It's time to rescue the bank rescue plan

The equity market reacted to Treasury Secretary Timothy Geithner's much-anticipated bank rescue plan last week with a resounding thud. Investors, through their sell orders, signaled what pundits were saying and what many others were thinking, namely that his plan is too vague and too ad hoc to instill confidence in either the banking system or the administration's ability to engineer a way out of the financial crisis. The intractable core issue that thus far has stymied the government, managers of private pools of capital and the banks themselves, actually is quite clear: the uncertain value of the hundreds of billions of dollars of mortgage-backed securities sitting on the balance sheets of banks around the world. If the questionable value of these securities and their derivatives is the problem, then what's the solution? At the moment, no one has a good answer. Going through the countless pools of mortgages that directly or indirectly back each security, and determining which ones are likely to be repaid and which are not, is impossible. Absent any reasonable guess of the viability of the mortgages underlying each security issue, no one can determine what the securities are worth. Banks are eager for the government to buy these toxic securities at, say, 75 cents on the dollar. But if the securities are worth only 50 cents on the dollar, U.S. taxpayers will be stuck with monumental losses, which will make the administration and Congress look like fools. On the other hand, if the government offered 25 or 35 cents on the dollar, which might make our elected representatives look good come November 2010, that could translate into monumental losses for banks, many of which could fail. In a general way, Mr. Geithner's proposal does include private-sector participation in the price discovery process, with investors taking part in a "public-private investment fund." But details of how that participation would work are missing — probably a reflection of the sensitivity on both sides to taking any kind of stance that might be interpreted as a pricing signal. Like any other stalled market, the "toxic-paper" market has too wide a spread. Worse, the buy and sell sides are represented by weak signals of intent, rather than actual bids and offers. Thus far, no one has figured a way to narrow the spread to a band that is workable both economically and politically. Ideologues from the right and left are equally stumped. A solution may lie in more input. Perhaps President Obama should ask Lawrence Summers, head of the National Economic Council, to convene a group of top academicians whose specialty is market structure and theory. In a closed-door setting where free debate and argument are encouraged, it's possible that the nation's brightest experts on how markets work (and don't work) may come up with a way out of the stalemate. Given our nation's current crisis, it's worth a try.