First Thoughts on the Fed Plan

by: Roger Ehrenberg

Details are sketchy, but my initial "blink" is positive. This plan is not a panacea by any stretch, but is helping to underpin a measure of confidence in the global financial system that didn't exist only a few days ago. That said, we've got a long, long way to go, and after the initial euphoria wears off investors will still be staring at a future laden with fiscal deficits, declining consumer activity and a shell-shocked public that will take a long time to recover.

That said, a few of my thoughts are:

  • Direct investment by the Treasury is smart. Was clearly a necessary step. Focusing initially on the largest and riskiest institutions attacks both systemic issues and market sentiment, the latter of which is critical for the stock market and the real economy to turn around.
  • Raising the FDIC-deposit insurance ceiling is a no-brainer. Directly attacks consumer sentiment.
  • Providing backing for senior unsecured bank debt issuance for a period of three years is also a well-considered move. The LIBOR/Treasury disparity needs to close, and confidence in inter-bank lending needs to be re-built. This is a way to specifically address this issue.

However, let me be clear - we still need a Good Bank/Bad Bank solution. It is not at all clear to me that private capital will rush in simply because the US Treasury has injected capital into these banks. Both the Treasury and the Fed hope this will happen, but I just don't see it. Write-downs on mortgage assets, LBO loans and committed bank lines can easily eat through these injections, putting us back to square one.

I am hoping that the US Government sees this as a first step in a broader restructuring plan, one which encourages on- and off-balance sheet housecleaning, with an emphasis on transparency. This means that bad assets should still be sold to a separate vehicle for warehousing, financing and monetization over an extended period of time. The last thing we need is for bad assets to be inexorably hitting the market, much the way they did in Japan which served to extend their decade-long economic malaise.

We've got to get this right, and the US Government's actions give us a better shot to make this push towards transparency and balance sheet stability a reality.