Geithner recovery plan too cautious?

The Obama administration’s policy on the US financial crisis represents a high-stakes experiment: It will test the notion that a careful and cautious plan can also work forcefully and fast.

Treasury Secretary Timothy Geithner argues that this experiment is better than any alternative, but doubts surfaced this week among congressional lawmakers and leading economists as he testified about his plan on Capitol Hill.

An overriding Treasury objective is to avoid repeating the economic distress that followed the bankruptcy of Lehman Brothers last fall. Secretary Geithner’s plan involves providing capital from taxpayers to at-risk banks, as well as using public-private partnerships to buy bad debts off their books.

This plan carries risks, however. The effort to patch up the banks this way could be very costly and slow – or it may falter for lack of funds, given the public mood of bailout fatigue.

“These elaborate schemes are time consuming, nontransparent, and may not work,” says Pete Kyle, a finance expert at the University of Maryland in College Park.

“We want a fast [economic] recovery,” Mr. Kyle says. But that’s not likely to happen in an economy weighed down by bank losses, he says.

Both Geithner and his critics agree that a healthy supply of bank credit is vital to the economy.

The industry’s condition has been weakened severely by the decline in real estate values – the collateral for many loans – and more recently by defaults linked to unemployment and weak business conditions.

Bank losses in the US will total $1.6 trillion from 2007 to 2010 – and the industry will need $275 billion to $500 billion in fresh capital as a result, according to estimates in a report issued by the International Monetary Fund (IMF) this week.

“Even if policy actions are taken expeditiously and implemented as intended, … economic recovery [is] likely to be protracted,” the report said.

Geithner emphasizes the importance of avoiding further financial-market turmoil. Taking over insolvent banks in order to restructure them is seen by many of his critics as the textbook response to financial crisis, but for big banks he has cast this only as a last resort.

“We will take all sensible actions,” he told a bailout oversight panel Tuesday. But “we will be careful and pragmatic,” seeking the approach with the least risk to the overall economy, he added.

Even as he spoke, lawmakers on Congress’s Joint Economic Committee had decided to solicit views from prominent economists with a very different take.

A former World Bank chief economist, a former IMF chief economist, and the president of the Federal Reserve Bank of Kansas City all made the case for a tougher approach to big banks – possibly including temporary takeovers by the government.

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