Bailout 2.0

John Marshall interviews Nobel prize-winning economist John Stiglitz explains Barack Obama's bailout plan. Stiglitz wants greater oversight and punishment to the bankers for not playing by the rules.

Stiglitz calls the government owners of bailout banks with "no control." It is a foolish policy to give billions to banks and then not have a say on how that money is spent. A perfect example is lending institutions using bailout money to lobby for more bailout money. I would laugh if the economic situation wasn't so dire.

Sec of Treasury Tim Geithner unveiled the Financial Stability Plan.

The core program elements include:

A new Capital Assistance Program to help ensure that our banking institutions have sufficient capital to withstand the challenges ahead, paired with a supervisory process to produce a more consistent and forward-looking assessment of the risks on banks' balance sheets and their potential capital needs.
A new Public-Private Investment Fund on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion, to catalyze the removal of legacy assets from the balance sheets of financial institutions. This fund will combine public and private capital with government financing to help free up capital to support new lending.
A new Treasury and Federal Reserve initiative to dramatically expand – up to $1 trillion – the existing Term Asset-Backed Securities Lending Facility (TALF) in order to reduce credit spreads and restart the securitized credit markets that in recent years supported a substantial portion of lending to households, students, small businesses, and others.
An extension of the FDIC's Temporary Liquidity Guarantee Program to October 31, 2009.
A new framework of governance and oversight to help ensure that banks receiving funds are held responsible for appropriate use of those funds through stronger conditions on lending, dividends and executive compensation along with enhanced reporting to the public.

"Legacy assets" translates into garbage assets. I am curious how the Term Asset-Backed Securities Lending Facility will jump start lending. Banks do not want to lend and the White House needs to get credit moving. Immovable object meets the unstoppable force. The White House and banks are in for a fight.

Private capital could later replace federal government capital. What Geithner is addressing is stocks. The idea of the Treasury Department on the hook for an Enron-like company is frightening.

Our expectation is that the capital provided under the CAP will be in the form of a preferred security that is convertible into common equity, with a dividend rate to be specified and a conversion price set at a modest discount from the prevailing level of the institution's stock price up to February 9th, 2009. This security would serve as a source of "contingent" common equity, convertible solely at the issuer's option for an extended period of time.

The instrument will be designed to give banks the incentive to replace USG-provided capital with private capital or to redeem the USG capital when conditions permit. In addition, with supervisory approval, banks will be allowed to apply to exchange the existing CPP preferred stock for the new CAP instrument.

The Public-Private Investment Fund will aqquire garbage real estate assets. This is allow companies to reduce bad assets. The federal government may end up buy many forclosed homes. There could be a return when the real estate market rebounds.

The Term Asset-Backed Securities Lending Facility will provide loans for small businesses and college students. I am rather uneasy about TALF getting into credit cards. We want credit moving. Not more people in debt.

The Financial Stability Plan will have inspector general and Congressional oversight.

Going forward, the Financial Stability Plan will call for a new level of transparency, accountability and conditionality with tougher standards for firms receiving exceptional assistance. These stronger conditions were informed by recommendations made by formal oversight groups – the Congressional Oversight Panel, the Special Inspector General, and the Government Accountability Office -- as well as Congressional banking oversight leaders.

Use of government-provided capital and impact on lending

Recipients of capital provided under the CAP will be required to submit a plan for how they intend to use this capital to preserve and strengthen their lending capacity – specifically, they will commit to increase lending activities above levels relative to what would have been possible without government support. This plan will be submitted during the application process, and the Treasury Department will make these plans public upon distribution of the capital investment to the firm.

These firms must submit to Treasury monthly or quarterly reports on their lending by category. This report will also include a comparison to estimates of what their lending would have been in the absence of government support. For public companies, similar reports will be filed on an 8K simultaneous with the filing of their 10Q and 10K reports. All these reports will be put on the Treasury website.

The oversight is good. The risk is great. I'm trying to figure this out and economics is my beat. Paul Krugman doesn't know what to think. Wow.