Reading Between The Lines Of The Geithner Plan

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THE STASH MARCH 23, 2009

Reading Between The Lines Of The Geithner Plan

So, from where I sit, Geithner's second pass at explaining his bank plan has already gone much, much better than the first. (Unlike last time, I actually got into this briefing.) 

The basic plan, as has been well-rehearsed by now, is for the government to provide generous loans to private investors for buying the banks' depressed, mortgage-related assets. A couple things jumped out at me during Geithner's discussion of it with reporters this morning (in chronological order):

1.) In his initial comments, Geithner explained that the "deep anger and outrage, frustration" toward the financial institutions who helped create the mess is "perfectly understandable," and that, if we're going to get through this, the administration will have to "engender more confidence" that taxpayer money is being used effectively.  

2.) When asked what happens if the banks don't want to sell their depressed assets at the prices investors offer them, Geithner suggested the banks would be willing to sell at a loss (relative to their current valuations) just to get the assets off their books and start fresh. "Right now, we don't really have a viable market in which to unload and sell these assets," he said. "But because you're holding onto them, it is harder for banks to generate greater confidence among the creditors and their investors. ... This will make it easier for them to raise capital privately."

3.) When asked about the prospect of more funding from Congress, Geithner said, as he must, that Congress has already provided "substantial resources," but that the administration would "work with the Congress to try to make sure that there are enough resources over time."

4.) When asked which metric we should use to judge the success of the new program, Geithner said the hope is that the price of credit will come down and that its availability will rise. He also said the price of the depressed assets should begin to rise (though it's unclear if the starting point is where the banks value them  now or what private investors are willing to pay now. I suspect the latter.).

Put all four nuggets together and I think you see the outline of a strategy: The banks will want to unload their bad, mortgage-related assets even if they have to sell them at a discount relative to where they currently value them. The banks will do this, assuming the discount isn't too great, because hanging onto the assets is creating uncertainty about the amount of capital they have, and the uncertainty is discouraging them from making loans. (Better to take a small, certain loss and be done with it than to keep facing the prospect of a very large loss later on.) Of course, this will still leave the banks undercapitalized. But, without the prospect of large future losses hanging over them (which the Treasury program will have eliminated), private investors might be more willing to provide banks with capital. More plausibly, having demonstrated to American taxpayers that it can manage something tricky like getting the bad assets off the banks' books, Treasury will find it easier to get more money from Congress to recapitalize them. (It will have "engendered confidence.") 

This sounds like it could work. On the other hand, there are a handful of big assumptions at work here. If they go unfulfilled, it's hard to see how the enterprise gets off the ground: 1.) Would banks really be willing to sell at a slight discount relative to where they currently value the assets? And how big is slight, anyway? 2.) If the banks get the bad assets off their books, will they start lending again? Or will they be too undecapitalized, even if they only sell at a slight discount? 3.) Is uncertainty about mortgage-related assets really what's stopping the private sector from investing in banks? Or is certainty the problem--maybe investors are convinced the banks are in terrible shape and don't want anything to do with them? 4.) How much confidence will Treasury actually instill even if the asset sales go well? Will the average American understand what's going on? Will the average congressman? Will it change his/her perception of the bailout?

I'm open to believing these questions can be answered the right way. But, if I'm being honest, I just don't know.

P.S. If nothing else, the plan proves that the market will reward you for offering investors generous loans. The Dow is up almost 300 points as I write this. One smart Stash reader suggests Treasury take the opportunity to pronounce the market reaction meaningless. I agree--it's an unbelievably crude metric, there are obviously going to be dips in the future, and you're never more credible on this point than when the market's rising.

--Noam Scheiber

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