Are we just going round in circles?

Fresh from his unveiling of the toxic asset plan on Monday, US Treasury Secretary Timothy Geithner called for a further overhaul of the US financial regulatory system. He said the system had failed a major test. What Geithner would like to do is to work with the Congress to lay down a stronger regulatory system in order to prevent future financial crises.

"Our system basically failed its most fundamental test," he said in remarks to a conference in Washington DC. "It was too fragile."

We are not sure whether Geithner was trying to address the AIG bonus scandal, which is badly affecting his standing in the immediate term, or whether he is really ahead of the game in strengthening the banking regulatory system, which has developed too much of a cosy relationship with Wall Street. The Congress and the American public are still fuming with rage over more than US$160 million(Bt5.6 billion) in bonus payments to top executives of AIG, which has received more than $170 billion in federal bail-out funds. The signal from the AIG episode shows that the system is rewarding market failure.

It is not yet clear what kind of regulatory package Geithner would like to push for. But President Barack Obama would like to have this proposal to bring with him to the G-20 summit meeting in London on April 1 and 2. Right now the US government does not have clear-cut authority to take over major troubled financial institutions, even if they are deemed to pose a systemic threat to the entire financial system.

However, the root problems of the US financial system lie in lax regulations and unrestricted financial liberalisation. US banks and investment banks operated in the belief they were too big to fail. They went on to create a huge financial bubble, backed by tiny capital and playing on public deposits. With the power of the paper currency, the Federal Reserve Board can print the US dollar almost at no cost.

Since the US is also the world's largest buyer of last resort, it had also been considered too big to fail. Besides this, it was believed that US growth would continue forever. This mentality fuelled the consumption bubble, the real estate bubble, the financial bubble and now the budget bubble, all of which have gone bust.

Understandably, Obama wants to have the financial reform package with him to show to the Europeans and others at the G-20 summit. It would prove that he is serious about financial reform. The Europeans have been reluctant to go along with Obama's call to increase government spending in a collective effort to pull the global economy out of recession.

The European Union is tied by the Maastricht Treaty, which prevents a member country from earmarking a budget deficit of more than 3 per cent of the gross domestic product. Moreover, the Europeans believe that the US should focus more on tackling the banking crisis rather than on stimulus packages.

After an initial delay, Geithner finally introduced his toxic asset plan, under which investors would be encouraged to buy up to a half-trillion dollars of bad assets, to shore up banks' capital and unlock credit. The programme could later be expanded to $1 trillion. Wall Street responded on Monday with its best day of 2009, sending the Dow Jones industrial average soaring almost 500 points, a rally of almost 7 per cent.

Henry Paulson, the former US Treasury secretary, could not implement his toxic asset bail-out plan because of the controversy over pricing. But Geithner's plan does not depart significantly from his predecessor's. The plan would offer low interest rate loans - drawn from the $700 billion bail-out fund approved by the Bush administration and backed by the Federal Deposit Insurance Corp and the Federal Reserve - to hedge funds, private equity or other investors to buy bad assets from the banks. It is an irony that some of the hedge funds, which have been short-selling bank stocks for profits, now might turn to benefit from the US government's programme to carve out the bad debts with government guarantees.

"It's going to take some time to separate the wheat from the chaff but the gist of it remains unchanged from Trouble Asset Relief Programme 1 - pay the banks two dollars for an asset worth one dollar and they will sell it and remain solvent. In TARP1, the government intended to do it directly but the taxpayer was upset and it didn't fly," said a report of DBS Group Research issued yesterday.

"In the current version, the private sector (with government help) will buy the asset for two dollars. How do you get them to pay two dollars? By guaranteeing any loss. Who underwrites the guarantee? The FDIC and the Fed. In other words, the taxpayer. So for the investor, it's heads I win, tails you lose.

"For the taxpayer, it's more of precisely the same arrangement that got the financial sector into this mess in the first place. Private profit, social risk. The Geithner plan looks like a round-about way to get back to where you started."

The Obama administration still drums up the beat that once the bad debts are taken out of the banks' balance sheets, the banks will become stronger and start lending again to revive the economy. This is not going to happen because the economy is still in severe recession, with rising corporate bankruptcy and consumer debt. Stronger banks from other countries are cautious with their lending because they are not certain about the economic outlook. We are still heading toward a severe downturn.