The Treasury released their plan on Monday to clean banks’ balance sheets. A five page document distributed by the Treasury offers some limited details. It looks like the plan has the government becoming the largest hedge fund with potential to invest up to $970 billion in risky assets. $30 billion more will come from private investors who will, according to the Treasury, accurately price the assets because their own money will be involved.
Will it work? Nobel Prize winning economist, Joseph Stiglitz, says the plan will give profits to private investors while putting taxpayers at risk for losses.
Aside from the concentrated benefits and diversified risks, the plan presents yet another shift in policy in dealing with the financial system. If this plan fails, then there will likely be another shift later.
Markets are resilient, but they need accurate prices to operate effectively. In order to have accurate prices, the relevant decision makers (consumers and producers) need knowledge to generate accurate prices. When the government keeps changing things every few weeks, then consumers and producers can’t set prices effectively. If government could find some way to credibly commit to one plan, then markets would likely end up fixing themselves faster than they would even if government developed better but changing plans over time.
The best plan, of course, would be to stop interfering with the market and get out of the way to let it recover.