Two Reasons Why Geithner's Plan Will Fail

1. This plan will not clear the bad debt from the banks' balance sheets. The reason the banks have not sold the so called toxic loans they hold to outside investors is that marking these loans to the actual market price would bankrupt the institutions. The banks’ mark to model is significantly higher than the prevailing market price for these loans. If Geithner’s stress test sets the number at $.80 cents on the dollar for the bank’s CDO and ABS portfolios, no outside investor will buy because this significantly overvalues the securities. If the plan sets a price closer to the price LoanStar paid for Merrill Lynch’s CDO book in August, .22 cent on the dollar, the companies that hold these loans will be declared insolvent. The 2007 vintage penultimate AAA ABX is trading at .37 to .40 cents on the dollar currently according to Markit. Everything AA or less is trading at under .06 cents on the dollar. The banks' only chance for survival is to hold these loans as long as possible, and pray the economy turns up while marking the toxic loans to fantasy land. The treasury is going to allow zombie banks in the US, much like the Japanese did in the 1990’s. Consumer and small business lending will continue to stagnate.

2. The size of the program is too small. $500 billion does not address the issue. Additional bad debt is probably two trillion dollars. This addresses only a quarter of the bad loans. Even when the plan is expanded to one trillion, it does not even come close to filling the whole. It does not provide any additional capital to get the banks lending again. This package is nowhere near big enough to stimulate lending.

This plan is a train wreck, and the stimulus will be highly ineffective. If you were not already short the market in anticipation of another colossal failure by the treasury, the time to get short is now. This plan will be remembered in infamy like the Titanic and the Hindenburg.

Disclosure: Short SPY, IYR, IWO, KIE Long FXP and EEV

Comments

[herbert hoover:]

That didn't take long. It might make more sense to wait until there is a plan before you start dissing it.

Feb 11 08:46 AM

[scfranklin94:]

Agreed; no real change from Paulson. Basically this plan will keep the banks alive, but the bad debt stays, so the banks will still be insolvent for years to come. If this is the extent of the Treasury's plans, then Obama and the country will still be dealing with either a recession or stagnant growth in 2012.

Feb 11 09:21 AM

[PROXIMO:]

Thanks for the article--details, to the point, useful information. Please continue posting on SA.

Feb 11 10:01 AM

[Fabien Hug:]

The only plan now is to keep the banks alive to avoid a collapse of the financial markets. Now, I don't see the point for the gvmt. to put itself more into debts to re start the economy. Trying to really stimulate the economy with credit, hoping that the growth so generated will allow to pay back the loans, doesn't work. This situation is the proof of it.
I mean, when you buy a car on credit, the time you start the engine, 25% of your "asset" value is gone. What a great deal!
Only time will really restart an economy with a sure footing. In the meantime it is important to avoid another crash in assets value that would follow a total collapse of one or more big bank.

Feb 11 12:13 PM

[Midwest:]

Well stated article and a clear headed outline.

As fabien_hug noted, this economy will only get better when some time has passed. "Restarting the economy" is a non-starter. It won't work as too much money is needed to fill hole.

The bad loans must be allowed to be reset to their present market value and that can be done via government purchase of the toxic loans or through extensive bank failures. Take your pick.

I don't like the bailout plan any more than I like bank failures but I know that we cannot allow the downward spiral of layoffs to continue. Failed banks will lead to even more businesses closing and more mass layoffs.

If the American consumer is pushed any farther to the edge, this economy will face a drop off not seen since the 30s or far, far worse. With two thirds of the economy's power coming from consumer spending, we cannot underestimate the importance of keeping the middle class supported and feeling optimistic about their future.

With China reporting a staggering 17.5% percent drop in January over January exports, the reality of a worldwide depression is getting closer and closer. Congress must act to lower taxes on the middle class and to reward companies that do not layoff their people.

Any bailout plan that does not include those provisions is doomed to failure and to likely line the pockets of the Wall Street thieves that got us into this spot in the first place.

Feb 11 01:17 PM

[Did U Think...:]

How about the obvious: you can't patch a busted dam with water and promises. Geithner thinks everyone is a fool and so does Bernanke. Turns out that the market is getting really savvy, really quickly.

The Ponzi scheme is going bust.

Feb 12 12:12 AM

[Mr. Ed, Jr.:]

Amen

Feb 12 12:44 AM

[ddavid:]

There's too much pork in this stimulus plan. I can't see how money allocated (such as) for space exploration will help the consumer drive the economy again.
IRS data shows 57% of American Corporation haven't paid any taxes for the past 5 years (IRS chart only showed 5 years). In the meantime States are raising taxes from License fees to sales taxes, to property taxes - (myself, just today, got notice the trash pick-up is going up 10% and water another 8%. Obama also raised taxes for "SCHIP" breaking his campaign promise. ..... if, and if any stimulus will reach the consumer then it will just be a zero sum game. I see the stimulus package going down another rat hole going nowhere.

Feb 12 07:35 AM