Why Markets Dissed the Geithner Plan

One of the cool things about being Treasury Secretary is that you get your signature on dollar bills, giving them authority, defending their honor. Timothy Geithner's plan to save the struggling banking system probably does the opposite, throwing good money after bad to a banking system struggling under the weight of its own mistakes. The markets don't like it. The Dow dropped 382 points Tuesday while bonds rallied as a port in a continuing storm.'

Mr. Geithner announced a three-point plan to "clean up and strengthen the nation's banks," and made a vague declaration to use "the full resources of the government to help bring down mortgage payments and to help reduce mortgage interest rates." Unfortunately, those are conflicting plans. Hence the markets' skepticism.

The Treasury secretary seems stuck on keeping the banks we have in place. But we don't need zombie banks overstuffed with nonperforming loans -- ask the Japanese.

Mr. Geithner wants to "stress test" banks to see which are worth saving. The market already has. Despite over a trillion in assets, Citigroup is worth a meager $18 billion, Bank of America only $28 billion. The market has already figured out that the banks and their accountants haven't fessed up to bad loans and that their shareholders are toast.

Second, Mr. Geithner wants to use up to $1 trillion to back new car loans, home loans and student loans. That's noble, but incredibly market distorting. Who gets these loans? Will banks be forced to loan to those with bad credit? Who sets loan rates? Doesn't this just set up another credit squeeze when government guarantees are lifted?

What we need are healthy banks with clean balance sheets and enlightened risk assessment to provide consumer and business loans that will generate returns to shareholders. And to this end, Mr. Geithner wants to create a public-private partnership to buy toxic securities off bank balance sheets. This is a truly worthy goal, but I don't think his plan for doing so will work. Banks are more than able to sell these toxic loans today. They just don't like the price.

The first iteration of the Troubled Asset Relief Program (TARP) last year was to buy these bad loans and derivatives. It didn't work. Nothing was bought when it became clear that paying face value was a taxpayer giveaway to banks, but paying market prices for this stuff would cause huge equity write-downs, wiping out banks which would be left with negative equity and effective insolvency.

The next round of TARP injected money onto bank balance sheets first, boosting their equity so they could absorb the write-downs to come when the toxic junk was bought later. It didn't work. The $45 billion to Citi and Bank of America wasn't nearly enough. Instead, $306 billion and $118 billion loan guarantees were extended to cover the bad debt, which unfortunately, the market believes still weighs down banks' balance sheets.

Now with TARP 2.0, renamed a friendly Financial Stability Plan, the idea is to entice private capital to buy these bad loans and derivatives in an effort to set the "market price." But Mr. Geithner hasn't solved the dilemma of banks not wanting to sell and become insolvent. Moreover, no one is going to buy these securities ahead of Mr. Geithner's action with the "full resources of the government" to bring down mortgage payments and reduce mortgage interest rates. Lower mortgage payments means mortgage-backed securities would be worth even less. Six months to a year from now, big banks may still be weak and the ugly "n" word of nationalization will be back.

Mr. Geithner should instead use his "stress test" and nationalize the dead banks via the FDIC -- but only for a day or so.

First, strip out all the toxic assets and put them into a holding tank inside the Treasury. Then inject $300 billion in fresh equity for both Citi and Bank of America. Create 10 billion new shares of each of the companies to replace the old ones. The book value of each share could be $30. Very quickly, a new board of directors should be created and a new management team hired. Here's the tricky part: Who owns the shares? Politics will kill a nationalized bank. So spin them out immediately.

Some $6 trillion in income taxes were paid by individuals in 2006, 2007 and 2008. On a pro-forma basis, send out those 10 billion shares of each bank to taxpayers. They paid for the recapitalization.

Each taxpayer would get about $100 worth of stock for each $1,000 of taxes paid. Of course, each taxpayer has the ability to sell these shares on the open market, maybe at $40, maybe $20, maybe $80. It depends on management, their vision, how much additional capital they are willing to raise, the dividend they declare, etc. Meanwhile, the toxic assets sitting inside the Treasury will have residual value and the proceeds from their eventual sale, I believe, will more than offset the capital injected. That would benefit all citizens, not the managements and shareholders who blew up the banking system in the first place.

Comments

[Bill Herbert:]

This is a good plan - I had thought of something similar myself. That is - make the ownership of the banks inure to the benefit of the public, and perhaps the profits in future years could be used to fund basic education, or give college scholarships to poor kids, instead of buying yachts for crooked CEOs.

I believe it would do wonders to focus current management at all companies if we kicked out every one of these incompetent, self-serving bastards in top management at these banks, and ditto for the boards. They are all a joke if you ask me, and should join the ranks of the unemployed with a big fat ZERO for severance pay. That is what they do to lower level employees - let these creeps see how it feels.

There is not one banking, IB or brokerage exec in America that is not 100% expendable.

Feb 12 06:23 PM

[Duude:]

Sounds good except for the big friggin' elephant in the room. Taking all the toxic assets into the treasury means taxpayers are bringing all that crap onto our own balance sheet. This is just piling on more debt onto our children. You only mentioned two banks. What about the others? If we make a deal with all in distress, we will be adding trillions and trillions onto government ledgers.
If we cherry pick these two, then what? Why is this a wise idea?

Feb 12 06:40 PM

[Aristophanes:]

You can't put the toxic assets inside the Treasury as is,not without setting off international geopolitical alarm bells. That's why the GSE's were not on the government balance sheet, nor are the future obligations of Social Security and Medicare. To do so would wreak havoc with bond markets as the government would be forced to dramatically advance its balance sheet and raise taxes or compel the Fed to print (QE) on a massively inflationary scale.

This may have to happen anyway because a US creditor strike is slowly underway (foreign central bank purchases of the most recent issues were at 38%; a year ago they were almost 60%; foreigners are slowly edging away from the US debt load, not quickly enough to cause a stampede, but just enough to send a frightening message).

Geithner's hands are tied unless the US wants to force the other shoe to drop—the other shoe being the US$ value. He has to slowly unwind at the expense of employment. If he had the courage to nationalize the banks and force massive creditor, equity and bond holder losses, then he'd have courage. His problem? Foreign governments own significant chunks of those bonds and equity and have signalled they will sell US dollars if they are not treated preferentially. At this point, foreigners see little difference between US foreign and US sovereign debt. Just like Iceland.

Feb 12 07:08 PM

[Blueman56:]

How exactly did the shareholders "[blow] up the banking system in the first place"? Simply by owning shares in banks, one is responsible for the meltdown? The top executives, traders, boards of directors, sure. Ordinary shareholders? I don't think so.

Feb 12 07:20 PM

[CAPITALIZER:]

Very insightful reasoning for the market reaction to Geithner plan. These banks should be allowed to fail in a very structured and planned way. We are indeed throwing good money after bad.

Feb 12 07:40 PM

[Just Say Whoa!:]

Unregulated markets creates bubbles and bursts.

We're in a burst right now.

Why?

Too much leverage in CDS (Credit Default Swaps).

Credit Default Swaps became exempt from regulation with the Commodity Futures Modernization Act of 2000, which was also responsible for the Enron loophole.

Who exempted CDS from Regulation?

Republicans.

U.S. Sen. Phil Gramm (R-TX) introduced the Act on behalf of financial industry lobbyists. The Modernization Act was rushed through Congress as a companion bill to the omnibus spending bill, the last day before the Christmas holiday.

Salute!!!!

Feb 12 07:53 PM

[philais:]

Ha! As you quoted...

"Mr. Geithner wants to "stress test" banks to see which are worth saving. "
and...
"Citigroup is worth a meager $18 billion, Bank of America only $28 billion."

Here's a "stress test" Don't bail them out and see who fails and who can make it! These banks are insolvent! Period! It is just that no one can say the words! Oh, we hear things like "to big to fail" ad nausea and the pumping of multi-billions of dollars to shore them up, all against the public's wishes and the true laws of economics.

Feb 12 08:13 PM

[David White:]

Bill Gross suggested that a 3.5% mortgage rate might be necessary to get us out of the current mess we are in. I don't see why a government guaranteed low interest loan program could not be instituted at least for all new purchases. This would effectively decrease the cost to the buyer. For example, you could take out a $500,000 mortgage on a $650,000 home at 5.5% for 30 years or thereabouts today.
payment: $2838.95
total of payments: 1,022,020
total interest: 522,000

If you took out the same loan for a 3.5% interest rate, you would have the following expenses:
payment: 2,245.22
total of payments 808,280
total interest 308,280

You have lowered the final cost to you by over $200,000. Houses would move off the market much more quickly under this circumstance. They would also not have to be devalued. This would have a similar effect to lowering the price of the house by $100,000.
Loans like this could be offered to buyers to help move some of the excess in the housing market off of the books. Loans like this could be offered to people with mortgages with ARM teaser rates, who simply cannot afford the higher rates.

I am unsure of the exact rate that needs to be put in place. This idea does have good points to it though.

Feb 12 08:28 PM

[Sentinel:]

Maybe the markets dissed Geithner because they found out this tidbit I saw over at iTulip.com

www.itulip.com/forums/...

The upshot.....Geithner bought a 1.085 million dollar home in 2002......

then promptly took out 1 million dollars in home equity loans.

THEN.....he sold that home just 2 years later for 1.45 million and bought ANOTHER million dollar home only to take ANOTHER home equity line of 400,000 thousand dollars.

And all his other homes had ARMS that had the potential to increase to 11.25% before he sold them.

My God, we are so COSMICALLY and METAPHYSICALLY SCREWED!!!

Feb 12 08:55 PM

[mwfall:]

the toughest thing to decide is whether the idea in the article is really stupid or really really stupid.

Feb 12 10:37 PM

[Robert D:]

WHAT? He is doing something about it, he has come up with a terrific and original plan that uses govt money to save a system and return value to the taxpayers for being on the hook for calamity.


On Feb 12 04:57 PM levin70 wrote:

> Mr. Kessler
>
> These suggestions have been going around for a while now. Nothing
> new. Here's a suggestion, stop blogging and start acting. Don't like
> the treasury plan, then do something about it. Raise money and take
> over a bank. Run it the right way and show everyone how its done
>
>
> Regards

Feb 12 11:35 PM

[Fracuss:]

How does Kessler figure ".. shareholders who blew up the banking system in the first place.". What did the passive shareholders have to do with it?

Feb 13 12:07 AM

[globalview99:]

Excellent thinking and a viable solution. Just a suggestion on the buy-out of toxic securities and debt. The governement should create a Clearance Exchange Bank (buyer of last resort) by guaranteeing its funding while it sells bonds to the private sector for funding. In a reverse auction, the banks with toxic securities and debt then post a sell price based on Net Present Value (NPV) rather than market price which the Clearance Bank must either accept or reject within 30 days (to enable due diligence). This gets rid of the Mark to Market rule which is the real deal killer. This NPV approach was originally crafted by Paul McWilliams of Next Inning. If rejected, they can either post a new price or write off. Here's the kicker: the banks have six months to either sell toxic assets or write it down based on NPV. The Clearance bank can either hold the assets until maturity or sell it at market price when the asset regains value. This approach of course assumes that in the long term, the economy and real estate will recover.

Feb 13 12:45 AM

[zanardm:]

The more debt the gov runs up, the higher yields rise, and hence interest rates. Therefore this further shuts down the housing market. Why not get debt down, yields down, and hence interest rates down for houses, cars, and consumers in general? Is this too simple a plan to advance and execute?

Feb 13 01:03 AM

[Nikola:]

I have one question, though. "Everyone" thinks Geithner failed to roll out a plan to save the economy. So "everyone" sold their stocks and ran over to buy.... dollars and treasuries.... both of which Geithner is now in charge of.

Who's the crazy one here?

Feb 13 02:21 AM

[Robert D:]

This would only distort the market by subsidizing and encouraging people to buy at above market prices. If house prices continued to slide becuase the true demand was 20% lower, we would create another huge problem. this only works to protect overshooting on the downside. I do not want politicians deciding what the right price level is with my taxes.


On Feb 12 08:28 PM David White wrote:

> Bill Gross suggested that a 3.5% mortgage rate might be necessary
> to get us out of the current mess we are in. I don't see why a government
> guaranteed low interest loan program could not be instituted at least
> for all new purchases. This would effectively decrease the cost to
> the buyer. For example, you could take out a $500,000 mortgage on
> a $650,000 home at 5.5% for 30 years or thereabouts today.
> payment: $2838.95
> total of payments: 1,022,020
> total interest: 522,000
>
> If you took out the same loan for a 3.5% interest rate, you would
> have the following expenses:
> payment: 2,245.22
> total of payments 808,280
> total interest 308,280
>
> You have lowered the final cost to you by over $200,000. Houses would
> move off the market much more quickly under this circumstance. They
> would also not have to be devalued. This would have a similar effect
> to lowering the price of the house by $100,000.
> Loans like this could be offered to buyers to help move some of the
> excess in the housing market off of the books. Loans like this could
> be offered to people with mortgages with ARM teaser rates, who simply
> cannot afford the higher rates.
>
> I am unsure of the exact rate that needs to be put in place. This
> idea does have good points to it though.

Feb 13 04:39 AM

[john s. gordon:]

capitalizer - how do we decide which zombie bank gets sent to the glue factory first, & who makes the decision. ?
> jack

Feb 13 08:28 AM

[Duude:]

The Obama administration is coming out next week with their $50 billion subsidy to homeowners that bought into the overpriced market. Who better to subsidize? New homeowners with a low fixed interest rate, or the original buyer who bought out of greed or stupidity and is now threatening to walk away if he doesn't get part of his original loan reduced? Who is more deserving? Regardless, it looks like Congress is writing up a bill now to allow bankruptcy courts to enact cramdowns as a solution. The ramifications of that 'solution' will be dire for the mortgage market and real estate appreciation going forward.


On Feb 13 04:39 AM Robert D wrote:

> This would only distort the market by subsidizing and encouraging
> people to buy at above market prices. If house prices continued
> to slide becuase the true demand was 20% lower, we would create another
> huge problem. this only works to protect overshooting on the downside.
> I do not want politicians deciding what the right price level is
> with my taxes.

Feb 13 03:06 PM

[philais:]

It is the abnormally low interest rates that made for the current melt down!

David, How about the idea of letting the markets set interest rates instead of the Fed? More of the same is NOT the answer!


On Feb 12 08:28 PM David White wrote:

> Bill Gross suggested that a 3.5% mortgage rate might be necessary
> to get us out of the current mess we are in. I don't see why a government
> guaranteed low interest loan program could not be instituted at least
> for all new purchases. This would effectively decrease the cost to
> the buyer. For example, you could take out a $500,000 mortgage on
> a $650,000 home at 5.5% for 30 years or thereabouts today.
> payment: $2838.95
> total of payments: 1,022,020
> total interest: 522,000
>
> If you took out the same loan for a 3.5% interest rate, you would
> have the following expenses:
> payment: 2,245.22
> total of payments 808,280
> total interest 308,280
>
> You have lowered the final cost to you by over $200,000. Houses would
> move off the market much more quickly under this circumstance. They
> would also not have to be devalued. This would have a similar effect
> to lowering the price of the house by $100,000.
> Loans like this could be offered to buyers to help move some of the
> excess in the housing market off of the books. Loans like this could
> be offered to people with mortgages with ARM teaser rates, who simply
> cannot afford the higher rates.
>
> I am unsure of the exact rate that needs to be put in place. This
> idea does have good points to it though.

Feb 18 03:10 PM

[Chickenpookie:]

Well, you're only 1/3 correct. Add in Predatory lending and ARM's you're getting closer. The third component that no one mentions was the pulling of the rug out from under by the FED raising rates when Bernanke came in without considering how many ARMS were on the edge. If I were to go on, I would mention Chris Dodd, Barney Frank, and on and on, but perhaps the following link might suffice as it's getting late:

tinyurl.com/4qfyov


On Feb 18 03:10 PM philais wrote:

> It is the abnormally low interest rates that made for the current
> melt down!
>
> David, How about the idea of letting the markets set interest rates
> instead of the Fed? More of the same is NOT the answer!

Feb 20 02:40 AM