DeLong Weighs & Measures the Bank Plan

Brad DeLong has an interesting piece in The Week in which he looks at the Geithner bank plan and does his assessment of it. The key bit for me is:

Q: How does having the U.S. government invest $500 billion in the world's largest hedge fund operations reduce unemployment?

A: The sudden appearance of an extra $500 billion in demand for risky assets will reduce the quantity of risky assets other private investors will have to hold. And the sudden appearance of between five and ten different government-sponsored funds making public bids for assets will convey information to the markets about what models investors are using to value assets in this environment. That sharing of information will reduce the perception of risk somewhat. When assets are seen as less risky, their prices rise. And when there are fewer assets on the market, their prices rise too: it’s simple supply and demand. With higher financial asset prices, those firms that ought to be expanding and hiring will be able to get money on more attractive terms that make expanding and hiring more profitable, etc.

A: And the recession will end, and unemployment will drop back to normal?

A: I doubt it. My guess is that we would need to take a total of $4 trillion in assets out of the market in order to move financial asset prices to a point at which it becomes profitable for businesses that should be hiring and expanding to actually hire and expand. “Toxic” assets account for only $2 trillion of this total; the government has to sponge up additional assets because the big problem now is not the inability of some people in the desert outside Los Angeles to pay their mortgages. The problem is that among financiers everywhere, the tolerance for holding risk has collapsed. The Geithner plan supplies $500 billion to acquire assets. The Federal Reserve's quantitative easing plan will add another $1 trillion. And I should hasten to say that the administration thinks that the information-sharing effects of the Geithner plan will do three times as much good as the simple supply-and-demand analysis suggests. (I discount that entirely.) So from their perspective, the glass is 3/4 full.

Note how DeLong, who is an optimist, is enough of a realist to admit that the Geithner plan falls short of solving the problem. If you read the whole article you can see that politics is what prevents Obama from solving the problem.