Why Geithner's Plan Will Work 12 comments
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Geithner's plan will work because it fixes what is wrong. The pundits and talking heads wasted a lot of everybody's time in personal attacks, citing lack of detail and vagueness and inferring a lack of decisiveness, rather than taking the time to read the fact sheet and consider the implications.
Foreclosures - What drives the current meltdown is the excessive rate of foreclosures. The plan will provide assistance to qualified homeowners, defined as middle class owner-occupants, reducing foreclosures. The upper class is assumed to be able to take care of themselves. The lower class by definition do not own homes. There is a lot of nitty-gritty detail involved in who gets help and it is beyond the scope of an outline to address the issues, which are complex. 50 billion spent here will seriously reduce the overall loss to the economy and financial system.
Troubled Asset Valuation – Nobody knows what the troubled assets are worth because nobody knows the future trajectory of the housing crisis and the economy. First and foremost, addressing foreclosures forcefully will change the trajectory for the better.
What puts a floor of sorts under the troubled assets is the stress test. The assets in question are those that will respond poorly in stress case scenarios. Two banks that are equally well-capitalized under the assumption that the economy will not deteriorate further may not be equal when their assets are stress tested.
The stress test assures that the government deals with the valuation issue only where it becomes a matter of public policy – when assets that respond poorly to stress create systemic risk in banks that are large enough to impact the system.
When combined with reasonable access to capital, the stress test forces and enables management to make responsible decisions about troubled assets.
Access to capital - The convertible preferred capital infusion provides certainty around several key issues. Shareholders will not be unfairly diluted by forced capital raises under a storm of short-selling.
Bank management can now make an informed decision whether to sell troubled assets or hold them until circumstances reveal their true value. The stress test creates a minimum or worst case value. If private buyers will pay more than that price, it makes sense to sell the assets and raise the remainder of the required capital buffer by requesting an infusion. Otherwise, the full amount of the capital would be raised by an infusion.
I tried a few hypothetical examples of what would happen to shareholders in a bank that was trading at well below book value and holding troubled assets. My results suggest that shareholders would ultimately absorb the actual economic losses from troubled assets, but would be protected from the depredations of manipulative short-selling during the process of capital raising.
Withholding of Capital – The private sector has been withholding capital from the financials. Partly this is fear - “smart money” suffered horrible losses on situations such as WaMu. Partly it is greed – the longer troubled assets are left to deteriorate, the greater the chances of huge profits by buying at fire sale prices. As noted, access to capital reduces the power of the dark side. Since the ultimate fire sale is off the table, greed would suggest to all but the most stubborn of the vultures that they participate in creating a market for troubled assets.
The private-public aspect of the plan is troubling to me because I seem to see the government partnering with and financing hedge funds and others who created this problem by collusive and manipulative behavior.
However, from a logical point of view anyone who is willing to bring capital into the financial arena should be supported for the common good. If there were evildoers who contributed to creating this mess, the SEC has authority to research past actions and punish the offenders. It's really a separate issue.
Rating Agencies – We are all familiar with their role in creating the original problem. As of this moment, they are the ones who are doing the stress testing, according to their visions of the future, and issuing destructive downgrades. Who knows what dark vision animates the destructive activities of Moody's?
By establishing their own stress testing criteria, regulators remove the rating agencies from primacy in this area. A good idea, why should they have the power to issue self-fulfilling prophecies of doom?
Systemic risk – A serious deficiency in the prior regulatory regime was the lack of authority over and insight into systemic risk. We have seen the results. The stress testing is a large step in solving this problem. It provides a definition of who is big enough to create systemic risk and it creates a window into that previously inaccessible area.
Summary - The forgoing is sufficient to suggest that the plan is workable. As Geithner said, the issue is not one of ability, it is one of will. We will all be better off if we get behind the plan and make it work.
Stock position: None.
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for me, the devil is in the details.
has our beloved treasury secretary even CONSIDERED the consequences when the foreigners decide not to buy t-bills?
its gonna happen....maybe our beloved president and congress will seek the advice of zimbabwe's gono
Will banks that fail the stress test be allowed to fail?
Will banks be given a second or third chance?
Will banks failing the test be required to sell troubled assets to the new public-private investmment partnership?
How will the toxic assets sold to the public-private partnership be valued?
Will any government guarantees be offered to private investors participating in the public-private investment partnership?
The point behind these questions is to simply underscore the lack of details offered by Geithner. It is a work in progress and a great deal of additional thought must be invested before there can be any hope that it is a viable plan. At this point, it is an outline of a broad policy initiative.
There is one solution- inflate. Not this seemingly fake threat that Bernanke has alluded to, but some real unsterilized Treasury money creation that will provide a long term monetary jolt. Yes, foreigners will wonder about the dollar- they already are, and keep buying. But the productive capacity of the US and all other dollar-denominated producers around the world will more than cover $3 Trillion (not that I'm saying to inject $3 Trillion totally unsterilized- but why not).
Once home values (and many other things) stabilize and start increasing again, confidence in the ability of the market to maintain value will be restored. Anything short of that in the meantime is just triage.
There's a long slog ahead, and I'm glad we're not getting presented with magic solutions.
Assets and all are worth nothing until all of this is sorted out. Some of these assets are now overgrown fields with shells of houses on them that will not be worth 10% of their original sale price for over a decade. Are banks that are currently insolvent going to wait that long for this field to come back to market, or are they going to sell the asset and call in their default swap insurance on it?
Geithner's plan will fail because it cannot price assets. Only a true real estate bottom based on final market value can do that. Anything else is a subsidy, and the markets are seeing that as well.
I appreciate your logical presentation, but I would change one word it the title: Replace "will" with "might". As many commenters have pointed out, Geithner has presented a strategy (broadly based) but few details (tactics). As others have pointed out, lack of detail may have been the best choice for the moment, but lack of detail in the coming weeks will be harmful. As The hand stated: "the devil is in the details."
If the devil remains undefined for a couple of months we will not like the results.
The point about 50 billion vs. 15 trillion is well taken: I would have made a stronger case by quantifying the resources vs. the problem. Many of the foreclosures are either unavoidable or should not prevented due to the conduct of those who borrowed without consideration of whether they could repay. So, perhaps less than half of the foreclosures that would otherwise occur should be prevented. The cost would be less than 20% of the value of the house, otherwise foreclosure should proceed. On that basis and assuming that banks are compelled to pick up half or more of the losses (in their own best interest) 50 billion is in the ballpark.
I agree that inflation is a requirement to make this work but hope it can be kept reasonable.
Aristophanes -
"Excessive" was a poor choice of words. A certain number of foreclosures is normal even in good times, and a larger amount is to be accepted and expected in times of economic stress. But a destructive cascade of foreclosures which destroys asset values and the economy should be resisted with all the tools at government's diposal.
i disagree with your assertion that assets are worth nothing until this is sorted out. The assets involved have values that are being destroyed by a financial regulatory system that exacerbates the normal cycle and is encouraging a financial conflagraton. Geithner has said as much "the financial system works against us," and intends to correct it. He needs to work quickly but should be allowed time to develop a consensus.
John and The Hand - perhaps I should have added some thoughts on how to work out some of the details, but efforts to do so generated a lot of text and a vague feeling of being in over my head.
Probably the strategy and tactics involved need tol be similar to those employed by Grant during the Civil War. He got results but at the expense of a lot of casualties. Many billions of dollars will need to be sacrificed to bring this thing to its end.
Assets are worth nothing if no market will accept them. Try cashing in a Weimar Republic mark now!
This is not different for a CDO. The same for Japanese commercial real estate bonds, some of which anguished……are still languishing! No one wants to admit they lent $100 billion for an asset the market now values at 90% loss. There are staggering amounts of US properties wrapped in CDO's worth pennies on the dollar in a real market where productivity determines buying power, sans over extended leverage.
Simply put, houses will not sell on the market until they closely match real incomes in a severe recession. There is zero chance of revaluation until that happens in a majority of markets. Some of these properties (esp. in CA and FL and AZ) could take over a decade to achieve liveable, community worth. They were as real an investment as fairy dust. Once the value of zero is accounted for in many of these CDO's then there will be a true reckoning.
The "financial system" that Geithner refers to is Wall St.'s fantasy about increasing value via collateralization. Canada has no collateralization products. None. So they can actually measure their real property asset values with no intermediaries, and thr banks hoild the equity and risk. Old fashioned, but it works. Geithner is unwilling to unwind that stupid system and make the system work without Wall St. getting its cut. A subsidized cut at that. Bring back the local S&L!