The Legacy Loans program, a sizable chunk of the Geithner Plan, is dead, reports the New York Times. The FDIC has “called off plans to start a $1 billion pilot program this month that was intended to help banks clean up their balance sheets.”
I’ve used my car before to explain this program, so maybe I can use it to explain the death. In this scenario, the role of the Bad Bank is played by me; the Toxic Asset is my car; and Tim Geithner and Sheila Bair, Treasury Secretary and FDIC chair respectively, play themselves.
By CatKaoe
Remember, if you will, that in our last scenario, my accountant, Tim, had offered to partner with his friend Sheila to offer potential buyers of my car a pretty sweet deal: Sheila would loan 80 percent of the money to any potential buyer, and Tim would invest up to half of the remaining cost of the purchase, which meant someone could buy my car for about 10 percent of its auction price. That would give me extra money to spend in the economy (hooray!). It would also allow the dealer that bought my lemon the chance to fix it up and hold onto it until the market for bad cars goes back up. Win-win, with the possibility of Tim and Sheila taking a big hit (taxpayer lose).
But what’s happened since this initial offer is that I, holder of the toxic car, have fallen back in love with it. That burning oil smell — it’s the scent of nostalgia, of summers spent on hot tar highways. The scratches and dents merely make the car more hip, like a worn pair of jeans. I’m starting to think I could convert it to bio-diesel. In short, I’m no longer willing to sell for anything less than the original $1,000 I thought it was worth. I am not willing to put it up for auction, as Tim said I had to do.
Now, maybe I’m being honest about that. Maybe I really do think the car’s gonna make it. But maybe I don’t want to put the car up for auction because last month, I applied for a new apartment, and as part of my credit check I listed the car as an asset when I did that — an asset worth $1,000. Now, I don’t want to put the car up for auction, because it will become clear pretty quickly that the car is only worth $700, and I could lose my apartment.
Or maybe I don’t want to sell the car because I no longer need to sell it. The market’s getting a little better, I’m feeling more flush, and I think I can afford to pay to maintain it until the time comes when it will be worth what I’m willing to sell it for. It will be vintage soon, you know?
Now, Tim and Sheila — Tim in particular — have an interest in making sure I’m telling the truth about my motivation. Because if I’m not selling because selling will make me look insolvent, well — that means I’m already insolvent. If I’m not selling because I’m ready to spend, spend, spend anyway, then that means the market is improving, and the healing has begun (and quick, Tim says, let’s get some posters printed about that one, and make sure we send one to Paul Krugman).
Ezra Klein outlined both of these reasons as why the banks might not be willing to jump into the Geithner plan. Kevin Drum at Mother Jones says it’s probably the insolvency problem, and that’s really, really bad, because it means that not only did the Geithner plan not solve the banks’ problems, but the banks are being allowed — and maybe, post-stress test, encouraged — to live on in denial that will eventually come back to bite us all.
To extend the metaphor: there exists a danger to the community if I continue to drive around a broken car while swearing that really, it’s fine. Not only am I not spending as much as I could be, since I’m constantly worried about my toxic asset, but I might be actively making the whole community less safe by showing them that it’s cool to keep broken cars.
I think there’s also a third option, here. Banks might be deluding themselves; they might be healthy enough to afford hanging onto their loans; and they might actually be afraid to deal with the government. Several banks, post-stress test, raised a bunch of capital in advance of leaving TARP. If they get re-entangled with the Geithner Plan now, they’ll also get pulled back into the shady land of government regulation over compensation.
In short: am I unwilling to sell the car because I still love it, because I still need it, or because you’re not the boss of me, Tim Geithner?
It could be all three (and none of these are particularly good reasons, really). But whatever it is, I hope there’s a plan B. I hope Tim and Sheila and Ben Bernanke have a better idea of what to do next than just what Sheila Bair said they’re going to do, which is wait and see if the PPIP might be needed later. That’s only an OK plan if the assets don’t get worse — and I am not at all encouraged by our jobless rates, the rise in foreclosure and bankruptcy claims, and the continued need of companies with terrible mortgages on their books (yesterday GMAC got another $7.5 billion).
At some point, Friends Don’t Let Friends Drive Toxic Assets. Apparently the banks still want to keep the keys — but at some point, Tim, Sheila, or Ben might have to step up and say, no way, man. The PPIP was the gentlest possible way of doing that, so I’m sorry to see it die.
By 
SATURN SMITH 