All Things Considered, March 23, 2009

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ROBERT SIEGEL, host: One person who wasted no time in criticizing the Geithner plan is Princeton economist Paul Krugman, who calls it in his New York Times column today, essentially a re-hash of the Paulson plan - the third one of the Obama administration's efforts, he says. And, he writes, the real problem with this plan is that it won't work. Paul Krugman joins us now. Why won't it work?

Mr. PAUL KRUGMAN (Economist, Princeton University; New York Times Columnist): Because the problems with the banks run a lot deeper than the arguable proposition that maybe some of this toxic waste is worth a little bit more than the market's willing to pay for it right now. This is basically a plan that's predicated on the belief that all we really have is a panic. Nobody's willing to buy this stuff, even though it's really not that bad. And if only we could sell it for what it's really worth, all our problems would be over. And that's just a really bad guess at the nature of our problems.

SIEGEL: But I spoke earlier with Bill Gross of Pimco, a huge bond fund. He's gung-ho. They're going to buy up lots of this stuff, he says.

Mr. KRUGMAN: Well, you know, of course they're going to buy a bunch of this stuff. There's a heavy implied subsidy, and it's basically presenting whoever participates in the plan with a heads-I-win, tails-the-taxpayers-lose proposition. So it's - of course it's going to make people like Bill Gross happy.

SIEGEL: But will it make things work better if he can unburden the banks of some of these securities?

Mr. KRUGMAN: You know, there's a big confusion here. People talk as if - in fact, the whole metaphor, toxic waste, I think is a problem, as if there's this bad stuff and it infects the good assets. The real problem is that the banks made a lot of bum investments, and as a result, they probably don't have enough money to cover their debts. And it doesn't matter, you know, that banks can take the stuff off their balance sheets however - any time they want, just by marking it down to zero. The problem is can they get a high enough price for this stuff to make them solvent? And the answer is, for the really troubled banks, no - even with this plan. So, sure, you know, we'll get some deals. This is a pretty sweet deal for the investors involved, but it's not going to resolve the problems with our banks.

SIEGEL: Since part of the problem here has been figuring out what the price of something is, has - does this plan hold the possible promise of getting enough people interested in buying something so that you will arrive at a reasonable price?

Mr. KRUGMAN: Well, the trouble is that it's not going to be a truly free market in this stuff. We are basically - again, if you're an investor running one of these plans, you are given a situation where if the asset goes up a lot in value, if it turns it - you know, things are really not that bad and these home mortgages get paid, then you get all the gains. But if it's a really lousy deal, if it turns out that the pessimists are right and this stuff yields very little, you just walk away and you leave taxpayers holding most of the bag. So prices will emerge from this, assuming they can find some banks willing to sell this stuff. But the prices won't necessarily have much at all to do with what a reasonable estimate says it's actually worth.

SIEGEL: What will you look at, by the way, if you're trying to figure out how well this is succeeding? What, for you, is the measure of its success or failure in the coming weeks?

Mr. KRUGMAN: How much stuff actually gets sold, what kind of prices. If this stuff ends up - if the toxic waste ends up being sold at, you know, 55, $.60 a dollar, then I'll start to reconsider. I'll say, gee, you know, even though there's a subsidy here, I didn't think the prices would be that good. If the banks start to look really good, then, you know, if suddenly anxiety about the bank starts to go away - and you'll be able to see that in things like prices on credit default swaps - then, you know, I'll say I was wrong. If, you know, in other words, if it really does look as if this has saved the banks, then I'll say I was wrong. But I'm not going to judge it by what happens to the stock market on one day.

SIEGEL: Economist Paul Krugman - Nobel laureate economist Paul Krugman of Princeton University. He's also a columnist for the New York Times. Good to talk with you once again.

Mr. KRUGMAN: Thanks a lot.

Originally broadcast, 3.23.09