Geithner Treasury Leverage Scheme
The
Secretary of Treasury is responsible for paying the bills of the US government
and when there is a government deficit the Treasury borrows to pay the bills. To borrow the Treasury sells US Bonds as
promises to pay in the future tax. Buying
a bond requires trust and main job of the Secretary of the Treasury is to
appear to be trustworthy.
Selling
or buying bonds, the Treasury influences the financial system in normal
economic times. Selling bonds lowers the
price of bonds and raises interest rates, discouraging investment. The present financial crisis is due to some
bankrupted large banks and misled government spending to keep them in business. Throwing good money after bad is a recipe for
disaster. Aside from pointlessly giving
cash to the failed banks Secretary Geithner has a
plan to increase lending in the faltering financial system with taxpayers
backing. This is a leveraged financial
scheme.
In
the Geithner Leverage Scheme, the Treasury will buy
bonds from private investors at 2%. Call
such an investor A. Investor A borrows
from the Treasury and will have to pay back the principle plus 2%
interest. Investor A will lend to firm B
at a higher interest rate with a Treasury guarantee of at most a 5% loss. In contrast such a loan could suffer 100%
loss if firm B defaults. The Treasury is
effectively providing taxpayer backed default insurance to investor A. Taxpayers are paying the risk of the default insurance
and are relying on the Treasury for supervision of investor A.
Investor
A will charge more than 2% interest to B and will make a profit. Investor A will also be able to borrow
another 95% of the face value of the Treasury bond from the private
sector. Such taxpayer dollars “invested”
by the Treasury will almost double the amount of credit in the financial
system.
The
catch is moral hazard since riskier firms will borrow given the taxpayer
subsidized default penalty. There will
also be fraud in that investor A and firm B might stage a planned default.
The
present financial crisis is due in part to credit default swaps that provide
some insurance against the default of private bonds. These swaps may reduce but do not eliminate
default risk. When firms began to
default on their bond payments the failed banks were overexposed and
effectively went bankrupt. The Treasury
is now attempting to remedy this bankruptcy with credit default insurance of
its own, backed by taxpayers as a default free funding source.
The
Geithner scheme will increase immediate credit to
some extent but the inefficiency will ultimately wear down gains. Once investors enjoy the subsidized profits
they will spend some of them lobbying to keep the subsidy. Any such public interference in the financial
system is inefficient and will make the US less competitive
internationally. The Geithner
scheme does not appear trustworthy in the least.