Geithner and Summers have now announced their plan to raid the Federal Deposit Insurance Corporation (FDIC) and Federal Reserve (Fed) to subsidize investors to buy toxic assets from the banks at inflated prices.
The plan should not go forward on such unfair terms. Under the law, Congress should apply the Federal Credit Reform Act of 1990, which requires budget appropriations to cover expected losses on government loans programs, which would presumably include the expected losses on FDIC and Treasury loans under the Geithner-Summers Plan.
With proper credit accounting, the entire operation in our little illustration would require a budget appropriation of $276 billion, equal to the expected losses of the FDIC and Treasury. If the Administration goes to Congress for such an appropriation it will be shot out of the water. The public will not accept overpaying for the toxic assets at taxpayers' expense. Thus, it is very likely that the Administration will attempt to avoid Congressional oversight of the plan, and to count on confusion and the evident "good news" of soaring stock market prices to justify their actions.
The Geithner-Summers plans for the FDIC are not the only off-budget transfers to bank shareholders taking place. Other parts of the plan support subsidized loans from the Treasury and, even more, from the Fed. The Fed is already buying up hundreds of billions of dollars of toxic assets with little if any oversight or offsetting appropriations. Since the Federal Reserve profits and losses eventually show up on the budget, the Fed's purchases of toxic assets also should fall under the Federal Credit Reform Act and should be explicitly budgeted.
There are countless preferable and more transparent courses of action.
The toxic assets could be sold at market prices, not inflated prices, making the bank shareholders bear the costs of the losses of the toxic assets.
If the banks then need more capital, the government could invest directly into bank shares. This would bail out the banking system without bailing out the bank shareholders. The process would be much fairer, less costly, and more transparent to the taxpayer.
Banks that are already insolvent should be intervened directly by the FDIC, that is, temporarily taken into receivership. The shareholder value would be wiped out, except perhaps for some residual claims in the event that the toxic assets vastly outperform their current market expectations. As I've written before, the allocation of bank shares between the taxpayers and the current bank shareholders could be make contingent on the eventual value of the toxic assets (Jeffrey Sachs: A Proposal on How to Clean Up the Banks
), ensuring fairness between the shareholders and the taxpayers.