4 Myths About the Obama-Geithner Bailout Plan

There's no secret solution to the banking problem.

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So far, it's an epic disappointment. Treasury Secretary Tim Geithner has pledged to harness the "full force of the U.S. government" to stabilize the financial system and set the stage for an economic recovery. The ultimate cost could be $2.5 trillion, a number so big that many Americans couldn't tell you how many zeroes it entails.

Yet Wall Street hissed, the press piled on, and critics groaned that the still-evolving plan is far too sketchy to inspire any confidence. If they had it to do over, no doubt Obama and Geithner would wait till they could offer more specifics instead of staging the faux-dramatic show of governmental force that they've managed so far.

[See why Geithner's missteps might work in his favor.]

But a big reason the Obama bailout plan has landed with such a thud is that we've been expecting way too much of it. Excessive expectations always breed disappointment, which is why smart leaders learn to underpromise and overdeliver. Here are some of the myths about the Obama bailout plan that we've been clinging to:

Obama has a secret formula. We have a new president promising to take America in a new direction and solve the problems that vexed the last president. That means there must be some new and improved way to rescue the banks, right? Wrong.

Obama and Geithner have one advantage over Bush and his Treasury Secretary, Henry Paulson: The virtue of hindsight and lessons learned from past mistakes. But the Troubled Assets Relief Program has been an unprecedented, trial-and-error intervention in the banking system since Paulson first devised it last fall. And it still is, to some extent.

[See how Wall Street continues to doom itself.]

Geithner - who worked closely with Paulson on the original TARP - doesn't know something that Paulson didn't. He doesn't have a secret weapon. The range of solutions now are the same ones Paulson considered: Investing money directly in banks, helping them get bad loans off their books, and taking steps to stimulate consumer credit. Geithner can call if a fresh start, but he knows that it's really a restart at best.

More accountability will solve the problem. Another advantage Obama and Geithner have is they're not working in the midst of pandemonium. The original bailout did accomplish one thing: It forestalled a financial panic after Lehman Brothers failed and AIG almost did. That means Obama's team can be more deliberate, and take more time to get it right. Paulson didn't have that option last fall: The clock was ticking, the markets were plunging, and value was being destroyed minute-by-minute.

[See what 8 bailout CEOs need to explain.]

Requiring more accountability from banks that get bailout money is an essential step forward at this point. Ideally, that would have been baked into the bailout at the beginning, but it wasn't. If done right, more accountability will improve confidence in the government and the markets. But it won't change the essential problem, which is that many banks - including some of the biggest, like Citigroup and Bank of America - still face deep losses that constrain their ability to lend, and maybe even their viability. An insolvent bank is a disaster, whether its books are open or closed.

The bailout will be good for Wall Street. The markets enjoyed a bailout bump in the days prior to Geithner's leaden announcement. Why? Apparently Wall Street expected a renewed bailout plan to generate stability or other conditions favorable to investors.

[Want to land a plum job without paying taxes? Here's how.]

But Geithner ended up sending the message that under Obama's terms, bailouts will be tough on banks. They'll have to pass a "stress test" to prove they're worth investing taxpayer money in, and explain how the investment will be in taxpayers' interest. That's good for the economy and it's good for taxpayers, but the unstated message is the government WON'T be willing to help banks in the worst shape. And those on the margin will bear most of the responsibility for fixing their own problems.

For bank shareholders, that's terrible news, because they could lose much or all of their investment. Eventually, a stronger economy will benefit Wall Street, because stocks will rise once the banks and their borrowers are healthier. But traders don't want results eventually. They want results now.

The bailout will fix the housing problem. We keep falling for this one. There have been several government and industry programs so far that have been designed to reverse the housing bust, slow the ballooning foreclosure rate, and keep more homeowners in their homes. None have worked on a large scale. There's a reason: This is an extraordinarily difficult problem to solve.

There may be as many as 5 million mortgages still at risk of foreclosure. Workouts and loan modifications may help save a small portion of them. But the vast majority of troubled mortgages aren't held by the banks that issued them. These are the mortgages that have been broken into components, bundled into securities (now derided as "toxic assets"), and sold to investors around the world. To renegotiate any one of those mortgages requires the participation of multiple parties, including some who will lose money and expect to be compensated. Now, multiply that by 5 million.

[See why the feds rescue banks, not homeowners.]

Obama has to take a stab at solving the problem, because doing nothing would make it look like he's helping the bankers while sacrificing the little guy. That was the rap against Bush and Paulson. But even the most ambitious plans would only help homeowners indirectly, by creating stronger incentives for lenders to help them out. And there's mounting evidence that about half of all modified loans end up in foreclosure anyway.

It's possible that a complex loan-modification program - with more moving parts than most people in Washington will be able to understand - might help roll back the foreclosure problem. But it won't be a quick fix. Instead, it will take time, diligence, and more tolerance of trial-and-error than most of us have shown so far. And it still might not work. So lower your expectations, or prepare to be deeply disappointed. Again.

Obama, Barack
Geithner, Tim
  • Rick Newman

    Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success and the co-author of two other books. Follow him on Twitter or e-mail him at rnewman@usnews.com.

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