The Financial Bailout Plan: First, Mr. President, k . . . ban all . . . uh, most of the economists.

Dear Mr. President:

As you know, the stock market today bungee jumped without a rope after Secretary of the Treasury Geithner announced the financial bailout "plan." All told, the Dow Industrials fell about 381 points, closing at their lowest level since last November. The salient reason for the market drop was the lack of details in the "plan." Another concern was the adequacy of funding for the plan.

The first and foremost thing business people want from the government is clarity. Skilled business people can find a way to make money if they know how things are going to work (and you want them to make money if we are to have a functioning economy). Without clarity, commerce is hindered. To take you back to your law school days, that's why all 50 states adopted the Uniform Commercial Code.

The lack of clarity is greatest with respect to toxic assets. The "plan" proposes to take $50 billion of government money, raise up to $500 billion or more of private money, and use the total to buy toxic assets. First, there are hundreds of billions of dollars worth of toxic assets remaining on the books of major banks. Then, there are trillions more in off-balance sheet vehicles for which the banks probably bear some liability (if you don't understand this point, Mr. President, get briefed on it because it's really important). All told, there might be three, four, five or more trillions worth of toxic assets out there. Today's proposed plan doesn't explain what prices will be paid for toxic assets. But it's clear that the total funding available (say, $550 billion) wouldn't begin to buy up all the financial waste. So, when some toxic assets are priced and purchased by the government program, those prices would logically apply to unpurchased assets (most likely those lurking in off-balance sheet vehicles), something that could force the banks to take major writedowns. The amount of money designated for recapitalizing banks, $120 billion, is highly unlikely to be enough to keep the banks on life support. The result could be that the toxic asset purchase plan, if it has any traction at all, could put the major banks under.

We also wonder whether the government could raise $5oo billion or more of private capital to participate in this venture. If the government puts in $50 billion and private investors put in $500 billion, that implies that the government will absorb not more than 9% of the losses. Given the toxicity of the assets and the still declining state of the economy, a 9% share for the government isn't necessarily going to bring in vast amounts of private capital.

The plan also includes $50 billion for foreclosure relief and $100 billion to help stimulate consumer lending. This plan has all the hallmarks of a multitude of chefs. Like many political programs, it appears to represent a mixed bag of viewpoints, with the nondecision on how to handle toxic assets being the most mixed up. Clarity is lacking. Investors can't see what the heck is really going on. That's why the market fell so sharply today. That's part of the reason why the market fell so sharply last year while the Bush economic team thrashed around.

A vague and underfunded plan will, unintentionally, lead to the nationalization of the banking system. If the government doesn't decisively do something else, there's no other option. Nationalization wouldn't necessarily be a bad thing, if it's temporary (see http://blogger.uncleleosden.com/2009/01/why-it-would-make-sense-to-nationalize.html). But it would be more effective if done sooner rather than later. The current "plan" for all we can tell means more delay and dithering, while the financial system's losses mount.

Recall, Mr. President, the joke about asking 3 lawyers the same question and getting 4 opinions. The same applies to economists, only more so. Lawyers learn to compromise, if for no other reason than they don't want to deal with frowning judges. Economists, being academics, tend to view compromise as undermining their intellectual (and therefore professional) integrity. You won't get a decisive or, ultimately, an effective financial bailout plan from a large group of economists. At last count, they've got you surrounded and seriously outnumbered, with one group headed by Summers, another by Romer and a third by Volcker. This is econ-overload. You're probably getting a plethora of opinions that you find impossible to parse and reconcile. That's what happens when you assemble enough economists in one place. Don't lock them in a room and tell them to work it out among themselves. That's a classic bureaucratic maneuver that turns what should be a thoughtful process into a power struggle; and is likely to produce, well, what we got today.

Pare down the number of economists you talk and listen to. Most likely, you'll have to choose one of the economic stars on your team and follow that person's point of view, even over the protests of the others. How you'll choose among them is impossible for a blogger looking into the White House from outside to figure out. But choose you must. Then, ask that person to put together a plan that is decisive and clear. Understand that the essence of the problem you face is nothing more or less than the allocation of the financial system's losses emanating from the mortgage crisis, the credit crunch, and the declining economy--trillions of dollars worth. Someone has to take these losses. There's no way to make them magically disappear. Creditors, shareholders, executives, employees, investors, depositors, and taxpayers are all likely to bear some of the losses. The bailout "plan" is simply a way to decide who bears how much. There is no perfect allocation. Whatever plan you choose will induce howls of outrage by hordes of people, because the enormity of the losses will inflict a lot of pain regardless of where the losses fall. The Bush administration's failure was, in many ways, a failure to do anything definitive enough. The best thing now is to put together a clear and decisive plan that allocates losses in a reasonable and well-defined way, and then get on with it. In the end, the most important thing is to get some sort of recovery process going, or the economy and financial system will continue their downward spiral.