Geithner and His Toxic Asset Bailout Plan


Here we go again. Maybe this will be the week that historians look back on and say, “That’s when it all started to get better. Geithner came out with his toxic asset bailout plan. China stimulated. Stock markets bottomed. The crisis ended and the world got better and better forever and ever.”

Or maybe not. We’ll just have to see. Either way, if Tim Geithner’s plan sends the market down five percent or more this week, we reckon it’s his last week on the job, which may be a relief to Mr. Geithner.

Kevin Rudd conceded that Australia’s economic fate is largely tied to forces beyond its control. In an interview with Channel Nine over the weekend he said, “A worsening global economic recession will make it virtually impossible for Australia to sustain a positive economic growth for the period ahead, with impacts, of course, for budget and employment.”

Of course. That means, by the way, February’s unemployment rate of 5.2% (the highest in four years) is probably headed higher. Not having worked in the private sector recently (or ever?) the Prime Minister may be underestimating how many of Australia’s businesses are prepared to shed jobs amidst uncertainty. “More than half of Australia’s mining and resource companies will fire staff in the next 12 months,” Bloomberg reports.

The “budget impact” will be a higher government deficit. True, it won’t be as bad as the A$13 trillion U.S. deficit over the next ten years. That’s what the Congressional Budget Office is projecting if Barack Obama’s spending plans go through Congress unchecked. It’s massive.

But a deficit is a deficit. The money has to be borrowed from someone. And it has to be paid back later, through higher taxes or more borrowing (not to mention the interest). It’s not a good habit to get into, living above your means because you are unwilling to cut back on your lifestyle.

In any event, the big news this week will be how markets receive U.S. Treasury Secretary Tim Geithner’s toxic asset plan. By all accounts, it sounds like Geithner wil make US$1 trillion (or thereabouts) available to hedge funds and private investors in order to buy aforesaid toxic assets from America’s banks.

“Here. Take this $1 trillion. Buy those bad assets. Benefit from the upside. We’ll take all the risk…What’s that? Why yes, of course I’m serious.”

If you’ve been paying attention to the way the U.S. Congress treated AIG executives during hearings last week, you’ll wonder why anyone of sound mind would want to become a business partner of the United States government. It’s a government that is now willing to change the laws to punish people of whom it disapproves. And before that, it’s a Congress that was willing to pass a thousand page stimulus package that no one had read.

Does anyone really believe these idiots have any idea what they’re doing? And does anyone believe private capital will hold hands with Uncle Sam and take his borrowed money to buy toxic assets?

On the face of it, using someone else’s money to take risk doesn’t seem so bad. But given the last few weeks in Washington, private investors would have serious doubts about whether any profits that might result from owning those assets would actually go to investors, or would be confiscated by the Congress. “Political risk” is the kind of investment risk you used to associate with dictatorial regimes in Africa, not democratic regimes on the Potomac. But there’s no doubt investors in America (like China and its US$700 billion in bonds) now face real political risk.

All of which is to say that the government is making investors more nervous and more risk averse. This is not the kind of indifference that comes with bottoms. This is the kind of panic that comes with crashes. There’s a chance that could change that week if the Geithner plan is well received and the morons in Congress put down their pitchforks. But if it doesn’t change for the better, it could change for the worse.

And even assuming the plan is well received, banks are still going to need more capital before they begin lending again. Former Fed Chairman Alan Greenspan told investors at a conference in Acapulco Mexico that, “Restoration of normal bank lending will require a very large capital infusion from private or public sources.”

He puts this number somewhere “north” of US$750 billion.

A trillion here. A trillion there. Pretty soon you’re talking about a bankrupt America.

What all this means for Australia is still not quite clear. Australian banks are still lending for new mortgages and they don’t, on the surface anyway, appear to be having any trouble borrowing money themselves. We’re keeping an eye on both (lending and borrowing by the Big Four).

The huge American deficits make the U.S. dollar weak. The Aussie has been rising, as have gold and oil. Greenback weakness is commodity bullish (not across the board though). And Australia is not one of those countries that has pegged its interest rates to U.S. rates. That means Australia does not have to match U.S. rate cuts to keep its currency pegged (as is the case in some of the Gulf States, China, and other places).

So the good news is that Australia does not necessarily have to import inflation from the U.S. The bad news is that economic conditions are getting worse, not better, meaning that inflation might get to these shores anyway. If unemployment rises, stocks stay flat, and trade weakens, it wouldn’t surprise us to bigger government deficits with larger spending plans and more rate cuts. Growth in the money supply is inflation. It shows up later in higher prices.

And for housing? That’s what many Aussies treat as “Plan B.” It could be that you see a resurgence in house price inflation as Aussies turn away from the share market in favour of the myth of perpetually rising house prices. Although it may look appealing for awhile, it may not end well.

Two or three years down the track-maybe sooner if unemployment grows faster-we can see the Reserve Bank in the position of having to raise rates to contain inflation. It will have done so after hundreds of thousands of younger, marginal buyers have been sucked into the housing market with First Home Buyer grants. How will they cope with rising rates? How will they cope with falling prices? How will they cope with losing their jobs?

“Australia has certainly been a levered play on this global commodity boom and if we truly had been in a super-cycle, then it was a brilliant move,” Stephen Roach of Morgan Stanley says. “But the global commodity boom has also gone bust, and this has caught Australia without much in the way of a diversification or a backup plan.”

More on how to actually diversify tomorrow.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. “If you’ve been paying attention to the way the U.S. Congress treated AIG executives during hearings last week, you’ll wonder why anyone of sound mind would want to become a business partner of the United States government. It’s a government that is now willing to change the laws to punish people of whom it disapproves.”

    Golly gee wow, a government making laws to stop people doing bad things. WELL I NEVER!

  2. The Australian Version of the Sub-prime crisis?

    The article below, from the weekend, suggests that Australia is starting on its own version of the US sub-prime stimulus.

    The article points out one vulnerability for Australian home mortgagees:

    “The average Sydney property already costs nine times the average annual household income, yet Britain and the US reached a peak of only seven times average income before their markets crashed.”

    Combine this with the ‘bubble” house price appreciation, it doesn’t look good long term.

    An earlier post had this quote from Graham Dyer:

    “… the property boom in Australia has been one of the most extreme in the world, rivalled only by Spain and Ireland.”

    This was illustrated in this week’s edition of “The Economist”.

    The chart on house-price appreciation from 1997-2008, in the article entitled “Caught in the downward current”, noted that Irish and Spanish house price rose 193% and 184% respectively. The next largest appreciation was Australian house prices at 163%.

    Other countries were France (152%), Britain (150%), NZ (102%).

    The United States had three measures – the Case Shiller national index (66%); the OFHEO index (84%) and the Case-Shiller ten-city index (102%).

    The only two, in the chart, that experience negative growth were Japan (-33%) and Hong Kong (-35%).

    The last paragraph, of three, that accompanied the chart, stated:

    “Gone is the optimism of yesteryear. Book titles such as “Are You Missing the Real-Estate Boom? The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade – And How to Profit From Them” (2005) are destined for the annals of folly, next to asset-bubble classics such as “Dow 36,000”. Fear has replaced frenzy, and house prices may overshoot on the way down. A recent report by Numis Securities estimated that British house prices could fall by a further 40-55%, saddling millions with properties worth less than their mortgage debt. Long was the uphill march, long will be the downhill descent”.

    Two sentences from George Elliot’s “Silas Marner: The Weaver of Ravelow”, may be relevant for today:

    “The sense of security more frequently springs from habit than from conviction, and for this reason it often subsists after such a change in the conditions as might have been expected to suggest alarm. The lapse of time during which a given event has not happened is, in this logic of habit, constantly alleged as a reason why the event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent.”

    (The peak to trough fall in Sydney house prices maybe anywhere from 60 to 80 percent, in the Next Great Depression).

    “First-homebuyers at risk thanks to stimulus package”

    Glenn Milne and Nick Gardner,, March 22, 2009:

    AUSTRALIA faces its own version of the US sub-prime housing crisis, with young homeowners risking bankruptcy thanks to the PM’s economic stimulus package.
    That’s the grim warning from the economic expert who first called the debt crisis that is driving the global financial meltdown. Dubbing the looming crisis “Sub-Prime Lite”, Professor Steve Keen said Australia was making the same mistakes as the US.

    Prof Keen said that in trying to avoid an economic crisis caused by too much borrowing, Australia was in effect encouraging the poorest in the community to take on even more debt.

    “Yet these low-paid first-homebuyers are the people who are most vulnerable to the economic downturn,” he said.
    The top end of the nation’s housing market has been suffering for some time. Meanwhile, the first-home buyer end of the market has been booming.

    But economists fear this flurry of activity at the lower end has inflated prices to unsustainable levels.

    The average Sydney property already costs nine times the average annual household income, yet Britain and the US reached a peak of only seven times average income before their markets crashed.

    According to Professor Keen, the First Home Owner Grant has cost the Government about $200 million, but has inflated property prices by close to $3 billion.

    “This is all illusionary wealth that could disappear very quickly,” he said.

    “The additional $2.8 billion or so has come from increased mortgage debt taken on by those most vulnerable to a serious economic downturn at a time when we can see very clearly that the global recession is coming our way.”

    The Government may well extend the First Home Owner Grant beyond its planned end-date of June 30, which Prof Keen says will end up pumping the market to even higher levels.

    The University of Western Sydney academic said he had sold his Sydney house because he feared a property crash, but his gloomy view on the market has been backed by other experts.

    Gerard Minack, chief economist at Morgan Stanley, said property prices were likely to fall by 20 per cent in some cities.

    “People paid Hamptons prices for properties up there but it is not the Hamptons,” he said.

    “Traditionally what has hurt people has not been rising (interest) rates but rising unemployment. I don’t care what rate you’re paying, if you have a mortgage five times your income and you lose your job, you’re toast.”

    Mr Minack said while he understood the motivation behind the grants, encouraging marginal buyers to enter the market at this stage of the cycle (just ahead of a sharp rise in unemployment and with interest rates so low), Australia risked “creating a sub-prime underbelly in our own housing market”.

    With unemployment at just over five per cent, many economists are forecasting it will peak at eight or nine per cent in 2010, leading to a “bloodbath” in the property market as thousands of mortgagors default on their loans.

    Most buyers were also taking out low, variable-rate mortgages, which left them exposed to rapidly rising rates when the economy began to recover and this would also spell trouble for many buyers.

    AMP Capital chief economist Shane Oliver said the tendency for buyers to take out low, variable-rate mortgages would spell trouble for many buyers when interest rates rose.

  3. We must love and pamper the nubile ‘subbies’ egos and borrowing power. Who else can we offload over priced property onto? Your wrecking it for the rich guys man and that’s mean.

  4. […] The Daily Reckoning Australia […]

  5. You don’t think the gubmint is going to let house prices fall too much if they can help it do you? I suspect that they would rather take their chances with ramping up inflation over their constituents taking massive hits on property “values”. The US seems to be have just leaped into the abyss of this very thing.

    I think our our governments are caught holding a double headed snake of their own making and don’t know what to do with it – either way they (and us) are going to get bitten.


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