If Geithner's Plan Is Bad, Why Do Markets Like It?

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Economic Recovery: The ink on the latest bank bailout plan hadn't even dried before it was being panned on both the left and right. But if it's so bad, why did stocks rally so impressively after it was announced?

Of course, one day's run-up can run down just as fast. But we've learned over the years to respect the market in ways we don't respect the pundits. Markets, after all, represent the collective wisdom of thousands of people and institutions around the world with trillions of dollars at stake.

And, collectively, markets seem relieved at the Treasury plan.

After Treasury Secretary Tim Geithner released the first outline of his plan last month to derisive hoots and hollers all around, people feared the worst. But the plan that Geithner formally unveiled on Monday wasn't the worst. It might even help.

True, it could eventually expand to as much as $1 trillion in size. But it will for now limit the amounts coming directly from the government — that is, you the taxpayer — to about $75 billion to $100 billion. And that's from money already approved by Congress under the Troubled Asset Relief Program. That means the program can start right away — without congressional action, a big plus in this case.

The rest of the cash will come from private investors, with some of the financing provided by collateralized loans from the Federal Deposit Insurance Corp. Private investors could make hefty profits from becoming the government's partners, but it's no slam dunk.

All told, under the so-called Public Private Investment Program the Treasury and private investors will be able to leverage up to $500 billion to buy troubled assets from banks — the so-called "toxic assets" that have now morphed into the more genteel "legacy assets" in Treasury's new nomenclature.

One other thing: Just last week, the Federal Reserve itself announced a plan to buy up to $1.2 trillion in Treasuries and mortgage-backed securities from banks both to push down long-term interest rates and move cash into the banking system.

Though that announcement caused some dyspepsia in the markets at the time, investors now appear to believe this one-two punch from the Fed and Treasury will help unclog the banks' balance sheets of junk home loans and shaky mortgage-backed securities and get them lending again.

We're still not sold that this is the best route to take. But as we said early on in this mess, the best model for getting out of it — if the government had to be involved at all — was the Resolution Trust Corp., which in the early 1990s bought up banks' bad loans and then slowly sold them on the open market, sometimes at a profit.

That seems to be what Geithner is trying to replicate. And if he can end up doing it more cheaply than expected, with the government actually making a profit on some of the beaten-down mortgage investments it buys from banks, all the better.

As Barclays Capital said Monday, "The policy response to the economic crisis has entered a new era." But actually, Geithner's plan is hardly new. Indeed, it's similar to what the Bush administration pushed early last fall.

Even so, this "new era" will be a treacherous one. We of course fear the heavy, smothering hand of big government. We hope Geithner is wise enough to lighten government's grip on our struggling financial system once it takes wing, despite repeated calls for ever-stricter regulations in Congress. Contrary to popular belief, this crisis was caused not by too little regulation, but by too much.

A de facto nationalized financial system will serve no one's interest. Rather, it will impoverish us all by removing salutary market signals from the allocation of capital in favor of political mandates.

That said, it's entirely possible this could be a turning point for the financial system as it struggles to get on its feet after a year and a half of bankruptcies, massive writedowns and shrinking lending.

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