Geithner's Five Big Misconceptions

Geithner's Five Big Misconceptions | Henry Blodget|Mar. 23, 2009, 9:02 AM
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In our opinion, because Tim Geithner formed his view of this crisis last fall, while sitting across the table from his constituents at the New York Fed: The CEOs of the big Wall Street firms. He views the crisis the same way Wall Street does--as a temporary liquidity problem--and his plans to fix it are designed with the best interests of Wall Street in mind.

If Geithner's plan to fix the banks would also fix the economy, this would be tolerable. But no smart economist we know of thinks that it will.

We think Geithner is suffering from five fundamental misconceptions about what is wrong with the economy. Here they are:

The trouble with the economy is that the banks aren't lending. The reality: The economy is in trouble because American consumers and businesses took on way too much debt and are now collapsing under the weight of it. ...

The banks aren't lending because their balance sheets are loaded with "bad assets" that the market has temporarily mispriced. The reality: The banks aren't lending (much) because they have decided to stop making loans to people and companies who can't pay them back. ...

Bad assets are "bad" because the market doesn't understand how much they are really worth. The reality: The bad assets are bad because they are worth less than the banks say they are. House prices have dropped by nearly 30% nationwide. That has created something in the neighborhood of $5+ trillion of losses in residential real estate alone ...

Once we get the "bad assets" off bank balance sheets, the banks will start lending again. The reality: The banks will remain cautious about lending, because the housing market and economy are still deteriorating. ...

Once the banks start lending, the economy will recover. The reality: American consumers still have debt coming out of their ears, and they'll be working it off for years. ...
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... The two charts below from Ned Davis illustrate the real problem: An explosion of debt relative to GDP. The first is Nonfinancial Debt To GDP. The second is Total Debt To GDP.

In Geithner's plan, this debt won't disappear. It will just be passed from banks to taxpayers, where it will sit until the government finally admits that a major portion of it will never be paid back.

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