each one is important, and they are different.
Why is it needed?
No credit for businesses, banks not lending, international trade is contracting, jobs are being lost, and a ‘dangerous dynamic’ is taking place … In the words of Geithner:
“Without credit, economies cannot grow at their potential, and right now, critical parts of our financial system are damaged. The credit markets that are essential for small businesses and consumers are not working.
.. Many banks are reducing lending, and across the country they are tightening the terms of loans. .. Trade among nations has contracted sharply, as trade finance has dried up. Home prices are still falling, as foreclosures rise and even credit worthy borrowers are finding it harder to finance the purchase of a first home, or refinance their mortgage…
Instead of catalyzing recovery, the financial system is working against recovery. And at the same time, the recession is putting greater pressure on banks. This is a dangerous dynamic, and we need to arrest it.
It is essential for every American to understand that the battle for economic recovery must be fought on two fronts. We have to both jumpstart job creation and private investment, and we must get credit flowing again to businesses and families.””
What will Obama’s FSP do?
“Our plan will (1) help restart the flow of credit, (2) clean up and strengthen our banks, and (3) provide critical aid for homeowners and for small businesses. As we do each of these things, we will impose new, higher standards for transparency and accountability.” [My brackets].
What about the Junior Bush’s actions last year?
“The actions your government took were absolutely essential, but they were inadequate.”
OK. Bush screwed up. Regulators screwed up. Rating agencies screwed up. Banks screwed up. Government and Americans screwed up by borrowing too much. And it all imploded.
Now what? Now comes the Obama Revolution, lead by this FSP:
“Our challenge is much greater today because the American people have lost faith in the leaders of our financial institutions, and are skeptical that their government has – to this point -- used taxpayers' money in ways that will benefit them. This has to change. To get credit flowing again, to restore confidence in our markets, and restore the faith of the American people, we are fundamentally reshaping the government's program to repair the financial system.”
And there must be transparency:
“Government support must come with strong conditions to protect the tax payer and with transparency that allows the American people to see the impact of those investments.”
And now for the key act of faith of the Obama/Geithner FSP – the use of the principle of leverage, first invented by Archimedes, who famously said: Give me a place to stand and I will move the earth.
That is what Obama is aiming to do: use the strength of leverage to arrest the dangerous dynamic, and stop the spiral downwards of the American financial system.
Leverage works because the application to one end of a lever of a small amount of force (or, in Obama’s FSP, government money or government guarantee) results in a massive amount of force at the other end of the lever.
So Obama is trying to apply the ‘government force’ on the economic lever, and achieve results far in excess of anything which the government might be able to achieve by using only its money. And the FSP plans to do this by using private money as part of its solution. It wants the money available to arrest the dangerous dynamic to be huge, with most of it non-governmental.
And the key to this use of minimal force to achieve maximal aims?
Two things: firstly, avoid going back to the Congress well right now for more money, given the tough time Obama had in persuading three Republican senators to pass the $800 billion stimulus plan. To go back now with cap in hand and ask for a half billion or more of government money from Congress is risky.
So Obama’s plan is to bypass Congress in the beginning, produce some results, and then go back for more money, once they have demonstrated that their FSP is working. That’s the political reality Obama is faced with, and his response to it: do an end run around the Senate until he has results – and public opinion – on his side.
But he still needs some money to use as the minimal government force on the one end of the lever. Where does he get it from?
Simple. He already has it. Last year, Bush stampeded the Senate and House to pass the $700 billion rescue plan. Only half was used – and with very little in the way of positive results, and very little transparency.
So Obama has $350 billion in his piggybank right now, to play with in his FSP. And he has the power to make the Federal Reserve do things without having to go to Congress for approval.
How is he dividing it up? He said he had three things to achieve (see above). Geithner has indicated the money is earmarked this way:
$50 billion for homeowners whose mortgages are under threat of foreclosure. Let’s call it the Foreclosure Fund.
$20 to 100 billion for a Financial Stability Trust (FST or Bank Trust), which will fund banks once they’ve been vetted to make sure everybody knows what assets they have and what liabilities they have.
$200 to 280 billion for the Public-Private Investment Fund (PPIF or Toxic Fund or as some call it Bad Bank) which will buy toxic assets from banks. This along with the private sector money will fund the Toxic Fund or Bad Bank with up to $500 billion, perhaps $1,000 billion.
Plus, the Obama FSP calls for government will commit another trillion dollars to support a Consumer and Business Lending initiative, designed to free up credit for business and individuals so that they can produce goods or buy goods (let’s call this the TAFL).
A bit more detail on each of these three items.
The Foreclosure Fund:
The $50 billion assistance to those with mortgages will be fleshed out later: “The President has asked his economic team to come together with a comprehensive plan to address the housing crisis. We will announce the details of this plan in the next few weeks.”
The Bank Trust:
The Bank Trust money used will come from the Government and will be “a bridge to private capital. The capital will come with conditions to help ensure that every dollar of assistance is used to generate a level of lending greater than what would have been possible in the absence of government support. And this assistance will come with terms that should encourage the institutions to replace public assistance with private capital as soon as that is possible.”
The Bad Bank or Toxic Fund:
The Toxic Fund “provide government capital and government financing to help leverage private capital to help get private markets working again. This fund will be targeted to the legacy loans and assets”
The Toxic Fund will have two kinds of money: government money and private sector money, from investors (whoever that might be – hedge funds, private equity funds, foreign governments like Saudi Arabia or China, whoever else has money and wants to invest in a high yielding, secure basket of assets).
The key is the value placed on the toxic assets bought from the banks by the Toxic Fund (or Bad Bank, as some call it). This will be a matter for negotiation between the private sector financiers, and the government, but the government will use third parties to help set the value: “Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets.”
The government’s moneys that go into the Toxic Fund or Bad Bank will take the first hit if the Toxic Assets re indeed toxic. But my guess is that the hit will – presumably – only be up to an agreed amount, hence the use of third parties to decide what level of risk the private sector money takes.
The total of $500 billion to start with and perhaps $1,000 billion a little later seems low, given that the subprime mortgages and bad credit cards and derivatives held by the banks are, by some estimates, as high as $2 trillion, if not more.
The TAFL:
“Third, working jointly with the Federal Reserve, we are prepared to commit up to a trillion dollars to support a Consumer and Business Lending Initiative. This initiative will kickstart the secondary lending markets, to bring down borrowing costs, and to help get credit flowing again.
In our financial system, 40 percent of consumer lending has historically been available because people buy loans, put them together and sell them. Because this vital source of lending has frozen up, no financial recovery plan will be successful unless it helps restart securitization markets for sound loans made to consumers and businesses – large and small.
This lending program will be built on the Federal Reserve's Term Asset Backed Securities Loan Facility, announced last November, with capital from the Treasury and financing from the Federal Reserve.
We have agreed to expand this program to target the markets for small business lending, student loans, consumer and auto finance, and commercial mortgages.”
There you have it - $350 billion from last years Bush $700 billion, together with $1 trillion from the Treasury and the Federal Reserve (which Obama can make happen without going to the Senate or Congress for approval).
