Roubini Backs Geithner's Toxic Asset Plan

Nouriel Roubini is backing Geithner's PPIP toxic asset plan, saying

Secretary Timothy Geithner's new toxic asset plan is a serious step in the right direction in that it creates a public-private partnership to buy the troubled assets of financial firms - in other words, to do the necessary cleansing.

Roubini admits, though:

The government bears the risk if and when the investors take a bath on the taxpayer-provided loans. If the economy gets worse, it could get very ugly, very quickly. The administration should be transparent in making clear that there is still a wealth transfer taking place here - from taxpayers to investors and banks.

Also, while this plan is designed by the Treasury, many of the big guarantees are being made by the Federal Deposit Insurance Corp. and the Fed. Why not use only Treasury funds? Well, then the administration would have to deal with Congress. While the populist hysteria of last week suggests this end run might make sense, there is something a little worrying about circumventing the legislative process on such a huge investment.

So even Roubini admits that PPIP is a massive wealth transfer from taxpayers to investors and banks, and that Treasury funds are being used to sidestep Congress and their constituents - the American people.

Nobel economist Michael Spence has also said that PPIP has a good chance of succeeding in cleansing banks of toxic assets.

And UC Berkeley professor Brad Delong has also defended the plan.

On the other hand, nobel economists Krugman and Stiglitz - and just about every other economist who has publicly commented on PPIP - have shredded the plan, saying it is robbing the taxpayers and that it will fail to turn the solvency of the banks or the economy around.

What do I think about PPIP?

I think - for two reasons - PPIP will fail:

(1) Citigroup, Bank of America and other players are already gaming the program (and see this), which will create unintended consequences; and

(2) Credit default swaps are some of the primary "toxic assets" which need to be cleared out of the system. As Nobel economist - and the "intellectual godfather of credit default swaps" - says, we must "blow up" the credit default swaps and close out the CDS contracts at less than full value. Anything less won't work to purge the banks and give them - and the economy - a chance to become solvent once again.