Posted on Edge Economy: March 23, 2009 2:59 PM

Let's make a deal. We'll make some bets together, and you get a fifth of the upside—but only a fiftieth of the downside.

Seems awfully generous of me, doesn't it? That's the plea the Geithner Plan makes to hedge funds.

Unfortunately for the global economy, the dollar, and, well, your future, that's a great bet for funds—but a terrible bet for the rest of us. The probable outcome of the Geithner plan is going to make today's crisis look like a zit on the face of the Elephant Man.

Why? Let's get the bean counting out of the way. For staking $30 billion out of $1 trillion, funds take a 17% of the profits. Think about the inequity inherent in that equation for a second.

Funds share 17% of the upside—but only share 3% of the downside. That's the cold hard logic of why the Geithner plan isn't likely to work: because it doesn't fix the yesterday's perverse incentives. Sound familiar? It should: it's the same recipe for moral hazard that created this mess in the first place. What adds insult to irony is Geithner's other inverse magic trick. He simply replaced leverage from banks with leverage

Yet, that's just the tip of the iceberg. The Geithner plan is a weapon of social, political, and economic mass destruction. Here's why.

The Geithner plan is a financial coup d'etat. The Geithner plan is the most radical—and radically toxic—cure for a financial disease in recent history. From an organizational point of view, it is nothing short of revolution: a financial coup d'etat. Yesterday, public expenditure and private investment were kept vastly separate—because of their vastly differing goals and incentives. The Geithner plan merges them, creating an entirely new kind of financial economy altogether.

Welcome to Looting 2.0. What does that financial system look like? In it, everything is a hedge fund. The Geithner economy is Milton Friedman's revenge from beyond the grave: it is one that puts the allocation of public resources in a very small number of almost totally hidden private hands. The Geithnerconomy is a kind of financial Frankenstein: run by hedge funds, leveraged by the public, whose interests overlap by only 20%. The problem of toxic incentives hasn't gone away: in fact, the Geithner plan institutionalizes and explodes it, like a biological weapon infecting an entire country.

What do these payoffs create the incentive for? For hedge funds to loot the public on a mega-scale. Heads, funds win. Tails, you lose.

Wait—hasn't it always been so? Not a chance. Never before in financial history has so much money been in the hands of so few, with so little transparency, and such clearly toxic incentives. Never before in financial history has the richest country in the world actively, irreversibly, and so radically merged public expenditure with private investment.

The financial coup d'etat lays the seeds of a Great Divergence. Last week, I discussed how the AIG bailout was the most pernicious kind of cronyism—not even crony capitalism, but crony socialism. When we zoom out, that's exactly what the curiously lopsided payoffs hedge funds get are. How would you like it if Geithner offered you or your company the opportunity to invest at the same risk/return profile? Of course, you won't get the chance.

What was, with the AIG bailout, a mere crack in the economic firmament is now a gaping fissure. The result of the financial coup d'etat is a Great Divergence: we have two economies running in parallel: capitalism for the poor, and socialism for the rich. The former essentially subsidizes the latter endlessly and perpetually.

Shades of Karl Marx? Sure. Except this time, it's not a prediction: it's reality.

The Great Divergence is igniting a new Cold War. The Great Divergence is, I think, going to give rise to a new cold war. Yesterday, there was a cold war between capitalism and socialism, conducted across nations: the Soviet Republics + China, and America + the European states stared one another down.

The New Cold War will be conducted within nations. Whether you're in China, Russia, America, or Europe, the new cold war will pit citizens of the same countries against one another, sharply reversing what it means to be a citizen, a capitalist, or a CEO.

Yesterday, capitalists ruled the world. Today, socialists do: if you're a hedge fund, you should be kissing your copy of Das Kapital. Yesterday, CEOs and the poor couldn't have had more different values and interest. Today, they are both pitted against crony socialists.

The New Cold War looks like this. Hedge fund manager vs CEO, plutocrat vs prole, Gatsby vs Galt.

The New Cold War is a battle between economic democracy and economic feudalism. In a democracy, you pay taxes, and elected administrators allocate those financial resources for the common good. In feudalism, taxes are appropriated from you, and allocated by private hands that the public cannot influence, for the private good. In Feudalism 2.0, hedge fund managers are essentially lords to whom people are vassals. You have the right to benefit from your financial assets—but fund managers are who determine their value. In the Geithnerconomy, the salaryman is the new slumdog.

What's the biggest difference between economic democracies and feudal systems? Economic democracies grow. Feudal economies eat themselves from the inside.

Listen. I know this sounds like science fiction. But so did the idea of a global financial collapse when we started discussing it, quite a few years ago. So consider the logic—instead of reacting to this post from your gut.

OK. That was a pretty heavy post—so fire away in the comments and let's discuss. What do you think of the Geithner Plan?

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