Ezra Klein has noticed something that the rest of the world seems to have ignored: Tim Geithner’s Public-Private Investment Partnership Plan, announced to great fanfare and much controversy in March, has gone kaput. The banks aren’t interested, and the FDIC has (temporarily, it says) pulled the plug.
Ezra takes this as an ambiguous sign: “The economy certainly “feels” better,” he writes, “and that’s been enough to drain the urgency from some of these questions. But have the questions really gone away?”.
I’ll stick my neck out there and say that it’s more unambiguously a positive sign. For one thing, among the reasons that the banks aren’t interested in getting loans subsidized by the Fed is because they’re raising unexpectedly large amounts of private capital: some $50 billion in May. For another, the economy is doing more than just feeling better; it’s showing some fairly robust signs of turning the corner and actually getting better. The Leading Economic Index improved significantly in April (the most recent data available; it is quite likely to improve further in May), with seven of ten key indicators improving — these are things like consumer sentiment, supplier deliveries, the S&P 500 (which is up about 20 percent since the Geithner plan was announced) and initial unemployment claims.
Mind you, we aren’t out of the woods just yet. For one thing, the most direct way in which most of us feel the impact of the economy — unemployment — is unfortunately a lagging rather than a leading indicator, and has particularly been so in recent recessions. That fewer people are losing their jobs doesn’t mean that the economy is creating jobs — it isn’t doing so yet. For another, the history of recovery from recessions is littered with false starts and double-dips.
But a lot of the debate about the Geithner plan was about the very “feeling” that Ezra describes. Were the toxic assets that the banks were unable to dispose of “probably fundamentally undervalued”, as Brad DeLong put it at the time, implying some fear and loathing and “irrational” sentiment? If that were the case — and this seemed to be the Geithner Plan’s bet — it would serve as a sort of artificial boost of confidence for the economy: an ecstasy pill for the banks. Conversely, if the toxic assets were correctly and appropriately assigned a (very) low value by the markets, the Geithner Plan would amount to a big giveaway — TARP III under another name.
The “spontaneous” recovery in equities markets, capital flows and bank balance sheets hints at the former scenario: there was a bit of fear and loathing that the markets have now shaken off. Current market valuations are now very much in line with long-term indicators like 10-year P/E ratios (although some smart observers now think they’re modestly overvalued); moreover, market volatility has decreased by about 40 percent since the Geithner plan was announced and is barely more than a third of what it was at the peak of the financial crisis over the winter.
There was always a bit of hocus-pocus to the Geithner Plan and, particularly, the stress tests. The markets needed to see some sort of coherent plan plan coming out of Treasury; they tanked in February when the initial rollout of the Geithner plan was woefully short on details. Treasury couldn’t just sit around and do nothing, even if — and perhaps specifically if — they thought the crisis was indeed being perpetuated by a certain amount of irrational despair.
But the goal of the Geitherner plan was never about the toxic assets themselves, and always to get capital flowing again in a sustainable way. If that is what’s happening, and it seems to be, the plan may be a victim of its own success.