Is Geithner Plan Road to Recovery or Road to 'The Road?'

(All references to apocalypse are tongue-in-cheek...I hope. Some of that gallows humor Obama loves so much.)

The markets are momentarily happy about the long-awaited, fleshed-out announcement of the Geithner plan to rescue failing banks. Increasingly frustrated since the Treasury Secretary's announcement of a plan Feb. 10 with precious little detail, this weekend's revelations were enough to make investors more hopeful:

"The (stock) market was looking for anything that was more definitive from Treasury than what we had," said Bud Haslett, chief executive of Miller Tabak Capital Management. "There are still are lot of unknowns, but it is more clear. The market is going to have a positive bias going forward."

Stocks have enjoyed a solid rally from 12-year lows hit this month. Investors are cautiously optimistic as they look ahead, although they will look to see that banks' balance sheets do show improvement. That goal has been elusive since the crisis began despite several previous aggressive steps by the government.

Geithner's op-ed on the plan is itself another indication of the administration's problematic priorities, wasting almost 500 words on touting stimulus bric-a-brac before even getting to the plan, but the New York Times offers a succinct explanation of the three-pronged, trillion-dollar gambit:

In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.

In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.

In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Securities Loan Facility, a joint venture with the Federal Reserve.

Whether the plan will actually work, allowing banks' balance sheets to show improvement, is an open question among economists. The aim is to unstick seized-up markets by clearing out banks' toxic assets, thereby allowing them to start lending again. The administration hopes to entice private investors to buy those assets with a combination of fire-sale prices and shared risk with American taxpayers, who would foot much of the bill. The administration is hoping a group of private investors, such as hedge funds, will be able to create market prices for assets for which there simply is no market right now.

Christina Romer called it "using the expertise of the market by trying to set the price for these toxic assets." Administration officials have emphasized that, when toxic assets, which they assume are "undervalued," mature and the market recovers, taxpayers will reap the benefits of taking on these risks as money flows back into government coffers.

But liberal economist Paul Krugman became an unexpected thorn in the administration's side this week, as he argued that there's a reason such investments are risky- because there's a significant chance they won't go up. His first shot came on Saturday when he called the Geithner plan and its underlying assumptions an "awful mess" - a critique Romer called "unfair" on the Sunday shows. Today, he's been debating the new policy again, refuting the administration's line that its financing does not constitute a subsidy, and fretting that the Obama administration is solving a problem of "misunderstood" assets when it needs to be dealing with the fact that the assets are actually bad.

But Treasury is still clinging to the idea that this is just a panic attack, and that all it needs to do is calm the markets by buying up a bunch of troubled assets. Actually, that's not quite it: the Obama administration has apparently made the judgment that there would be a public outcry if it announced a straightforward plan along these lines, so it has produced what Yves Smith calls "a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for [I don't think I can finish this on a Times blog]"