Geithner’s Multitrillion Dollar Bailout

Douglas J. Elliott
Douglas J. Elliott Former Brookings Expert, Partner - Oliver Wyman

February 11, 2009

Treasury Secretary Timothy Geithner’s $2.5 trillion bailout plan would create a public-private fund to buy up hard-to-sell assets from banks, inject more capital into banks and use Treasury and Fed money to finance up to $1 trillion in assets backed by consumer, auto and small business loans. Is this plan sufficient? Will it stabilize the financial system? Doug Elliott and other experts discuss these questions in an

op-ed piece in The New York Times.

In addition to more capital infusions into weakened banks, Secretary Geithner’s plan proposes a major expansion of a new program by which the Federal Reserve, with support from Treasury, would encourage new lending to consumers, small businesses, and commercial real estate. Although the price tag is huge — $1 trillion — it is a smart move.

In fact, it has been clear for some time that the financial bailout could not be limited to bailing out the banking system alone. A big part of the rescue would have to address the secondary markets that supplement the traditional banking system.

The financial markets have evolved to the point where, at its peak, fully 40 percent of lending was placed with mutual funds and other passive investors. That is, a bank or other intermediary would originate loans — for small businesses and autos, for example — with the intention of packaging them together and selling the package on to those investors. This process, called securitization, has become much more difficult since the beginning of the credit crisis. This helps explain the paradox that the traditional banking system is holding roughly the same loan volume on its books, but total lending has dropped sharply, as securitization has virtually vanished.

The Federal Reserve announced last fall that it would begin tackling this problem by agreeing to provide loans on attractive terms to qualified investors who wished to buy newly minted securities representing packages of certain types of consumer loans. Back then, the Fed, through a program called the Term Asset-backed Securities Lending (TALF) program, said it would provide up to $200 billion of loans with very low interest rates. Even though the plan will not start for a few weeks, the deepening credit freeze has required an expansion of the program, and the inclusion of additional loan classes like commercial mortgages.

Is $1 trillion the right number? No one knows, but this is less than the recent decline in securitization volume, (some reports show a $1.2 trillion decline in securitized lending in these markets in the past two years), so it’s worth starting here. The Fed guarantee and the cheap financing should do the trick of substantially increasing investor appetite.

Of course, there are risks in involving the Fed and Treasury so intimately in the business of day-to-day lending to consumers and small businesses. This kind of government support can become politicized or bureaucratic, resulting in large credit losses or the playing of favorites among borrowers. But in this environment, those risks seem well worth taking.