New Obama plan similar to AIG bailouts?

While final details are still a little sketchy, the Obama administration has proposed a plan to provide both public and private investment in removing toxic assets from bank balance sheets in an attempt to improve the credit markets. Although improving unemployment should remain the priority at this stage of the economic recovery, there is little or no doubt that the financial markets need to be strengthened so that viable companies which actually have a demand for their products can obtain credit in order to obtain more inventory and increase payrolls. So, will this plan actually strengthen the financial system?

The proposed plan will involve the purchase, by both the government and private investors, of both troubled securities and loans currently on bank balance sheets. While purchasing the loans may prevent some foreclosures and therefore steady the housing markets, there should be more than a little skepticism about purchasing troubled securities – most of which are tied into the housing market. Under the current plan, the government (including the Federal Reserve) will hold upwards of 93% of the toxic securities. It is important to note that this plan will NOT improve the market for such securities - that will only occur when and if the housing market returns to its pre-2007 high water mark. The plan simply assumes that, by removing these toxic assets from the banks, the banks will have incentive to once again provide loans and hopefully raise the GDP.

One problem (amongst many potential issues): what is the total amount of “toxic” assets that we are talking about? The initial plan seems to call for a grand total of anywhere between one half and one trillion dollars in total relief. But what if the total amount of the assets in question exceeds the amount provided by the federal government? In that case this would resemble the AIG bailout, with government (and a little private) funds going to banks to purchase the securities, the government left with the toxic assets and hoping their value rises over time, the banks paying off the investment banks or other parties they are currently indebted to, and not enough capital left over to provide for credit consumers. If any estimate of the total amount of toxic assets is available, I have yet to see one in any of the press releases.

Instead of simply paying off the investment bankers in the hopes that credit will start flowing again, why not provide the relief to banks in the form of zero-interest loans with a five-year maturity under the condition that the funds be used in extending credit? That is the surest way to get loans out to businesses which are willing to expand and provide more jobs. It doesn’t solve the toxic asset problem anytime soon, but it does get credit flowing, and by improving the unemployment rate and stimulating the economy the impact of those toxic assets can eventually be either be lessened or completely negated, and there will be a stronger base for the U.S. economy going forward. Besides, by making economically sound loans and earning interest, the banks can gradually fulfill their prior obligations and thereby remove the toxic assets.