Jeremy Warner: Believe it if you will as Geithner's $1trn elephant takes flight

Outlook: For some banks there remains a certain inevitability about at least a temporary period of state ownership
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The Independent Online

A neat way of providing price discovery and sharing with the private sector the risks of buying up the banking industry's toxic assets, or just too clever by half? When Tim Geithner, the US Treasury Secretary, first outlined in early February the new administration's proposals for relieving credit-crunched banks of their toxic assets, it was greeted by Wall Street with a resounding raspberry. Mr Geithner has been on the back foot every since. The plans as outlined then seemed poorly thought through and were lacking in crucial detail. Republicans sensed blood and, despite his newness to the post, insisted Mr Geithner wasn't up to the job.

Yesterday, the US Treasury put a little more flesh on the bare bones. Wall Street's reaction was much more positive, but still there is something of a credibility gap. Can this latest elephant be made to fly? Certainly it is going to take quite a while to find out. As in Britain, main street is meanwhile left wondering why the government is bothering with all this pussy-footing around in front of the goalmouth and doesn't simply put the ball in the back of the net by nationalising some of the worst-affected banks outright.

The Geithner plan lies somewhere between the "bad-bank" proposal of Hank Paulson's original Troubled Asset Relief Programme (Tarp) and the insurance scheme the British Government has introduced by way of an alternative – the asset protection scheme. Mr Paulson proposed to buy the assets outright with government money. In Britain, the APS leaves the assets with their originating banks but for a fee insures losses on those assets beyond a certain point.

To add to this alphabet soup of plans, Mr Geithner has come up with the Public-Private Investment Programme (PPIP). Equity put up by private sector market participants such as Pimco and Blackrock is matched by the US Treasury and then geared up with cheap loans from the US government and the Federal Deposit Insurance Corporation.

One of the key difficulties encountered with Tarp was how to value the assets. Sold too expensively, and Tarp would be just a subsidy by the US taxpayer to the miscreant banks. Sold too cheaply and it would only create further solvency problems for the banks and therefore undermine much of the purpose of the bad-bank approach.

Mr Geithner's proposal aims to ease the problem of price discovery by providing a market mechanism for valuing the troubled assets. In this sense, it might be considered an improvement on the British approach where the price at which the assets were insured was the result of a negotiation between the Government and the banks. The suspicion is that the banks have managed to lumber the taxpayer with a thumping great liability by offloading their worst assets at inflated prices.

Notwithstanding the present witchhunt around those who profit from taxpayer bailouts, Mr Geithner shouldn't be short of partners. Participants get the benefit of cheap public sector leverage (something of an irony given that it was leverage that created this mess in the first place), and they also get to choose what assets they buy and at what prices.

What's more, Mr Geithner has said that participants won't be subject to the same restrictions on pay and bonuses that have afflicted those who have taken the Tarp money. The Obama presidency seems to draw a distinction between unconnected parties, who are allowed to profit as much as they like from government subsidy, and the banks, which are not.

In any case, it shouldn't be difficult to attract buyers. The problem occurs rather with the willingness of sellers. PPIP gives participants initial buying power of up to $500bn, potentially rising to $1trillion. Yet even the higher of these two numbers is thought by many to be insufficient to relieve the banks of enough of their troubled assets to do the trick. Remember, the problem is no longer confined just to mortgage-backed securities. Recession has prompted a conventional bad debt problem too.

Nor is it clear that distressed banks will want to sell at the prices buyers are prepared to pay. The scheme suffers from some of the same flaws as Mr Paulson's Tarp programme in that if the price is too low, it will only succeed in crystallising solvency issues for banks which have yet adequately to recognise their bad debts. As I say, it will be months before any of these public-private partnerships are up and running and possibly several months thereafter before they start performing their intended purpose of unclogging credit markets through purchases of troubled assets.

And if the "price discovery" thereby enabled ends up demonstrating many banks are indeed essentially bust, then nationalisation, at least for the worst offenders, may be the ultimate outcome anyway. It all seems a peculiarly complicated and long-winded approach to the problem. Nationalisation, by contrast, provides a comparatively simple way of restructuring the banks, so their bad assets can be removed into a long-term workout fund and the "good" bank which is left can start lending normally again.

The US authorities are against this approach for much the same reasons as the British Government. Ideological objections figure high on the list, particularly in the US, but also in Britain, where the Brown Government is terrified of revisiting Old Labour's Clause Four traditions.

With good reason, there is a natural aversion to the idea of putting governments back in charge of credit allocation. These are judgements best left to commercial organisations. Then there would also be the difficulty of refloating banks that had been nationalised without compensation. For obvious reasons, investors would be wary. Maintaining the listing should make it easier for governments to offload their shareholdings when conditions return to normal.

Even so, for some banks there remains a certain inevitability about at least a temporary period of state ownership. Who knows? The Geithner plan may work. Combined with yesterday's US housing data, showing a sharp pick-up in transactions last month, Wall Street seemed minded to regard the Geithner plan as a turning point. But how many times have you heard that before? There are still plenty of reasons for scepticism.