Markets Plunge Following Geithner's Plan - And That's Not a Bad Thing

Is the Grim Reaper masquerading as Tim Geithner?

That’s the emerging storyline. After President Obama’s Treasury Secretary unveiled a new bank bailout plan that sounded more like a plan to make a plan, the stock market went into an immediate funk. Stocks started to plunge while he was still speaking. The Dow Jones Industrial Average ended the day of Geithner’s debut down 4.6 percent, the worst showing of Obama’s nascent presidency. And the press pilloried the performance:

• “Geithner sinks markets,” declared BreakingViews, the financial Web site.
• “Geithner’s Financing Fiasco,” is how Forbes labeled the plan.
• “Is Tim Geithner Ready for Prime Time?” wondered Larry Kudlow on National Review Online. His answer: “Plunging stocks say no.”

I don’t know if Geithner is up to the job or not. Certainly neither he nor Obama planned to kick off a new and improved bank bailout scheme by thrashing the stock market. Like we need any more drama on Wall Street. If Obama and Geithner thought that a vague, incomplete plan would inspire confidence, they badly underestimated how fragile the markets really are.

But Geithner’s first misstep could end up working in his favor. Here’s why:

It’s not about the stock markets. We’ve gotten into the habit of thinking that the direction of the Dow accurately reflects whether the economy is improving or not. Sometimes it does. But not always.

There are many times when bad news about the economy – like a rise in unemployment – sends the Dow up instead of down, because traders guess that the bad news might give the feds more incentive to take action that could be good for stocks. All that reflects is a short-term belief that stocks might go higher tomorrow than today. It doesn’t say anything about whether the economy is actually getting healthier.

Many of the bailout actions up till now have been driven by the need to reassure the markets. That’s one reason for those familiar, weekend-long emergency meetings between government officials and frantic corporate executives that end with a bailout announcement late on Sunday night: Those meetings were timed - and probably rushed - to come up with some kind of reassuring outcome before the Asian stock markets opened, half a day ahead of New York. God forbid we should start the trading week on a sour note.

But it’s not the government’s job to worry about whether the stock markets go up or down. In a crisis like we’re in, the feds should worry about what will get the economy growing again, give banks a reason to lend, and motivate companies to stop firing and start hiring. Stock values might help gauge whether that’s happening, but they’re an indicator that will rise along with the economy – not a catalyst of growth in themselves.

Merely trying to goose the markets is a sucker’s game. If Geithner and Obama shrug off the markets' reaction to their draft of a plan – and eventually produce some real action - the markets will learn to adapt to them. As they should. But if the process happens in reverse, and the Obama administration starts to pander to what the markets want to hear, there’s no end to the potential misuse of the government’s power.

What’s bad for bank stocks might be good for the economy. If Geither had announced that the government was giving away unlimited funds to solve all of the problems at Citigroup (C) and Bank of America (BAC) and any other troubled bank, the stock markets would have soared. Because the banks would have been off the hook! But does anybody think that’s what Geithner should have announced?

Instead, he basically said that banks seeking bailout money in the future have to prove they’re healthy enough to put it to good use – the “stress test” – and they’ll also have to abide by conditions that are much stricter than before. Investors hate that, because it’s going to be costly and time-consuming for many banks to solve their own problems. It’s so much easier when a rich uncle materializes with a wad of cash to wave away the demons.

Geithner didn’t say what would happen to banks that need a bailout but fail the stress test. That produced the dreaded uncertainty, which always sends Wall Street into paroxysms. Once again, it raises the prospect of “nationalizing” some of the biggest, most important banks, which would wipe out shareholders. Hundreds of smaller banks could fail, taking down those shareholders, too. That’s why financial stocks led the market plunge on Geithner’s big day, with Citigroup falling about 15 percent, and Bank of America about 19 percent.

Obviously that’s a major bummer for bank investors. But for taxpayers, it sounds as if bank-bailout money will be doled out more carefully than before. Nationalizing Citigroup or Bank of America is a dire scenario, but it would stabilize the banks and keep them in business, and it might even help with lending. After the excesses we’ve seen so far, should we really complain about Washington turning a cold shoulder to the worst Wall Street offenders?

The Geithner plan lowers expectations. And they need to be lower. The only market-mover capable of sending stocks upward lately has been the government. That’s not good. Investors have been anticipating an Obama stimulus extravaganza and a reformulated bank-bailout plan for weeks. That’s probably kept stocks at higher levels than they would otherwise have been at, given that other economic news has been relentlessly bad. Is it possible that investors have been overoptimistic about Obama’s ability to boost the economy? Sure is.

We’re all learning to expect less. In his first press conference, Obama basically cautioned Americans not to expect much of an economic recovery until next year, despite his huge stimulus plan. Geithner followed that up by saying that fixing the banks “will cost money, involve risk, and take time.” If you were expecting a quick fix, that kind of language is quite a buzz-kill. But we have to accept that the party’s over before we can start nursing the hangover.

Disclosure: no positions

Comments

[CIK:]

The problem is not the expectations of investors. Given the fragile state of the economy and the US financial system the timing and lack of transparency of the Treasuries statements were simply irresponsible. The markets reaction yesterday is a reflection of the cost of uncertainty. We cannot afford to have chicken little (aka President Obama) running around for a week telling us what we already know (i.e. the dark clouds out there are not going away) only to be followed by Geithner not revealing what we should know (i.e. what's the plan?).


On Feb 11 07:44 AM Tradememe wrote:

> The problem is the expectations of investors. They all think that
> somehow the new Treasury secretary will open his mouth and say some
> magic words and everything will go back to where it was before. I
> guess it takes time for reality to sink in.

Feb 11 08:11 AM

[M-P:]

We all know the government can't really control the economy. We want to believe they can, but it's a complicated mix of factors. There are no silver bullets here. It is well-known, however, that specificity manages expectations and can inspire confidence. Platitudes and bromides only win the buzzword bingo game. I like the stress-test idea - we should do that with goverment as well, including zero-based budgeting. We can't go back to the same old consumerism, negative savings rate, and reckless risk management.

Feb 11 08:22 AM

[Tetrapod:]

Nice Article!
I think you've hit it on the head.

Feb 11 08:26 AM

[ACCOUNTANT:]

i think the market was looking for one or both of two things from Geitner regarding the banking sector, and got neither. It was looking for either some movement to ease the mark-to-market rules (which make absolutely no sense for many of the holdings of financial institutions) or some easing of the equity or liquidity ratios required. Without one of those happening, many banks will not be able to resume normal lending patterns, regardless of what else Washington does - and that will hamper the economy, and that is why the market took a dive yesterday. Don't be surprised to see additional downward movement. I thought we had a floor at about 8000 - am now thinking that floor could move to 7000 or even lower.

Why do i say that mark-to-market makes no sense for financial institutions? Because of the nature of the overwhelming portion of their assets. Mark-to-market takes a current balance sheet approach to valuing assets - if you were to liquidate the business as of today, what could you reasonably expect to receive in value for the assets on your balance sheet? Problem is, banks have many financial assets on their balance sheets that they intend to hold for years, perhaps decades, until maturity. THus, in volatile times, by marking to market, there becomes wild gryrations on the balance sheet and the income statement as the value of those instruments fluctuate up and down. But, does that make sense, if it is the intention and purpose to hold till maturity? No. On those types of holdings, the only time they should be repriced is if there becomes some sort of evidence that the obligor in the investment will be unable to repay in full at maturity. Otherwise they should be carried at cost to avoid the wild gyrations that are taking place in the market.

I see people talking now talking about a $4 trillion hole. Pure BS. EAse the accounting and regulatory rules on the banks so they start lending again, and that hole shrinks to half or less of that number virtually overnight. Right now we are pursuing a self inflicting prophecy.

Feb 11 09:00 AM

[Speedspirit:]

I agree and this article makes some good points. But the spending proposed in the stimulas isnt as drastic as the situation at hand. We all know we are on a precipious of a new "DARK AGE" and putting a bandaid on some goverment branches with hybrid cars and new computers system for health care will not do any good when unemployment reaches 50%. This proposed wait and see how bad 2009 will really be policy will be our downfall. The time to act is NOW!

Feb 11 09:12 AM

[Harry Tuttle:]

Great article!

We have become a society obsessed with the stock market and forgotten that the interests only align over the very long run.

In any case, although Geithner's plan is tougher than I had expected, according to media, he was the dove in a room full of hawks.

In my opinion, the whole thing will be resolved once they go through the bank's books. The emperor has been running around without clothes long enough.

Feb 11 09:33 AM

[kelm:]

What was required was a plan that shows how we get from where we are today to where we have only solvent banks operating in America. That means details, that means failing banks where necessary, that means restructuring. Equity will be wiped out in many cases. It also means there needs to be a timetable for how we get there. That is the definition of a plan to any project manager. Geithner's project is to fix the banking system. We saw none of these elements from him. Forget Wall Streets reaction - I agree, pleasing the street is irrelevant. The important thing is when do we have a solvent banking system again? Our government offered no insight.

We have become Japan.

Feb 11 09:42 AM

[msgijoe:]

The financial sector to date has looked to its own survival, not that of the country's. It does not want taxpayers to know what they have done with Bail-out money. Geithner did not give the financial sector good news yesterday, but I think it was good news for the country. Time will tell. In the meantime, the country will begin to rebuild the regulatory aspects of government that has suffered terribly under the GOP.

Feb 11 09:45 AM

[phaf:]

Nice article.
"That produced the dreaded uncertainty, which... raises the prospect of “nationalizing” some of the biggest, most important banks, which would wipe out shareholders." Weren't they already basically wiped out by the stocks' 80-90% plunge since last year?

Feb 11 10:20 AM

[Larrysyr:]

I think the blaming of mark-to-market rules is a red-herring. The values of the toxic assets have been overstated since day one. They were propped up by undeserved ratings, and the underlying cash flow streams impair them permanently. Even if a bank holds one of these to maturity, they will realize a substantial loss. Not recognizing that loss now is dishonest. If the losses ruin a bank's ability to lend, then we have other tools to address the problem, but suspending accurate valuations only sets us up for worse losses later.

If the market has mis-valued the securities (a dubious argument at best), then there is a potentially profitable trade out there.

What the markets and the country need now is a steady hand on the rudder. After the wild gyrations of last fall, I find the current administration's measured approach refreshing. There is no quick fix.

As commented before, when the market goes up on bad news (because it should prompt government intervention), it should go right back down. There are lots of proper roles for the government to play, but simply propping up private financial markets is not one of them.

Feb 11 10:28 AM

[Heaven, Hel...:]

I agree with the article and that expectations of a magic bullet were unrealistic at best, but what unnerves me the most with the respect to the lack of details is the implication of what is going on "behind the scenes".

Those who are in charge of crafting a Financial Stability Plan are not quite sure how to achieve that stability at this juncture and with the accumulating and accelerating bearish economic data coupled with the now ubiquitous negative feedback loops and arguably, self-fulfilling prophecy tendencies, that is very scary at a time when confidence needs to be restored, or at the very least, its deterioration arrested.

Feb 11 10:34 AM

[antiquary:]

Accountant, your point about mark-to-market is a valid one, but it assumes the market undervalues assets intended to be held for a long time. The point of view taken these days about banks' health is not their long-term profitability, but whether they'll survive at all. Liquidity is the first question about any asset in these illiquid times.

Add to that the fact that allowing the banks to value their own assets encourages asset inflation because so many other things of political and investor-relations significance, like leverage ratios, depend on the balance sheet. It's like getting an appraisal for insurance purposes-- it'll be a bit different than an appraisal for auction purposes, when what you actually want is something much closer to the true market value. We can't let banks control how they appear by oodging their numbers around with creative accounting, equivocation and outright lies; allowing corporations to out-complex regulators is part of how we got into this mess in the first place.

Feb 11 11:10 AM

[coldcut:]

Believe or not, Republicans are in control of this stimulus package. Not saying it's good or bad, just saying it will affect the size and the speed.

www.nytimes.com/2009/0...
www.nytimes.com/2009/0...


On Feb 11 09:12 AM Speedspirit wrote:

> I agree and this article makes some good points. But the spending
> proposed in the stimulas isnt as drastic as the situation at hand.
> We all know we are on a precipious of a new "DARK AGE" and putting
> a bandaid on some goverment branches with hybrid cars and new computers
> system for health care will not do any good when unemployment reaches
> 50%. This proposed wait and see how bad 2009 will really be policy
> will be our downfall. The time to act is NOW!

Feb 11 12:38 PM

[Perry B:]

That was a good article and good comments. I am not an econimic major. Today I am just a rantor, paying a mortgage on a home that has lost 30 percent of it's value. No one said you were guaranteed a profit in real estate. It is a long term investment.
One of my bizarre solutions to this mess is to broaden the use of credit unions where you could buy preffered stocks have a voice in your local union and invest in your local community. If everyone could pull their money out of the existing banks and put the funds into federally backed credit unions. There would be plenty of cash to lend locally, borrow locally and invest in your community.We woiuld then find out how truly strapped the banks are. Would it really hurt your feelings if one of the present financial institutions went broke knowing that your funds were safe in a federally backed Credit union? That you had a voice in? This is over simplistic. But do we need to continue complicating this mess?
I do feel we need a new banking system one that reflects local communities needs with a local community voice. Just like the old day's.
Give a local credit union $10,000 dollars for every registered voter.in his community (which I believe is what this bill is going to cost each registerd voter) and watch the local economy grow.
I do not see this stimulas package helping my community grow. I just see more financial institution greed and control on the table.I hope Obama can hold his ground against this old guard regime. Change does not come without a price and a sacrifice. We owe our children and grand children the return to common sense that made this Nation great.
While I am ranting we should also have an internet site where we could line item this bill with congress. ( No media sound bites please.) Let the powers that be see our side as taxpayers. As well as see the concerns of congress.That is democracy.

Feb 11 12:47 PM

[henarl:]

The truth is ugly and investors don't want to hear it. Obama and Geithner told some truth instead of false reasurance and, like spoiled children, the market threw a tantrum. The problem isn't the markets spoiled reaction but whether the truth continues to get worse, over the entire spectrum, for a long time. One thing investors need to realize is that banks and Wall St. are not the whole market and they need to find better things to invest in.

Feb 11 01:06 PM

[Socialism c...:]

Dems and their EXCESSIVE interference are actually what ruined the housing economy...and their MARXIST "bailout" and "stimulus" plans will bankrupt us for the foreseeable future!!!:

www.thestreet.com/stor...


On Feb 11 09:45 AM msgijoe wrote:

> The financial sector to date has looked to its own survival, not
> that of the country's. It does not want taxpayers to know what they
> have done with Bail-out money. Geithner did not give the financial
> sector good news yesterday, but I think it was good news for the
> country. Time will tell. In the meantime, the country will begin
> to rebuild the regulatory aspects of government that has suffered
> terribly under the GOP.

Feb 11 01:25 PM

[Moon Kil Woong:]

Thank goodness the market is getting acclimated to stupid government stimulus and bailout programs. Hopefully, soon we can have real economic discussions rather than thinking we can solve everything by charging it on the tax bill of our children.

Obama is right that JP Morgan is one of the only big bank worth any salt. When they got $25 billion they loaned out over $100 billion. None of the other banks can say such a thing because they are concerned with covering their bad loans rather than lending. Thus Paulson's attempt to use the bank multiplier effect was a miserable failure.

Instead of getting a multiplier effect to his action he got a fractional effect. For every dollar he stuck in these firms, it resulted in a fraction of it seeping into the market. That is, unless you call paying out billions in executive bank bonuses the type of multiplier effect he was seeking.

We need to fund good banks, not bad banks at this point in time.

Feb 11 09:00 PM

[Kevin Lamson:]

In my view the Stock Market fluctuations, up and/or down, has no correlation what so ever to the acutal underlying value of the stock of a particular company. Nor will the various "bailouts" or "stimulus" packages shore up the stock market prices long term. Government "bailouts" and "stimulus" packages have historically been proven not to work. What has been historically proven is the "bailout" and stimulus" funds end up in the coffers of a very few well heeled and well connected people or entities. This certainly appears to be the case with the 750 Billion Bank bailout bill that was bums rushed on our congress in late 2008 by the Treasury Secretary, Barney Frank and Former President Bush. Despite the fact that polls showed 70% of American's were opposed to that bailout.

Feb 12 01:01 AM

[fa28:]

Geithner is Eddie Haskel's son.

Feb 12 01:09 AM

[CuriousMonkey5:]

Are there any big downsides to those two ideas?


On Feb 11 09:00 AM accountant wrote:

> i think the market was looking for one or both of two things from
> Geitner regarding the banking sector, and got neither. It was looking
> for either some movement to ease the mark-to-market rules (which
> make absolutely no sense for many of the holdings of financial institutions)
> or some easing of the equity or liquidity ratios required. Without
> one of those happening, many banks will not be able to resume normal
> lending patterns, regardless of what else Washington does - and that
> will hamper the economy, and that is why the market took a dive yesterday.
> Don't be surprised to see additional downward movement. I thought
> we had a floor at about 8000 - am now thinking that floor could move
> to 7000 or even lower.
>
> Why do i say that mark-to-market makes no sense for financial institutions?
> Because of the nature of the overwhelming portion of their assets.
> Mark-to-market takes a current balance sheet approach to valuing
> assets - if you were to liquidate the business as of today, what
> could you reasonably expect to receive in value for the assets on
> your balance sheet? Problem is, banks have many financial assets
> on their balance sheets that they intend to hold for years, perhaps
> decades, until maturity. THus, in volatile times, by marking to
> market, there becomes wild gryrations on the balance sheet and the
> income statement as the value of those instruments fluctuate up and
> down. But, does that make sense, if it is the intention and purpose
> to hold till maturity? No. On those types of holdings, the only
> time they should be repriced is if there becomes some sort of evidence
> that the obligor in the investment will be unable to repay in full
> at maturity. Otherwise they should be carried at cost to avoid the
> wild gyrations that are taking place in the market.
>
> I see people talking now talking about a $4 trillion hole. Pure
> BS. EAse the accounting and regulatory rules on the banks so they
> start lending again, and that hole shrinks to half or less of that
> number virtually overnight. Right now we are pursuing a self inflicting
> prophecy.

Feb 12 02:31 AM